Due to COVID-19, many businesses are considering what broader changes are needed to their corporate structures.
Now is an opportune time to conduct that review. While there is uncertainty in the marketplace, this is borne by all.
There is an effective pause with consumers and customers delaying their spending, while policy-makers are offering incentives to support businesses to survive. In light of this, we expect that there will be a new wave of restructuring activities that will trigger transfer pricing and income tax challenges that will need to be carefully managed.
This is particularly relevant if your business has a global supply chain and/or you are heavily reliant on a workforce or other functions outside Australia. It is likely that many MNEs may need to reorganise supply chains and transfer pricing policies in the upcoming months.
Tax structuring was a particular focus for the ATO before the pandemic hit. It will be again and all companies should consider this when making changes to their business. We highlight three areas, in particular, that could or should trigger changes to group structures and transfer pricing.
Operational and structural changes
Assess your operations
Operations and functions may need to be reorganised, reduced, or relocated due to voluntary or involuntary closures, excess capacity in some jurisdictions and decreases in sales.
Bringing business services back to Australia
Many Australian companies with offshore operations have experienced supply chain disruptions – ranging from the closing of key service centres or shut down of manufacturing facilities. With this unprecedented pause in operations, some clients and Boards will look to examine the permanent return of business services to Australia after the crisis has passed. This will require local country tax planning on exit and broader tax effective group restructuring.
Separation of assets and demergers
We are also seeing certain groups expressing a desire to separate core and non-core assets. Further, we expect to see demergers increasing where profitable parts of a business are separated from those parts are that not performing or need a different strategy. This will require careful tax planning especially around the ATO’s new draft tax determination on demergers (TD 2019/D1).
Absorbing extraordinary expenses
Extraordinary expenses may arise and will need to be adjusted across the supply chain. These extraordinary expenses may include redundancies, increased advertising expenses, inventory write-offs, or restructuring expenses.
Structuring your investments
Companies in financial distress are seeking outside investment and support. The nature of these investments will need to be structured having regard to tax implications e.g an equity investment can cause the Available Fraction attached to tax losses to be adversely impacted.
We are participating in conversations on the potential for Public to Private deals with Private Equity. Buyouts of listed companies that have experienced a fall in their share price could emerge.
Liquidity and funding access
Liquidity and funding access are going to be vital, hence revisiting the groups financing arrangements, including the intercompany financing will be key. This will involve:
- optimising the pricing and cost of liquidity.
- reducing the cost of currency conversions associated with the funds relocation, restructuring costs and operations’ wound-up.
- additional funding capital/injections to support operating costs to reduce the financial strain in the jurisdictions impacted, to afford salaries and other extraordinary expenses.
- increasing the debt capacity beyond the Thin Capitalisation safer harbor and likely placing more reliance on other alternatives such as the Arm’s Length Debt Test.
- relying in parent cross-guarantees to either having access to funding or reducing the cost of funds.
Intercompany financing instruments
As the cost of funding is likely to spike, intercompany financing instruments would need to be revisited, particularly in such instances where the interest rates paid to related entities no longer reflects the cost of funding in the current environment. This will be of particular relevance in instances where the funding was agreed at the time in which base rates were lower.
Arm’s length outcomes in times of economic downturn
Correcting financial misalignments
Current transfer pricing policies may not reflect the commercial reality of a supply chain in times of a downturn. As a result, profits and expenses may not be allocated in the appropriate jurisdiction. A review of the transfer pricing policies may assist to correct this misalignment. This may inadvertently resolve certain risks and liquidity issues
Revisit your policies
MNE’s should take a look at identifying locations with significant losses or excess of profits and revisit their policies to ensure that they are reflecting arm’s length outcomes, as the functional and risk profiles of a supply chain should be aligned with the operational reality. For this purposes it’s recommended that MNE’s ensure that the following considerations are addressed:
- review that the management fees charges are appropriate (including the cost base and the mark-ups applied).
- royalties being paid are commensurate with the benefits received.
- are some of the fitout costs really branding costs.
- are the marketing costs allocated correctly.
- which entity should absorb extraordinary expenses like excess of capacity, redundancies, and legal costs.
- are all the risks recognised in the appropriate jurisdiction.
Every organisation will have unique circumstances and requirements. Please reach out if you would like to discuss your tax structure in more detail.