Intra-group service charges – are your group’s processes up to date?
Tax Alert - June 2021
By Bart de Gouw, Julian Bryant and Georgia Fsadni
Intra-group service charges are commonplace but an often overlooked area of transfer pricing. Most cross- border charges are for relatively routine activities and calculations simply rolled forward from one year to the next. We set out in the article a word of caution on the approach of simply rolling forward calculations. The reasons for this caution include:
- Increased tax authority scrutiny of management fees;
- Increasingly digital, borderless and remote business models;
- Changing of Inland Revenue and OECD guidance on routine service charges and high-value services;
- Abnormal costs incurred during the COVID-19 pandemic;
- Impact of government COVID-19 subsidies on service fee calculations.
In a cross-border context, transfer pricing rules generally require an arm’s length charge to be made for intra-group services. As the particular business context in respect of which services are performed may change from year to year, and the rules and guidance in this area evolve, it is important to regularly revisit the internal processes applied to ensure that tax rules are complied with. We have described below a number of current considerations and frequently seen issues in this area.
Increased Inland Revenue scrutiny
Inland Revenue’s 2020 International Questionnaire contained a new requirement to disclose the amount of management fees and service charges paid to non-resident associated persons, suggesting a current Inland Revenue focus in this space.
Are all services being appropriately identified?
As digital and “borderless” business models and remote working become more commonplace, the scope of employee roles may change, expand, or cover wider geographies. There are also increasing trends towards centralisation of key activities. It is therefore important to review transfer pricing policies regularly and ensure that all intra-group services are appropriately identified each year. Relevant activities may include:
- A head office providing support to subsidiaries, such as management, administrative, and technology support.
- An employee of one subsidiary assisting with projects of another subsidiary.
- An employee of a remote subsidiary fulfilling an important headquarters role, or engaging in other group-wide matters.
In the context of remote workers choosing to be situated in a new location different to their historical place of work, wider tax issues may also arise as covered in previous Tax Alert articles.
Are intra-group charges being made on an appropriate basis?
Under transfer pricing rules, it is necessary to support the arm’s length nature of charges made through the application of an appropriate transfer pricing method. The methodology applied should generally also be documented.
In the context of routine services, the mechanism applied to calculate a service fee is commonly based on the relevant costs incurred plus an arm’s length mark-up. Issues to consider include:
- Have all relevant costs been included? A reasonable allocation of indirect costs should generally be included, such as office overheads, depreciation, etc.
- Has an appropriate mark-up been applied? Generally, transfer pricing rules require a benchmarking exercise to be undertaken in order to determine the pricing that would be applied in an arm’s length context. There is guidance and simplification measures that can apply, depending on the value of the services. This is discussed further below.
- Where services are performed for the benefit of multiple group entities, have service fees been charged to each entity on a reasonable basis, proportionate to the level of benefit received? Depending on the nature of the service, a particular allocation key such as revenue or headcount may be appropriate.
Do the transfer pricing approaches adopted reflect the “value” of the services?
To limit taxpayer compliance costs, the Organization for Economic Cooperation and Development (OECD) has previously introduced an elective, simplified approach for pricing low value-adding intra-group services. Qualifying services (being services which are supportive in nature, not part of the core business activity and do not involve unique and valuable intangibles or the assumption of or control of significant risk by the service provider) may be priced at cost plus a 5% mark-up without the need to undertake benchmarking analysis (see further in a previous Tax Alert article). This approach was initially adopted by Inland Revenue with a NZ$1 million total cost threshold, but this threshold has been removed for income years commencing after 1 April 2021. The removal of the threshold is favourable and will allow larger service transactions to be dealt with in way consistent with the OECD guidelines. It should be noted that the applicable rules in any counter-party jurisdiction would also need to be considered, as these may differ from New Zealand’s approach.
Where services are not “low value” qualifying services per the guidance, further consideration is needed in relation to the appropriate mark-up to be applied. Furthermore, to the extent that services relate to important strategic or risk management functions (e.g., the activities of the group CEO based in a different location to the group’s headquarters), special care would need to be taken to ensure that the pricing approach appropriately reflects the value of activities performed. In some circumstances, it may be appropriate for such high value services to be remunerated through a sharing of profits and losses of the group, rather than charging a routine service fee based on costs incurred. High value services can be complex and require careful analysis.
Are any abnormal features factored appropriately?
During periods impacted by the COVID-19 pandemic, there may be various changes to the nature and magnitude of costs incurred by group entities. If costs are incurred relating to business disruptions and/or changes to working models, it would be necessary to consider whether and how such costs relate to any services under consideration, and how they should be treated in calculating service fees. Furthermore, special care should be taken in the context of government assistance programmes (for example the wage subsidy), which, depending on the accounting treatment applied, may impact the level of net employee costs recorded in entity accounts, and potentially distort service fee calculations (see further in a previous Tax Alert article).
If you would like to discuss the above with us, or require any assistance with reviewing service charge methodologies in your group, please contact the Deloitte transfer pricing team.
June 2021 Tax Alert contents
- New business continuity test – Inland Revenue releases guidance
- Intra-group service charges – are your group’s processes up to date?
- The wage subsidy debate continues… over a year on, was the scheme a success? And are you safe from audit?
- Advantage sports: being a team player can reduce your tax bill
- Are your records up to standard?
- Mileage reimbursement rates – what you need to know
- Snapshot of recent developments