European firms could fall foul of transfer-pricing plan

The Republican tax bill unveiled last week in the US Congress could disrupt the global supply chains of large, multinational companies by slapping a 20% tax on cross-border transactions they routinely make between related business units.

European multinationals, some of which currently pay little US tax on US profits thanks to tax treaties and diversion of US earnings to their home countries or other low-tax jurisdictions, could be especially hard hit if the proposed tax becomes law, according to some tax experts.

Others said the proposal could run afoul of international tax treaties, the World Trade Organisation and other global standards that forbid the double taxation of profits if the new tax did not account for income taxes paid in other countries.

The proposed tax, tucked deep in the 429-page bill backed by US President Donald Trump, caught corporate tax strategists by surprise and sent them scrambling to understand its dynamics and goals, as well as whether Congress is likely ever to vote on it.

Reuters contacted seven multinational companies and four industry groups. None would comment directly on the proposal, with most saying they were still studying the entire tax package.

The proposal is part of a broad tax reform bill unveiled by House of Representatives Republicans, which promises to lower overall tax burdens and simplify the tax code.

Whether the proposed reforms ever become law is uncertain, with weeks and possibly months of debate and intense lobbying still ahead. The package overall has drawn criticism for adding too much to the federal budget deficit and too heavily favouring the rich and big business.

However, the corporate tax part, experts said, included some ambitious proposals worthy of further discussion. They said the 20% excise tax is one such proposal targeting the abuses of so-called transfer-pricing where multinationals themselves set prices of goods, services and intellectual property rights that constantly move between their national business units. Under global standards, those prices should resemble those available on the open market.

However, if a foreign parent charges US affiliates inflated prices, it can reduce its US tax bill and effectively shift profits to a lower-tax country, reducing the entire corporation’s overall tax costs. “Clearly there’s a transfer-pricing issue and something should be done,” said Steven Rosenthal, senior fellow at the Tax Policy Center, a non-partisan Washington think tank.

“I would view this 20% excise tax as a blunt instrument to address the problem. And the problem with blunt instruments is sometimes they hit what you want to hit, and sometimes they hit what you don’t want to hit,” said Mr Rosenthal, a former legislation counsel at Congress’s Joint Tax Committee.

Under the proposal, US business units that import products, pay royalties or other tax-deductible, non-interest fees to foreign parents or affiliates in the course of doing business would either pay a 20% tax on these or agree to treat the amounts as income connected to their US business and subject to US taxes.

As proposed, the new tax rule would apply only to businesses with payments from US units to foreign affiliates exceeding $100m (€86m). The rule would not take effect until after 2018.

European companies that sell foreign-made products into the US market through local distribution units could be among those most affected, said Michael Mundaca, co-director of the national tax department at the accounting firm Ernst & Young.

Such companies could end up paying tax on the transfers twice — first if they paid the excise tax in the US and then at home where they are taxed now and where the new US tax would not be accounted for without changes to bilateral tax treaties.

“That would be a structure that would at least initially be hit by the full force” of the excise tax, said Mr Mundaca, a former US Treasury Department assistant secretary for tax policy.

He said European officials would be registering concern.

“I am sure they are making calls right now to their counterparts in the US Treasury looking for some explanation… and making the point that this might be contrary to treaty obligations.”

Reuters



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