A new administration in the White House and renewed consideration of U.S. corporate tax reform may not have taxpayers thinking about transfer pricing. And yet, the consideration of a border tax adjustment on goods imported into the United States may persuade multinational businesses, particularly manufacturers, distributors, and retailers, to reevaluate their intercompany supply chain—which has U.S. and international transfer-pricing implications.
For example, automobile giants such as Fiat Chrysler, Ford, and Toyota have announced billion-dollar plans to build plants or grow their existing operations in the United States. Retailers such as Target and Walmart and other companies that rely on imported goods and materials in their supply chain have suggested that a border tax adjustment could increase their costs to the point of eroding profit margins. The proposed border tax adjustment comes on the heels of the Organisation for Economic Co-operation and Development's (OECD's) base erosion and profit shifting (BEPS) guidelines and a global movement for transfer-pricing reform, and adds yet another layer to the global discussion of keeping taxable profits (and losses) where value is created.
Serious discussion of a border tax adjustment began last year with A Better Way: A Pro-Growth Tax Code for All Americans (Better Way Plan), the House Republicans' proposal for tax reform, released in June 2016. The Better Way Plan proposes many changes related to corporate taxation, including: (1) lowering the corporate tax rate from 35% to 20%; (2) taxing businesses on activity conducted in the United States and not on worldwide income (also known as a territorial system); and (3) establishing a border adjustment, where deductions are limited by the costs of imported inputs for goods and services sold in the United States.
The proposed reforms are intended to lower the corporate tax rate significantly and allow businesses to not pay taxes on profits earned overseas, even when those profits are brought back to the United States (currently, profits earned by U.S. companies overseas are taxed only when they are repatriated to the United States). The potential limitation on deductions associated with imports means that companies that purchase their goods from outside of the United States would pay higher taxes related to those activities (fewer deductions would increase the income base to which taxes are applied). On the other hand, companies that receive their goods from U.S. suppliers can deduct a greater portion of those costs from their taxable income. These U.S.-sourcing companies would then have the advantage over those that import, in that even when they pay higher costs of goods sold, the U.S.-sourcing companies could possibly pay less in taxes and earn an overall greater net income than companies that import their goods sold.
Because of the many possible effects on the pricing of goods and services coming into and going out of the United States, it is unclear how beneficial a border tax adjustment would be and which companies would benefit. Despite the ambiguity, it is already clear that companies will be looking at this issue closely. Like large automotive companies, multinational businesses may make changes to their value chain as a result of the passage of a U.S. border tax adjustment. In such a scenario, these businesses will look toward transfer-pricing experts who can help with pricing objectives and policies that are supportable and defensible in harmonization with the new tax objectives—import pricing and greater integration of U.S. operations.
Value chain and BEPS
As taxpayers with global operations may well know, the OECD released 15 action items on preventing BEPS in October 2015. Those action items are a product of the increasing emphasis by global tax authorities on tax-avoidance strategies to move profits from high-tax jurisdictions to low- or no-tax jurisdictions. Four of these action items provide guidance related to transfer pricing. The IRS also released regulations for a country-by-country reporting form that is in line with BEPS, adding to the robust transfer-pricing regulations that are already in place. The main underlying idea for all of these regulations and guidelines is that profits (or losses) must follow functions and risks. An entity that performs high-value-adding activities or undertakes significant risks for its corporate group should earn the profits (or bear the losses) associated with those functions and risks.
The proposed border tax adjustment thus comes into play with its potential to encourage businesses to make changes to their value chain and relocate their operations and investments. Furthermore, these companies' suppliers may follow suit to avoid the tax, to keep their operations close to their customers and to promote cost efficiencies.
In deciding whether to move operations in a post-BEPS world, a company should take a comprehensive approach to transfer pricing through value-chain analyses that take into account the function and risk profile of the entire organization, to ensure that key value drivers are properly aligned within the organization. If there are changes to companies' value chains in terms of where functions are performed or risks are assumed, these companies must ensure that the profits (or losses) of each entity follow suit. Specifically, these entities will need to earn or pay the arm's-length price for any intercompany exchange of goods or services.
In addition, both the U.S. transfer-pricing regulations under Sec. 482 and the OECD Transfer Pricing Guidelines on transfer-pricing documentation require that companies provide an explanation of their group's value chain in transfer-pricing documentation. Therefore, not only is it important for a business to conduct value-chain analyses before making operational changes, but also these changes should be followed by proper documentation that is transparent and complies with U.S. and foreign transfer-pricing laws. Transfer-pricing professionals can assist with each of these issues, whether they arise from a border tax adjustment or from operating one's business post-BEPS.
Kevin Anderson is a partner, National Tax Office, with BDO USA LLP in Washington.
For additional information about these items, contact Mr. Anderson at 202-644-5413 or firstname.lastname@example.org.
Unless otherwise noted, contributors are members of or associated with BDO USA LLP.