My wife and I have a tradition of holding a New Year’s Day brunch for the family, and since the pandemic, this year was the second event. I’m not quite sure how it came up, but a discussion developed over the salary of executives versus workers. And as the discussion developed, a transfer pricing comparison unfolded in my mind.
“There is no reason why an executive can’t reduce X% of their salary and give that to their workers,” inspired the conversation. While considering this thought, it appears to be a very egalitarian objective, and probably worth pursuing as a concept. But reality has a nasty habit of interfering with high-minded goals.
As any tax professional knows, dividing compensation isn’t that straightforward. First one must consider the size of the organization. Are we looking at a one-location business with an active owner, or a larger enterprise? If it is a larger enterprise, how much larger are we talking about? Is there a distinction to be made between a Fortune 100 company and a regional business?
Each of these elements presents a different set of parameters to the discussion. With our first example—a one-location business—one can argue that the owner and the workers are all part of the success of the business and therefore, each may have a claim to the profits generated. Of course, there are aspects of the business that give the owner a larger share as the owner prepares bids, gives estimates etc., and essentially contributes more to the business than the others. If the owner is not sufficiently accurate, there may be little or no profit—so he also assumes more risk. If his errors led to little or no profit, would the workers agree to share in the loss? There is a technical name for that type of arrangement—partnership.
In a larger context, the same issue remains, but in place of workers, let’s consider subsidiaries. In concept, a Limited Risk Distributor (LDR) is similar to the workers in our example. They perform a specific role and, like the workers, they’re given a predetermined compensation.
The distinctions between the two are also obvious. In the event of a decline in work, employees can be furloughed while subsidiaries will likely remain in existence, (it costs time and money to close companies in almost all jurisdictions). During the course of the COVID pandemic, many companies found themselves in loss positions and yet some argument was made that LRDs should not suffer (or share in) from overall losses. Carried to the extreme, the parent organization can continue to support its subsidiaries at its expense up to the point of bankruptcy. Of course, at that point the “guaranteed return” no longer exists, and everyone everywhere is rendered “non-productive.”
While some may argue that there isn’t a precedent for this type of “sharing the pain”— or that LDRs just shouldn’t have to—2007’s landmark contracts between the Big Three automakers and the United Auto Workers (UAW) provide an example of how the pain can be shared to stay afloat. Entrepreneurs should be rewarded for their risk-taking and workers should be fairly compensated, but as we concluded at lunch, there are times that warrant compromise and the need for everyone to accept some pain.
