Increased regulation by both the U.S. and the European Union (EU) may ultimately create new tax obligations for multinational organizations. To maintain compliance with domestic and international tax requirements, organizations will need to solidify their internal reporting mechanisms in order to determine their obligations for compliance with new procedures.

Many companies have already begun the process of outlining impact assessments and have created a framework to align to these new standards. At the moment, the EU’s new reporting standards seem to be focused on transparency with the principal financial casualty being costs associated with reporting. In the case of the U.S. requirements, the Supreme Court’s recent decision not to challenge important policy decisions will result in heavy tax obligations for multinationals previously seeking to shelter earnings abroad. The following recaps these two major developments.

Cross-Border Arrangements with EU Tax Benefits

The EU’s cross-border tax arrangement rules, known as the DAC6 directive, will reach the scheduled one-off reporting deadline on Aug. 31, 2020 for arrangements entered into during the range of June 25, 2018 through June 2020. While several EU member countries have decided to extend this August 31 deadline for six months, at least one member – Germany – has announced it will not extend it. These rules require companies based in the EU as well as intermediaries to disclose any Reportable Cross-Border Arrangements (RCBAs).

Any RCBA entered into after July 1, 2020, also must be reported to the EU home country on a rolling basis no later than 30 days after its inception.

Several factors will contribute to determining whether an activity where a material tax benefit is realized qualifies as an RCBA, including:

  • Confidentiality
  • Fees related to the tax advantages of the arrangement
  • Standardized documentation
  • Using a company’s losses to offset tax liability
  • Taxable revenue converted into lesser or tax-exempt revenue
  • Asset exchange resulting in a circular transaction
  • Deductible payments where the tax rate is approximately zero

Other distinguishing factors of an RCBA will by themselves trigger reporting requirements, such as claiming depreciation in multiple jurisdictions or entering into transfer pricing arrangements between related parties. These reporting changes may have larger implications for companies that have enjoyed easy access to European markets as local residents – now, companies may be encouraged to move operations in order to capitalize on tax benefits which otherwise will be under greater scrutiny.

U.S.-based multinationals are required to comply with these provisions for any of their EU-based entities.

Altera v. Commissioner and the Arm’s Length Standard

U.S.-based companies not only will face increased regulatory pressure from the EU’s tightening of tax reporting, but may also see their own domestic tax planning upset by policy change.

The U.S. Supreme Court recently denied Altera Corporation’s request to hear an appeal of the Ninth Circuit’s decision, which requires U.S. stock-based compensation to be included in cost-sharing agreements for intellectual property development with foreign related parties, resulting in significant additional taxable income to U.S. parties. Altera has received support from other large multinationals in urging that this decision will result in extreme financial losses for both public and private companies.

Previously, compensation in the form of stock options was not thought to be regarded as an actual cost in determining a QCSA (Qualifying Cost Sharing Arrangement). However, the development of FAS 123 determined that stock-based and other equity compensation must be included on a company’s balance sheet and reported with revenue. The Appeals Court asserted that the evaluation of stock-based compensation supports its inclusion under the arm’s length standard applicable to pricing between related parties. Both Altera and other major companies with similar compensation vehicles supported the dissenting opinion that certain arrangements with international scope fall outside of this arm’s length classification.

The Supreme Court’s refusal to hear appeal of the Altera case will make offshoring of intellectual property development more difficult for organizations that use stock options and other equity compensation to attract talent, as is very common among technology companies and start-up ventures. It also opens the door for the IRS to apply its newly validated regulatory principles to prior years in an effort to claw back substantial taxes on existing cost-sharing arrangements. The larger adverse consequence of this precedent could be the loosening of regulatory rulemaking required by the Administrative Procedure Act, thus reverting to the observed practice of the U.S. Treasury obfuscating its adoption of new tax regulations. In light of this outcome, U.S. companies may be more motivated to keep even international intellectual property development within U.S. boundaries.

Stay Tuned for Tax Implications

In the case of DAC6, strict sanctions will be levied on those that fail to comply with the new rules, so U.S. companies will need to pay close attention to tax benefits that fall within EU jurisdictions. Under newly affirmed cost-sharing regulations, U.S. companies will have a harder time deferring U.S. taxes on intellectual property developed for use abroad.

If you have questions or more information on these developments, please feel free to contact John Forry, Managing Director and Leader of the CBIZ West Coast International Tax Practice. He can be reached at JForry@cbiz.com or (646) 345-0586.

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Published on July 27, 2020