Implications of Disallowed Foreign Deductions for Multinational Enterprises

Implications of Disallowed Foreign Deductions for Multinational Enterprises

by Nicholas L. Raby, Susan W. Stanley and Elizabeth A. Sweigart *

Although the majority of U.S.-based multinational enterprises make efforts to document and charge for headquarters general and administrative services provided to foreign affiliates under Treas. Reg. § 1.482-9, not all taxpayers are aware of steps needed to protect themselves from disallowed deductions...

The majority of U.S.-based multinational enterprises incur general and administrative expenses related to headquarters services rendered on behalf of foreign affiliates. While the U.S. Treasury Regulations governing the provision of services between related parties under Treas. Reg. § 1.482-9 allow for many of these expenses to be charged at cost, in some cases the services are required to be charged with a markup. Many tax authorities are skeptical of these charges - particularly those including a markup - and impose local requirements mandating documentation showing the direct benefit received or disallow the deductions altogether not considering potential treaty implications. Leading practices direct that corporate tax personnel and their counsel recognize that a disallowance of an otherwise appropriate expense allocation or charge - in a treaty country - is a direct violation of the treaty and take action to remedy the situation.

With respect to non-treaty jurisdictions, taxpayers should note that all reasonable and effective measures to reduce the local tax liability must also be exhausted before a payment is made, lest the payment be deemed voluntary under Treas. Reg. § 1.901-2(e)...

 

Intercompany Headquarters Services. To capitalize on economies of scale and remain cost competitive in the global marketplace, U.S.-based multinational enterprises generally centralize administrative, management and back office services...

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Broadly, headquarters activities can be bifurcated between those activities that provide a benefit to related parties and those that are performed on behalf of the company performing the activity. As a threshold matter, headquarters services must not duplicate the activities performed at the local level and be seen as providing a recognizable benefit to the recipient in order for a charge to be made.

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U.S. Rules Governing Intercompany Services. The current U.S. regulations governing intercompany services, issued on July 31, 2009, represent an update of the regulatory rules first introduced in 1968.

In addition to applying the best method, comparability, and arm's length range requirements of Treas. Reg. § 1.482-1 to intercompany services transactions, the regulations also specify six transfer pricing methods to evaluate the arm's length nature of the services charges. The specified methods include the Services Cost Method (SCM), which is broadly similar to the cost safe harbor provided by the 1968 services regulations and allows for services meeting certain criteria - principally those viewed by the U.S. Internal Revenue Service (IRS) as not adding significant value - to be charged at cost...

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Issues Raised by Foreign Tax Authorities.

Increasingly, U.S.-based multinational enterprises are facing tax authorities in foreign jurisdictions - including members of the Organisation for Economic Co-operation and Development (OECD) - taking aggressive positions on audit to disallow the deduction of allocated headquarters services charges. In the case of more sophisticated tax authorities, the disallowance may be explained in a well-reasoned manner. Conversely, in less advanced economies, no justification may be offered at all...

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Dispute Resolution in Treaty Countries. If allocated headquarters services charges are disallowed in a treaty country, then the U.S. foreign tax credit (FTC) regulations promulgated under 26 USC § 901 must be carefully considered...

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Dispute Resolution in Non-Treaty Countries. Many of the same controversies also exist in non-treaty countries. While the same FTC considerations apply, there is no Competent Authority to intervene when mutual agreement cannot be reached between the taxpayer and the local tax authority. In the absence of Competent Authority, corporate tax personnel and their advisors may best be advised to retain the services of advisors with experience and a physical presence in the foreign jurisdiction...

Leading Practices. While the challenges related to foreign deductibility of headquarters services charges allocated by U.S.-based multinational enterprises will likely continue, corporate tax personnel and their advisors can take proactive steps to better defend these deductions...

Ultimately, advance planning and documentation prepared in accordance with both U.S. and local jurisdiction requirements is essential to U.S.-based multinationals successfully defending headquarters services charges in both domestic and foreign environments.

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* Nicolas L. Raby, Susan W. Stanley and Elizabeth A. Sweigart are with PricewaterhouseCoopers LLP. Nick, a Principal at PwC, has been with the firm for 29 years and is a member of the global leadership team with responsibility for operations for the firm's Tax Controversy and Dispute Resolution practice and also Principal in charge of transfer pricing services for PwC in Southern California and Texas. A graduate of Brasenose College, University of Oxford, England, he also holds an M.B.A. from the University of California, Irvine. He can be reached at nick.raby@us.pwc.com. Susan, a Director at PwC, is a member of the Washington National Tax Services' IRS service team with over 34 years of corporate tax controversy and dispute resolution experience. Prior to joining the firm, Susan served as the IRS Tax Attache for 30 countries in Central and Eastern Europe and CIS based at the U.S. Embassy in Berlin, Germany. She can be reached at susan.w.stanley@us.pwc.com. Liz, a Director at PwC, has over a decade of transfer pricing, financial reporting, and project management experience. She earned an M.B.A. at the University of St. Thomas (Houston) and a B.A. at Rice University. She can be reached at elizabeth.a.sweigart@us.pwc.com. Learn more about PwC at http://www.pwc.com.

Information referenced herein is provided for educational purposes only. For legal advice applicable to the facts of your particular situation, you should obtain the services of a qualified attorney licensed to practice law in your state.

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LEXIS users can access the complete commentary HERE. Additional fees may apply. (Approx. 6 pages)

RELATED LINKS: For more discussion about 26 USC § 482, see:

For more discussion about the services cost method, see:

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