United States: As Tax Rules Shift, Companies Need Flexible Structures And Strategies

Technology companies with international operations are increasingly using global tax avoidance methods, despite growing opposition from the public and politicians in the U.S. and abroad. As this opposition fuels ongoing changes in tax rules, organizations must be able to quickly adapt their corporate structures and tax strategies to maintain a tax advantage.

Tax rules are a moving target

Businesses have a duty to their shareholders to legally minimize their corporate tax bill, and companies have been using international tax strategies at a growing rate. A Bloomberg News analysis of 307 companies in the S&P 500 index found that they accumulated $1.95 trillion in offshore profits in 2013, up 11.8% from the year before. (The analysis didn’t include purely domestic corporations, those that don’t disclose offshore holdings, those headquartered outside the U.S. and real estate investment trusts that aren’t subject to corporate taxes.)

The rules companies use to minimize taxes are an ever-shifting target for a number of reasons. Governments are looking for ways to boost their tax revenues; there is a growing public outcry against corporate loopholes in the U.S. and overseas; and countries with high corporate tax rates are pressuring tax haven countries, such as Ireland, to eliminate what they see as unfair tax breaks. At the same time, some jurisdictions provide tax incentives to attract business. All these forces have led to an ongoing array of rule changes, many aimed at technology and pharmaceutical/nutraceutical companies.

Ireland is one example of how the tax landscape can shift. In October 2014, the country did away with the “Double Irish” provision―one of its most contentious tax loopholes. The provision had allowed companies to send royalty payments for intellectual property (IP) from one Irish-registered subsidiary to another that is registered in Ireland but resides for tax purposes in a country with no corporate income tax. As Ireland closed this loophole, however, it opened another one by expanding tax breaks for profits earned on IP. These expanded tax breaks are meant to keep Ireland an attractive home for business while the country prepares yet another, longer-term set of tax regulations.

New rules also are in the works elsewhere. The Organization for Economic Cooperation and Development (OECD) is working on global regulatory guidelines intended to curb aggressive tax avoidance, and individual countries are making their own changes.

For example, the U.S. Treasury Department in September 2014 released new regulations aimed at curbing corporate tax inversions, a legal but much-maligned practice in which a U.S.-based company merges with a foreign company in a lower-tax country and relocates its headquarters there to decrease its tax rate. Then in December, U.K. legislators announced a new 25% “diverted profits” tax for multinational companies that use international tax laws to avoid paying corporate tax.

Some common tax strategies

Technology companies with global operations have adopted a wide range of complex tax minimization strategies, many of which use international legal entities located in jurisdictions with low tax rates. Common strategies include:
• Transfer pricing – Subsidiaries sell each other goods or services, allowing the company to book profits in a lower tax jurisdiction and book expenses where taxes are higher. (The prices must be realistic and comparable to what an unrelated customer would pay.)
• M&A – Inversions are one high-profile M&A tactic. Another technique involves acquiring the assets of a company with net operating losses to apply the tax benefit. In addition, many technology businesses are buying operational foreign companies in order to become more vertically integrated. Such acquisitions can allow companies to minimize or bypass tax liability for the purchase/sale of goods as well as tariffs associated with import/export. This also allows them to book a sale in one country and have it fulfilled by a subsidiary in another jurisdiction.
• Licensing agreements – Companies redistribute income by transferring IP or other assets to an international subsidiary and charging licensing fees.
• Expense allocation – Companies are allocating payroll and other expenses in order to use government-funded R&D grants and other incentives offered by local jurisdictions.
• Corporate restructuring – Businesses are reconfiguring their organizational structure, often every year or two, to maximize their tax credits and incentives as credits are used up and regulations change.

ERP Systems Must Provide Flexibility

To stay competitive, technology companies need to closely monitor the tax climate and adjust their structure and tax strategies as needed. So they must make sure their ERP system can support complex strategies and provide a high degree of flexibility. For example, companies that want to use a foreign entity to manage R&D need robust product management capabilities to handle configuration, approval, and release of items and bills of materials for engineering in their respective entities.

The ERP system also has to be powerful enough to give decision makers visibility into activities and key metrics across the web of entities. A COO may need visibility into production activities across multiple entities, for instance, or a CFO may need to monitor billings, bookings and backlog thresholds for sales across the organization.

A good system can keep pace with frequent changes and help the business implement them faster and more smoothly. For example, a company may acquire an operational foreign subsidiary and use it to fulfill orders booked by a sales subsidiary in another country. An ERP system can ensure that intercompany drop shipments run seamlessly―from order taking, to transfer pricing, to fulfillment.

More Change Is Certain

These are just some of the complex tax minimization tools used by technology businesses. As the regulatory landscape continues to shift, we’re sure to see new methods evolve. To maintain a tax advantage, companies need to be ready to react and implement new strategies, whatever they may be.