Traps of Low-value-adding Intra-group Services
Do you consider low value-adding services to be really simple in your transfer pricing compliance annual exercise? For sure, you already know that according to the OECD’s simplified approach to low-value-adding intra-group services you may not be required to prepare a benchmarking study for such services, provided of course, a 5% mark-up is applied. Such an approach is highly appreciated from a compliance point of view, but it may be also misleading for tax-risk management. Documenting low-value-adding services isn’t quite as easy as it seems, and certain aspects require special attention. Here, you’ll find a few traps I’ve seen clients fall prey to in their eagerness to apply that 5% mark-up.
Trap # 1: No Benchmark Required
This simple rule may end up with lack of any attention from taxpayers, but still may be in the spotlight of the tax authorities. Why? Such services may not require a separate benchmarking study, but, just from the transfer pricing perspective at least two key issues should always be investigated: the definition of low-value-adding intra-group services and local requirements.
First, we have to check if the services are really low-value-adding intra-group services. OECD Guidelines indicate the characteristics that such services must possess to qualify for the application of the simplified approach, and it also lists activities that are excluded. We can also find specific examples of services that may qualify as low value-adding services. But local regulations will trump these guidelines, so it’s important to check the local rules, while there could be specific requirement, or any threshold added.
Secondly, to benefit from the simplified approach you have to document how the renumeration has been established. All the steps that should still be taken are already described in OECD Guidelines:
- Calculation of a pool of all costs incurred by all members of the group in performing each category of the services, done on an annual basis;
- Identification and removal from the pool of the costs that are attributable to services provided by one group member solely on behalf of one other group member;
- Allocation of the costs.
In addition, local regulations may require additional information to be provided like functional analysis of the transaction.
So, before deciding that simplified approach may be applied detailed investigation and defense file should be in place.
The key issue is to check if and how the services are defined under the local regulations and what are the local requirements to apply the simplified approach to low value-adding services. Relying on OECD Guidelines without double-checking local rules may be a dangerous trap.
Trap #2: How much is tax deductible? Usually a limited amount.
Low-value-adding services may be a headache not only from a transfer pricing point of view but from a tax-deduction standpoint More and more countries are introducing the limitation of deductibility of the invoiced services. So, many times only a partial amount of costs borne may decrease the tax basis and specific calculations have to be made to establish the deductible cost.
Trap # 3: Do you always recognize the cost?
And if we want to see any amount—even that limited one—in tax-deductible costs, we should be able to prove that the services were actually provided. An invoice or an agreement is not a proof that services were actually rendered. The substance of the services is actually the very first step that should be taken while analyzing the low-value-adding services.
Quite a long journey for compliance for “easy” low-value-adding services. Practice due diligence to manage all the traps hidden in the taxland’s woods.