[IMGCAP(1)][IMGCAP(2)]By doing what they do best—taking care of their clients—international accounting firms may be exposing themselves to multiple tax claims on their own account.
With the growth of international accounting firms, tax administrations aren’t far behind, seeking to tax the profits earned by the international firms.
At heart, international accounting firms provide specialized services to myriad clients, in locations across the world. The term “specialized services” is important for tax purposes, as it affects enterprises such as accounting firms. Tax administrations need to apply transfer pricing techniques to ascertain the revenues they could bring in. The organization setting up these tax rules is the Organization for Economic Co-operation and Development.
The OECD issued new transfer pricing guidelines in 2010. The guidelines address the treatment of services companies for the first time, including international accounting firms. The new guidelines suggest that the answer to pricing issues might be to apply the transactional profit split method. This method would require a multinational enterprise to cumulate income and expense from its jurisdictions across the world, and then divide up that income among the various jurisdictions on a rational basis.
International accounting firms should check with each jurisdiction in which they do business to make sure that country uses the new OECD rules. The multinational enterprise or the tax administration’s application of the transactional profit split method presupposes that there are no true comparables among firms.
Selecting the “Most Appropriate” Transfer Pricing Method
The OECD requires businesses, including international accounting firms, to select the “most appropriate” transfer pricing method for them:
• The cost plus method of transfer pricing might apply to the transfer of services, but the cost plus method requires the multinational enterprise or the tax administration to secure comparative data. Virtually all international accounting firms are private, making this data unavailable.
• The international accounting firm might apply the transactional net margin method of transfer pricing, but the transactional net margin method requires the multinational enterprise or the tax administration to secure and analyze extensive comparative data. Virtually all international accounting firms are private, making this data unavailable. Despite these seemingly insurmountable obstacles, multinational enterprises and tax administrations have mostly preferred the transactional net margin method for pricing until recently.
• The final—and newest—pricing approach is the transactional profit split method. International accounting firms and tax administrations can apply the transactional net margin method by comparing the magnitude of its operations in one jurisdiction with its operations in other jurisdictions. The guidelines acknowledge that there won’t be available external data, but they permit the multinational enterprise to use its internal data instead. The transfer pricing guidelines suggest that the multinational enterprise or the tax administration might apply the transactional profit split method to the activities of the business that consist of the integrated production of highly specialized goods, unique intangibles, or providing specialized services.
How the Profit Split Method Works
Services are “specialized” if the providers of these services require training and expertise.
The specialized services are the prime function of the firm—both business-getting and performing services. Other activities aren’t primary or specialized, and the tax administration would treat these amounts merely as costs.
The next step in determining the tax allocation is for the tax administration or the international accounting firm to aggregate the entire income of the entire business. The international accounting firm or the tax administration may aggregate these amounts by using International Financial Reporting Standards, making this determination across all jurisdictions in which the enterprise performs these specialized services.
The final step in determining the tax allocation is for each tax administration, or the international real estate brokerage as a group, to allocate the worldwide operations in that jurisdiction. The international accounting firm or the tax administration can apply a formula or develop allocation keys. The transactional profit split method does not entirely eliminate the risk of double taxation because the tax administrations in each location may select differing—and conflicting—allocation keys.
Multinational Services Enterprises
International accounting firms are not alone in facing international tax issues. The tax rules affect other multinational services enterprises that meet the following characteristics:
• One or more entities in the services enterprise group provide services for different entities in the group in different jurisdictions, and entities expect to receive services from different entities in the services group from different jurisdictions.
• The services enterprise provides a cross-border exchange of services.
• The physical transfer through other sale or lease of goods across borders is typically not material to the services enterprise.
• Entities in each jurisdiction in which the services enterprise does business are profit centers rather than being just cost centers.
• The services enterprise makes use of market intangibles such as trade names or trademarks, such as through branding.
• The selling function or the listing function is material to the enterprise.
• The providers of the selling function might be in a different location than the person effectuating the completed services.
Industries Potentially Subject to Profit Split Provisions
Providers that might fall within the specialized services provisions include the following industries: advertising, aircraft leasing, management consulting, tax consulting, real estate brokerage, legal services, car rental agency, remediation, education, architecture, dating service, employment service, testing services, computer consulting, construction, mortgage servicing, conference companies, publishers and media.
In short, the new transfer pricing guidelines could have a wide-ranging impact in not only the tax and accounting profession, but on a wide range of industries around the world.
Robert Feinschreiber and Margaret Kent are attorneys and counselors with TransferPricingConsortium.com.
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