To a visitor from Mars, the term ‘business restructuring’ would have only the vaguest of meanings. In recent years, it has been used to describe emerging patterns of supply chain organisation within multinational companies. In particular, it is used to describe the process of change from ‘traditional’ organisational structures to ‘new’ structures, involving a division of functions among different parts of a multinational companies on an entity and geographic basis. Companies are increasingly choosing business models that get their products to their clients in the most efficient way.

The tax consequences of different business models and the conversion and the focus points of tax authorities in different parts of the world vary. Indirect taxes are also relevant so it is important to keep an eye on these taxes when a company changes its business model. Tax accounting issues also need to be considered. The issuance of an Organisation for Economic Co-operation and Development (OECD) discussion draft in September 2008 that deals with all the above issues has created a flurry of discussion in the business world.

Business restructurings

Each business model has tax consequences. The conversion of a fully fledged manufacturer into a toll or contract manufacturer or the conversion of a fully fledged distributor into a limited risk distributor, for example, has tax consequences.

Different global tax authorities focus on different items relating to business restructurings. German tax authorities have an increased interest in understanding the value of intangible assets which were developed and which might be subject to a restructuring or transfer. The result is an increased documentation burden.

In the US, transfer pricing provisions include a commensurate-with-income provision specifically related to intangibles. The US government’s Internal Revenue Service’s view of intangibles has most recently been expressed in a co-ordinated issue paper that dealt specifically with buy-ins for cost-sharing arrangements and in the recently issued cost-sharing regulations.

In China, the number of audits with regard to intellectual property transactions is growing. Another issue in China is that courts have discretion to determine whether indemnification clauses are valid, and in the past, when the courts have become involved, they have determined indemnification damages based on ‘lost profits’, among other things.

With the exception of rules for agents, there are no requirements under UK law that would oblige the payment of compensation when two parties to a contract agree to waive or change the provisions of that contract. However, the UK’s revenue and customs service will often argue that some sort of right or entitlement has been lost or surrendered for which the UK entity should have received compensation.

Post-restructuring issues are an area of concern. In China, it is important to obtain proper approval documents from tax authorities in the relevant jurisdiction, to ensure the restructuring is arranged in such a way that previous entities continue to enjoy the same tax benefits, and that entities are operating in line with their prescribed business scope. Post-restructuring issues in Switzerland largely relate to unintentional or intentional restructuring implementation failures. Such misalignment often relates to poor execution of the transfer of functions, risks and assets. This is also often the case in India.

Business restructurings can also be costly and obtaining a tax deduction for the costs incurred can be a challenge. Restructuring, reorganisation and closure costs can be defined as both direct and indirect costs. Such costs typically include severance costs, accelerated depreciation charges or write-offs as well as costs of external advisers. Local tax authorities tend to scrutinise such expenses. Tax authorities sometimes take the line that the costs should be allocated to the other group companies because they made the decision or benefited from the activities. Alternatively, tax authorities can take the line that the costs are not deductible because they are not beneficial to the local company.

In Germany, restructuring expenses are ultimately borne by the recipient. In Switzerland, the commercial justification of any expenses and costs related to business restructuring depends on the benefits achieved by the Swiss entity concerned. In the UK, business restructuring expenses would typically be regarded as redundancy costs, staff relocation costs and costs arising from disruptions to the business while the restructuring takes place.

If these costs are capital related, they will not be deductible. If they are revenue related, they are in principle deductible, subject to the normal rules on non-deductible expenditure, but if a UK company is adversely affected by the business restructuring such as if its profits decline as a result, it is more likely that these will give rise to a case for compensation.

Indirect taxes

When companies change business models, they need to be aware of the consequences this can bring with regard to customs duties and goods and services tax. Companies that do not pay sufficient attention to value-added tax aspects, for example, expose themselves to significant financial risks and a less-than-efficient restructuring.

Different global rules apply to customs duties, for example, under the World Trade Organization and the EU customs valuation rules. As a result of the different valuation methods, while transfer pricing policies are considered adequate and acceptable by the direct tax authorities, the customs valuation might attract criticism. So companies must comply with both customs and transfer pricing guidelines or they may be subject to incremental taxes, duties and penalties, as well as to the burden of complying with potentially onerous customs valuation methodologies.

Tax accounting

The income tax consequences of business restructurings are typically considered from a cash tax perspective. However, the effect of income taxes on financial reporting is also becoming a top consideration of the finance function, given the impact on financial results and the increased scrutiny by regulatory bodies, especially in the US and Europe. It is almost impossible to assess the income tax consequences – and thus the income tax accounting consequences – of business restructurings without considering transfer pricing.

Transfer pricing is important, given that inter-company transactions are inherent to most business restructurings. Business restructurings typically involve the movement of assets, both tangible and intangible, functions and risks between related entities and across borders. These movements are governed by transfer pricing regulations. It might be that the tax authorities have a different opinion about what should be considered to be held at arm’s length.

The global business community, tax authorities and the OECD are all focusing on transfer pricing and business restructurings. They have provided their comments on the topic to the OECD discussion draft.

It will be interesting to see whether, and if so to what extent, the credit crunch will play a role in this.

Will new economic and political issues such as energy and food security, as well as environmental issues, result in decreased globalisation and render the issues of tax consequences, indirect tax and tax accounting insignificant?

Anuschka Bakker is a chief editor at IBFD.

PRACTICAL TIPS

Effective tax planning while streamlining a business

• There is no legal or universally accepted definition of business restructurings. But the Organisation for Economic Co-operation and Development’s discussion draft on transfer pricing aspects of business restructuring, published in September 2008, defines business restructurings as involving “transfers of functions, assets and/or risks with associated profit/loss potential”.
• When companies change business models, they must be aware of the consequences this can bring with regard to customs duties and value-added tax (VAT) or goods and services tax. First, a business should realise that a restructuring may result in additional amounts of VAT that must be paid by the company, without the company being able to claim a refund from the tax authorities. Second, a business should ensure that all legal requirements relating to VAT are met.
• Companies must comply with both customs and transfer pricing guidelines or they may be subject to incremental taxes, duties and penalties, as well as the burden of complying with potentially onerous customs valuation methodologies.
• Business restructurings typically involve the movement of assets, both tangible and intangible, functions and risks between related entities and across borders. These movements are governed by transfer pricing regulations. It might be that the tax authorities have a different opinion about what should be considered to be held at arm’s length. So companies must ask the question of whether they need to form reserves with regard to these transactions and, if so, in what amount.