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Paying Their ‘Fair Share’ of Tax: How Do Multinationals and Governments React to Tax Reform?

Paying Their ‘Fair Share’ of Tax: How Do Multinationals and Governments React to Tax Reform?. State Bar of Michigan: International Section. March 21, 2018. Overview. What is transfer pricing and why is it important to tax reform discussions?

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Paying Their ‘Fair Share’ of Tax: How Do Multinationals and Governments React to Tax Reform?

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  1. Paying Their ‘Fair Share’ of Tax: How Do Multinationals and Governments React to Tax Reform? State Bar of Michigan: International Section March 21, 2018

  2. Overview • What is transfer pricing and why is it important to tax reform discussions? • Which multinational companies affected by tax reform? • Who benefits from lower US tax rates? Who loses? Who isn’t sure? • How could other governments react? • Looking to the future

  3. Transfer Pricing – Why Now? “Apple wasn't satisfied with shifting its profits to a low-tax offshore tax haven. Apple successfully sought the holy grail of tax avoidance.” • - Senator Carl Levin, (D-MI) • May, 20, 2013

  4. German auditor challenges when cross-border parts prices are too low IRS challenges if the transfer prices are too high Transfer Pricing Dilemma for All Multinationals German manufacturer plant Auto parts Retailers U.S. distributor subsidiary German tax payable 30% of $X U.S. tax payable was 35% of $Y now 21% of $Y (2018)

  5. Assume a total taxable income adjustment of $10M (prior to 2018) Additional income tax owed - $10M x 35%= $3.5M Plus non-deductible penalties of 20% $700,000 $4.2M+interest+ US state taxes+potentialdoubletax penalties start at $5M tax rate falls to 21% starting in 2018 What if the IRS Concludes Transfer Pricing is Wrong?

  6. Big Picture Transfer Pricing Goal – multinationals pay their fair share of income taxes in every country • Rules apply to cross-border prices for goods, services, royalties and loans • Fortunately, principles are broadly similar on a global basis (OECD Guidelines) • “Arm’s-Length Standard” Heartburn - Two tax authorities can audit the same transaction

  7. Transfer Pricing – Why Now? Governments have few options when addressing budget deficits: • Raise taxes • Reduce expenditures for public services An alterative: audit multinationals to pay their ‘fair share’ of tax • Over 100 countries have transfer pricing rules in place

  8. Transfer Pricing – Why Now? Who has transfer pricing issues? • All multinationals - large or small • US company expanding to Canada/Mexico or anywhere • Foreign companies with a subsidiary anywhere in the U.S. or overseas All of these companies can be audited for not paying their ‘fair share’

  9. Governments React to Profit-Shifting • Outrage over aggressive planning sparked a global response by tax authorities • Organisation of Economic Co-Operation and Development (OECD) • Base Erosion and Profit Shifting (BEPS) Program to target profit shifting • Governments worldwide have raised disclosure and documentation standards • 15 “Actions” under the BEPS program

  10. What Does Tax Reform Do? Previously, companies tried to minimize their tax footprint in the US at 35% • Complicated international tax structures to park profits in low-tax jurisdictions Tax reform intended to encourage more investment in the US at a 21% rate • ‘Territorial’ Tax System, rather than ‘Worldwide’ System of Taxation • Carrots-and-Sticks to discourage movement to even lower-tax jurisdictions High state taxes (California, New York) may still discourage investments

  11. What Are Multinationals Doing Now? Transfer pricing documentation • Detailed analysis of how business operates • Economic analysis to demonstrate why transfer pricing is correct • Defend against audits and penalty protection • IRS and other tax authorities request documentation under audit

  12. What Are Multinationals Doing Now? Lower tax rate and ‘territorial’ system changes the dynamic for tax planning • Consider correcting transfer pricing if facts warrant • e.g. new US R&D activities = higher royalty rates charged to subsidiaries • Goal - more income at a lower US tax rate • Additional deductions in high tax countries

  13. Storms on the Horizon • Overseas governments concerned about companies shifting profits to the US • Potential challenges under World Trade Organization rules – illegal subsidies? • New ‘Nexus’ standards for taxing moreinternet sales • Aggressive interpretations of transferpricing rules • More tax enforcement = additional uncertainty for multinational companies • Can governments resolve double tax disputes?

  14. Summary • Tax reform is a welcome change for multinationals with US operations • Incentivizes investments in the US, but ‘devil in the details’ • Expect countermeasures from other countries to protect their tax base • Transfer pricing audits are a high return on investment

  15. Contact Details Alex Martin, Principal – Transfer Pricing amartin@claytonmckervey.com | +1 248.936.9472   Clayton & McKervey 2000 Town Center, Suite 1800 | Southfield, Michigan 48075 USA ClaytonMcKervey.com ClaytonMckervey.com/author/alex-martin/ blog.ClaytonMckervey.com/blog/tag/transfer-pricing/

  16. Thanks for attending.

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