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Allocation of headquarter expenses

Allocation of headquarter expenses. Tax issues Dmitry Alimov Tax manager Russia/CIS General Electric American Chamber of Commerce, Tax Conference 29 October 2008. Incurs costs: Salaries Rent 3 rd party services Etc. HQ. Reimbursement of costs. Group member. Group member.

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Allocation of headquarter expenses

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  1. Allocation of headquarter expenses Taxissues Dmitry Alimov Tax manager Russia/CIS General Electric American Chamber of Commerce, Tax Conference 29 October 2008

  2. Incurs costs: • Salaries • Rent • 3rd party services • Etc. HQ Reimbursement of costs Group member Group member Group member The topic Management services Cost contribution arrangements Cost-sharing • HQ costs allocation Intra-group services No or low sales revenue

  3. Types of services • Relating to more than one • member of the group (indirect services) • Management • Marketing • HR • Finance • Legal • Quality • Meeting a need of a specific member (direct services) • Research & Development • Obtaining 3rd party services • Training • IT

  4. OECD approach • 2 main issues: • Whether the services have been rendered, i.e. would an independent company acquire such services in similar circumstances • Direct services • Indirect services • ‘On call’ services • Stewardship activities • Determining an arm’s length charge for such services • Which allocation method to use • Which TP methodology to use: CUP, cost+, others? OECD covers many common situations and is a valuable guidance

  5. Russian reality • No cost-reimbursement concept – only services  service agreement, service fee, acts of acceptance etc. • Tax Code in general allows deduction of management services expenses • However general provisions of expenses deductibility require them to be: • Economically justified, i.e. aimed at income generation • Properly documented • Transfer pricing provisions also apply, because this is an intercompany transaction and/or cross-border transaction Generally, Russian issues are close to those determined by OECD, BUT Together with de facto applied presumption of guilt, form over substance approach, lack of guidance this leads to significant tax risks for all MNCs operating in Russia

  6. Economical justification/Documentary support • Duplication of functions with in-house team • Usually there is local HR, legal, finance, management, marketing teams. Paying to HQ for essentially same services is not economically justified Relevance to income generation • Global policies, procedures, GAAP/IAS accounting do not contribute to Russian income Fact of provision of services • In general, services are provided under request of the customer relating to particular need. Absence of such requests can mean that there was no need and services did not relate to Russia • In general, there should be some result of services (report, meeting, work performed etc.) Lack of clear relevance to the local entity (at least Russia) or absence of such result of services can mean that no services has been provided Service contract must be in place

  7. Service charge determination • Allocation method • Should be the same globally • Use of allocation keys does not clearly fall under regular service contract • Year-end true up does not fully fit under regular service Service fee determination • CUP • Hard to apply it worldwide • Fee can be too high (if compared to Big 4, for instance) • Hard to compare internal HQ service with 3rd party service • Cost plus • Which “plus” is OK? • Should there be “plus” at all?

  8. Challenging economical substance is easier and more beneficial for authorities Risks • Fee level • Challenge CUP/ Cost+ • Challenge the allocation key • Challenge the level of HQ costs • Risks • Profit tax and VAT for the challenged amount • Economical substance • Challenge the fact of services • Duplication of services • Documentary support • Risks • Denial of expense in full • 2 ways to deny HQ allocations

  9. Challenges • If poorly structured may lead to double taxation: costs deduction in HQ, fee deduction in group entities • OECD TP Guidelines also do not give answers to all questions • Direct services are easier to adjust to Russian requirements, but regular payment for ‘on call’ services availability is still an issue • Cost-contribution arrangements are also not known to Russian law • Easily could be used for tax evasion The problems arise mainly due to trying to fit cost sharing into the frames of service arrangement

  10. To do • Educate tax authorities and judges • Use OECD experience • Develop draft legislation • Promote the idea of cost sharing HQ costs allocation is not tax evasion!

  11. Questions?

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