Every Monday we send out an email with insights, guidance, and views on the legal implementation of transfer pricing for multinational groups. (If you don’t subscribe to it, just scroll to the bottom of this page and fill in the box.) A couple of weeks ago we looked at the frequency of invoicing of intercompany transactions, particularly when it is done annually. Are tax authorities likely to challenge this? We received so many replies that we decided to share those views in a blog.
For some who wrote to us, the question was not something they had considered in any detail. Some thought that frequency of invoicing was unlikely to give rise to a material TP risk, given how low-interest base rates are currently. However, one respondent pointed out that legal interest rates for late payments were still high in some countries (e.g. 8.5% and 8.1% in Austria and Germany respectively), and that payment terms therefore can be very material.
The various responses received are set out verbatim below.
We are very grateful to everyone who has taken the time and trouble to share their views. As with many other aspects of transfer pricing and intercompany agreements, this consultation has shown the power of raising awareness of different perspectives, and the fact that no one person has all the answers.
“We encourage more frequent invoicing. If one invoice is issued during the year, most likely right at the end of the year, it can look more like a crude accounting entry without much thought given (even though that may not be the case at all), rather than a managed process as part of a transfer pricing system. We usually suggest quarterly where possible, together with a brief internal notation – reviewed/confirmed / calculation continues to make sense... etc. We try to demonstrate a thoughtful ongoing TP process, rather than a year-end calculation – can be helpful in audit discussions. But of course, only reflect in the ICA if the parties can commit to that.”
“In theory, the tax authorities may have a point when looking at the margin, in that that annual payments for services performed throughout the year could potentially result in a non-arm’s-length charge for those services i.e. the margin charged on the services does not reflect the cash flow benefit of paying annually.
However unless we have internal comparables it is difficult to see how to calculate any adjustment based on third-party data, in particular where the TNMM is used to calculate the margin, as we do not have access to payment terms. In addition at current interest rates, it is difficult to see the potential adjustment would be material.”
“We do all IC invoicing monthly (also to manage the local closing (including taxes)/IC matching and cash flow for the group to our best abilities). IC prices for goods/merchandise are updated 3 times a year (we work with internal price lists), invoices are produced when the goods leave the warehouse.”
“I’ve never heard this objection. If I ever did, I’d be happy, as it indicates a naive tax inspector who is willing to waste time on things that are immaterial, which may distract them from other arguments that might have a much bigger potential yield.
Theoretically, it is right that most suppliers expect to be paid more frequently than once a year, but I would tell an inspector that I don’t see how this has any significant consequence. At worst, being paid at the end of the year means an extra working capital cost for the controlled supplier, so this is a comparability difference and arguably the fee should be slightly higher, to compensate. But in the current interest rate environment, the adjustment would usually be tiny, so even if you make the adjustment the price is almost certainly still going to be ‘in the range’. (I never want to be so close to being outside the range that a small adjustment could nudge me out.)
Maybe in a country where interest rates are high (India, Turkey), this might be more material (though not if paid in hard currency, as this would be likely to give an exchange gain).”
“Apart from payments for tangible goods, which is set within 45 days, TP allocations, royalties, etc. are paid quarterly. This makes it easier from a governance perspective as well.”
“We’ve not seen any challenges on this basis. However, virtually all our invoicing is done quarterly as we believe that best aligns with third-party practice. In a few instances – around items such as guarantee fees or similar – we would invoice annually on the anniversary of the agreement.
What we have seen raised is the lag between invoicing and settlement. In some organizations, this can be longer than the 30/60/90 days allowed in the agreement. In those cases, certain tax authorities have assessed interest on the overdue intercompany balances.”
“Let's pose this question in terms of a US distribution affiliate that pays its UK parent annually even as goods flow throughout the year. An implied account receivable builds up for the year so days receivable = 365 days. Section 1.482-2(a) regulations has certain language with respect to whether this triggers an implied loan receivable.”
“From my experience, the payment and invoicing terms are rather often a topic in TP audits. The typical issues we discuss are:
IC Invoicing/payment term is different from third party contracts: often the case for core business transactions where group companies both have IC and external transactions. Outcome is not that transaction is requalified, however, but that late payment interest is assessed and/or an IC loan is assumed. This may have a huge impact even in the current interest landscape - e.g. Austria/Germany the legal interest rate for late payment is still extremely high (Austria: 9.2 bps above reference rate, which currently still means an interest rate of approx. 8.5%/Germany 9bps = 8.1%). Another issue I currently discuss in a tax audit is whether the fact that a third party normally makes a prepayment must be mirrored in the IC transactions or if this can be “price” in (we were of the latter opinion).
IC Invoicing/payment term in agreement is defined but not “implemented” in practice: also often the case – third party customer conditions are copy-pasted into IC agreement. Payment between related parties in practice is based on liquidity.
IC Invoicing/payment term of specific IC transactions is challenged: for IC services/royalty agreements I have discussed both the issue of a yearly payment (upfront/ex-post) as well as in some rare cases (untypical) monthly payments which are meant to ensure liquidity/going concerned of the service provider and where normally the invoicing would be per project. Always depending on which level the tax audit is performed.
I am not aware of any rules of thumb. For low value adding services charged by a centralised service provider the typical payment is monthly or quarterly and this is usually accepted. For core business transactions we normally try to check the typical behavior of third parties/industry practices.”
“This is an excellent topic and quite often overlooked by many MNEs. The frequency/timing of the invoicing can have a massive WHT (and cash flow) impact, so professionals should devote some time to thinking strategically about it.
Some jurisdictions require the WHT to be paid upon the invoice accrual; others, upon invoice payment; and there are some cases, where even if you don’t pay the invoice(s) at year-end, you are still required to pay the WHT.
A few observations from my experience:
1. Before year-end do the most accurate True up (or True down) you can since WHT paid in excess is hardly ever reimbursed.
2. Shall we apply the WHT over the markup only or over the whole invoice, which may contain reimbursements (no income nature)?
3. Some invoices are too generic as they don’t provide any graduality about the type of services being rendered. In my opinion, that’s very low handing fruit for many tax authorities.
4. Would a third party dealing with you in arm’s length basis accept being paid only at year-end, even if it provided services to you from January to December? Remember that the service provider pays its own salaries monthly, contracts third parties (for example for IT), and so on, throughout the fiscal year.”
“While I have not seen any client case so far where the tax auditors challenged the invoicing terms and frequency, I believe they will be within their rights if they do so. I have seen them questioning delayed collections of receivables and treating them as loans. For similar reasons, there is nothing that stops them from scrutinizing delayed invoicing such as in case of an annual frequency.
Their argument that the third parties would not agree to that arrangement would have some force, and I believe the onus would be on the taxpayers to explain the basis and rationale for the frequency they agreed to.”