In today’s globalized landscape, management services are instrumental in aligning related parties with the group’s broader strategic and operational goals. These services, ranging from executive oversight and strategic planning to legal, HR, and IT support, are usually centralized in developed countries where the corporate nerve centers reside. However, when the bill is due, tensions often arise. The receiving entity is left questioning the value of the support, with their local tax authority breathing down their necks, expecting the charges to be as small as possible. Transfer pricing (TP) consultants are then tasked with navigating the delicate balance between economic reality and compliance expectations.
The Centralized vs. Local Management Dichotomy
At the heart of this issue lies a fundamental question: Should multinational groups prioritize centralized control or empower local management teams, which may operate at lower costs but could be less aligned with the group’s long-term strategy?
Empowering local management in emerging markets offers clear advantages. Local teams are often better positioned to respond quickly to market conditions, cultural nuances, and regulatory requirements. This proximity to operations allows for more agile decision-making and tailored solutions that may be impractical for a centralized team to deliver. From a cost perspective, services such as HR administration, procurement, or basic IT support may be performed locally at significantly lower cost than if delivered from a global hub. Moreover, local managers often have better visibility into service effectiveness and can more easily align costs with actual business needs. This decentralized approach can foster accountability and ownership, while also avoiding disputes over perceived “top-down” allocations that lack transparency or local buy-in.
On the other hand, centralization brings undeniable benefits. It enables economies of scale, consistent policy implementation, and access to highly skilled professionals. The OECD Transfer Pricing Guidelines acknowledge that centrally performed services can create real value for the group and may justify charges to other group entities if performed for their benefit (OECD, 2022, Ch. VII).
Subsidiaries in emerging markets often operate with leaner resources and may perceive centralized charges as disproportionate or misaligned with their actual use of services. Particularly when allocations are based on turnover or headcount, which may not reflect the real value received. In jurisdictions with heightened scrutiny, such as India, Brazil, or Argentina, tax authorities routinely challenge the deductibility of management service charges, arguing that they are duplicative or non-beneficial.
Measuring the Benefit: A Persistent Challenge
The OECD Guidelines emphasize that for a management service charge to be arm’s length, the recipient must receive a benefit for which an independent party would be willing to pay. This presents a key difficulty: how to reliably measure the benefit received, especially when the services are of an indirect or strategic nature, such as oversight or group-level planning.
TP professionals often rely on documentation, management interviews, and allocation metrics to justify the benefit. However, the cost-benefit relationship is rarely straightforward, particularly when outcomes are intangible. Unlike procurement savings or IT uptime metrics, the value of corporate oversight or group-level governance is harder to tie directly to financial performance.
To mitigate risk, many groups opt for low-value-adding service treatment under OECD rules, applying a 5% markup or using cost-pooling arrangements. Still, this may not satisfy local auditors, especially where the burden of proof remains high. Tax authorities in emerging markets increasingly request localized benefit analyses and often question the duplication of services already provided in-house.
Could It Actually Be Done Cheaper Locally?
Emerging market tax authorities frequently argue that services could be obtained locally at a lower cost. While labor arbitrage is real, local salaries are often a fraction of those in New York or London, this argument often overlooks the depth and consistency of centralized services, particularly in risk-sensitive functions such as compliance, cybersecurity, or legal support.
Moreover, centralized teams often develop proprietary systems, group-specific knowledge, and internal networks that local providers lack. While outsourcing or replicating services locally might reduce costs, it may also compromise quality, coordination, and ultimately, compliance with group standards.
Striking the Right Balance
For multinationals, the key lies in transparency, defensibility, and communication. Clearly define service scopes and align charges to actual benefits; use reasonable, supportable allocation keys; prepare robust documentation, including local benefit narratives; and, where appropriate, consider advance pricing agreements (APAs) to secure certainty.
In emerging markets, TP consultants must walk a fine line between justifying the strategic value of central services and addressing local sensitivities around cost and autonomy. As the global tax environment evolves and focuses increasingly on cross-border payments, a nuanced, well-documented approach is no longer optional; it’s essential.
