Stephen C. Fox, CPA
U.S. International Tax
Stephen C. Fox, CPA, CMA
PO Box 880695
Port Saint Lucie,  FL  34988
+1(973) 610-5669
   International Tax      Transfer Pricing      Shared Services

Shared Services Costs

Shared Services Costs

 

International tax planning for mid-market multinationals can reduce risk of IRS audit and save taxes at the same time.  A key component of this planning is charging subsidiaries for shared services costs.  This requires proper contracts and yearly analysis.  The foreign subsidiaries get local tax deductions, and transfer pricing risks are reduced in both jurisdictions.

 

Nearly all company groups with foreign operations incur costs in one place that benefit another part of the group.  Big companies centralize the activities and costs in shared services centers.  Where the costs are trivial, tax authorities do not care where they are incurred or who benefits.  But if the costs are non-trivial, the tax authority where the costs are incurred will want a bigger piece of the profits.  Tax authorities may adjust prices charged, or not charged, under transfer pricing rules.  The IRS has specific authority to adjust intercompany prices under IRC section 482.  Where companies perform services for affiliates, or benefit from such services, the IRS may adjust prices charged or impute a charge under Reg. §1.482-9.

 

Example:  Smith Mfg. makes stuff in the U.S. and sells it worldwide. Smith has a Netherlands distribution subsidiary that sells the stuff in Europe.  Smith U.S. runs the centralized computer system, sets human resources policies, devises advertising campaigns and marketing strategies, contracts with a security firm, and hires lawyers as needed.  All of these functions benefit Smith Europe, as well as Smith U.S. and other business units.

 

If the IRS audits Smith, it will likely make Smith U.S. pick up income as if it had charged Smith Europe for a portion of these costs.  If Smith U.S. then tries to bill Smith Europe for this IRS adjustment, the Netherlands tax authority will say, “No way!  Deduction denied.”  If the foreign company pays the bill, some tax authorities (like Canadian Revenue Authority) will even charge a withholding tax.

 

There is a solution, and it works consistently.

 

Smith can determine what costs benefit each business unit individually, and the company incurring the costs can charge the unit that has the benefit.  Also, Smith can analyze the above shared services costs (as well as others identified).  It should then bill these costs across business units in a rational and systematic manner.

 

The IRS has long had fights with taxpayers about the amounts that should be charged to subsidiaries for services.  In Young and Rubicam, the Tax Court laid out guidelines for what costs should be charged, and what costs are treated as stewardship expenses.  In 1988, the IRS issued PLR8806002 as technical advice to an IRS examiner.  The advice served as a cookbook for what to bill out until new services regulations were recently issued.

 

A mid market company can reduce both IRS audit risk and foreign taxes by billing for shared services. Here's what should be done:

·      Make sure the accounting system is tracking costs well.  Use separate cost centers for each major headquarters function. Note that this is best practices in any case.

·      Make sure agreements are in place between U.S. and foreign entities within the group for cross billing of costs that one unit incurs for the benefit of another.

·      Identify those cost centers that provide benefits to more than one business unit.

·      For each such cost center, determine the cost driver or the manner in which business units derive benefit.  This may differ from one to another.  Example: number of service calls to the IT helpdesk.

·      Tack that cost driver as part of your monthly accounting records.

·      Track those separate project costs (such as outside services or internal special project costs) that directly benefit foreign operations.

·      At least once per year, and preferably monthly or quarterly, do a spreadsheet that accumulates the shared services costs and apportions them among the business units based on the cost drivers.

·      Bill the shared services and project costs to each business unit.  For foreign units, you must actually generate invoices.  For domestic units, bookkeeping entries are adequate.

·      Settle the bills periodically.

 

My clients have won 100% of the time in IRS, CRA, HMRC and other tax audits when they follow this procedure.  I have inherited clients who lost in each of these jurisdictions because they did not track and invoice costs properly, or did not have proper intercompany agreements in place before billing.  Canada Revenue Authority is particularly adamant about following the above procedure. Clients who can produce the documentation outlined above win with CRA without even a fight.  Those who do not face recharacterization of management fees as nondeductible dividends subject to withholding tax.

 

Interaction with Unicap Sec. 263A

Many of the costs of shared services are also mixed service costs under the Uniform Capitalization rules of section 263A (Unicap). Any analysis and billing of shared services costs should be integrated with the Unicap calculations for the tax return.  At a minimum, the tax preparer's Unicap worksheet should draw data from the shared services worksheets.

 

Shared services are not "one size fits all".  Each company conducts business in its own way, and has costs and activities unique to that company.  The practitioner must understand the company's business to effectively manage shared service costs.

 

Winning the tax audit battle requires the right records and the right tax positions.  Billing subsidiaries for shared services costs, and supporting the bill with good records, lets you keep the deduction on tax audit.  But billing must be done in time to make year end books.  If the intercompany charges are not recorded in the foreign financial statements, deductions will almost certainly be lost.

 

Call or e-mail Steve Fox, CPA to get the help you or your clients need to be prepared and win IRS and foreign tax audits of shared services costs. 

It's your business:  get personal.  Call Steve Fox at  1(973) 610-5669  or  email steve @ sfoxcpa .com
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