Some organisations prepare thorough business cases to help with any investment decisions – but only include pre-tax figures in their calculations. Others have a thorough handle on the full cost of acquiring new fixed assets – but less clarity on the quantum or timing of any tax rebates that may be relevant to such a purchase. International groups might also make a decision based on a single division’s results, forgetting to build in the impact of cross-border transactions and taxes.
The common understanding is that tax is a consideration after a business decision has been made. This approach has historically been adopted due to a lack of knowledge around calculating tax, and often misses potentially large negative cash impacts from increased taxes which may undermine the savings / benefits of the business decision.
Including tax planning in business decisions helps ensure actual cash benefits are understood and costly issues are avoided. It will also help ensure that efficient processes are implemented to run the intercompany transactions supporting the business decision and enable data to be efficiently gathered to meet tax needs.
While there are a multitude of taxes that can impact decision points, we'll focus on three specific areas of examples – research and development tax claims, capital allowances, and transfer pricing. R&D tax rebates and capital allowances can be claimed for qualifying expenditure and are in essence a means for HMRC to encourage business investment.
Depending on exactly what type of investment a company is making, an R&D or capital allowance claim could equate to more than 100% of the cost of the investment being recouped within a year of the expenditure being incurred, meaning that the impact can be significant on an overall cost-benefit analysis.
Transfer pricing is a mechanism to ensure that the 'correct' tax is paid in each country when an organisation undertakes cross-border intercompany transactions. This is done by aligning statutory profit with the value driving activities undertaken by legal entities – in essence looking to ensure that intercompany prices are equivalent to those generated between third parties.
At the time of writing there's increasing consensus on the transfer pricing rules with the OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS), which builds on the OECD’s Transfer Pricing Guidelines (which are commonly adopted or referenced), signed up to by 135 countries. This consensus is helpful when trying to plan intercompany transactions as it gives some certainty on how to create and defend transfer pricing policies, but similarly means that poor planning will have a greater likelihood of creating tax audits and potential cash tax costs which are detrimental to the business case.
Tax is increasingly built into business decisions. Changing business models, such as remote executive working, can lead to additional direct compliance costs, a different tax rate being applied to profits, and other costs incurred documenting changes to the business model.
Consider a group moving to a centralised European warehousing model based in Poland that will service mainland European customers of Polish, German, French, and UK divisions. This will enable economies of scale and reduce costs – something which has been built into the business case for the move, but based on pre-tax profit and loss forecasts only.
A best-informed decision on going ahead will also need to consider the tax impacts. A first port of call may be considering which forms of capital allowances are available or being given up through the change in warehouse location – as these will be a direct cost attributable to the business case. Then, practical decisions which impact transfer pricing will need to be considered.
One of the first decision required is to establish who will legally own the stock in the new warehouse. If the current owners (Poland, France, Germany, and the UK) retain ownership, this is likely to give rise to permanent establishment issues (ie, the UK entity would now be considered to be trading in and taxable in Poland) and VAT registration issues (ie, the UK entity would need to register for and pay VAT on its products in Poland).
Alternatively, the stock could be transferred to the Polish entity. But that would represent a transfer of stock and give rise to tax charges, such as VAT and customs duties.
Assuming that the decision is taken to transfer the stock, a transfer pricing analysis would need to be undertaken to determine the functions, assets, and risks of the centralised warehousing activity and therefore what price is reasonable to charge between the Polish and UK/French/German entities. That will impact the tax charged by the tax authorities in each jurisdiction.
The costs of these tax related tasks may diminish the benefits driven by the centralisation of the warehouse.
As companies look to expand they often incur capital expenditure to create new production lines. The cost-benefit analysis for these new production lines will focus on expected revenue and the ability to produce product as efficiently as possible to drive higher pre-tax profit.
A crucial point these business cases miss is the option to claim capital allowances and R&D tax credits to make the business case more compelling.
Capital allowances give companies the ability to get tax relief on capital expenditure by allowing it to be deducted against annual taxable income and thus reducing actual cash tax – which will improve cash flow forecasts and improve the post tax P&L.
Similarly, R&D tax credits may also be available if the new production line is innovative which will provide additional mitigation to the companies’ tax liability and, in some circumstances, provide payable tax credits to the business. This will again improve the cash flow forecasts and could improve the pre- and post-tax P&L position.
An often overlooked factor is the complexity of implementing process changes required to meet the tax compliance issues that arise from a key business decision. Most businesses will at least consider the impact on their accounting system and processes, but tax, and more specifically transfer pricing, compliance implications are often missed. This can lead to inefficient processes, increased complexity, and additional costs in ensuring tax compliance.
In the warehousing scenario it's likely that management will need to assess the performance of the warehouse as well as track the relevant details for the different tax authorities. If costs and revenues are tracked without the transfer pricing rules being incorporated, then there is a real danger of two different sets of numbers being tracked: one for management reporting and one for statutory reporting. This is obviously more expensive and time consuming to run and will also create complexity and costs in reconciliation.
The simple solution is to have one allocation method and then to consider the impact on, and potential changes required to, management performance metrics.
While taxes should never be the driver behind a business decision, considering them is critical. Building the tax impact into cost analysis, benefit assessment and cash flow forecasts is highly recommended.
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