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Friday, 20 November 2020

HR tax & transfer pricing: an unexpected journey

Tiberghien and Tiberghien economics work together on HR tax and transfer pricing, which are two distinct fiscally- and economically-inspired disciplines that have more interaction than is often realised at first sight and that affect both personal income tax and corporate income tax. This article clarifies the interaction between certain aspects of, on the one hand, the structuring of remuneration schemes for employees working in cross-border group set-ups and, on the other hand, the setting of transfer prices applied between group entities for the provision of services and the consequences that such setting-up might trigger in the future.

Cross-charging of costs

A key issue is the cross-charging of costs, and in particular labour costs between associated enterprises.

Transfer pricing ensures that the provision of services is remunerated on an arm’s length basis and service fees are allocated to the service recipients that benefit from the services. The key transfer pricing principles to take into account are: (i) the physical place of work, (ii) who has oversight/authority over the employee(s) in question in which ‘substance over form’ prevails, (iii) is there any added-value created? (iv) whether or not a mark-up on costs is applied, and (v) what is the appropriate mark-up percentage. The practical implementation of the cross-charge can be done through: a monthly fixed amount, standard hourly rates, a combined service fee, or the cross-charge of salary costs on an individual basis. The definition of the cost base and the allocation key(s) are also important factors that should be considered. The cross-charge will affect the operating result - and consequently - the taxable basis of the in-scope entities that are subject to corporate income tax.  

In practice, we note that multinationals work more and more across borders and not all employees work and live full-time in the country where their employer is located. From a transfer pricing perspective, for these employees one should assess who the material employer is by identifying a relationship of authority; such a relationship determines whether a service has been provided for which profit-related remuneration might be due or that only labour costs should be cross-charged to the company that is the material employer. In addition, one might need to assess the potential personal income tax consequences for those employees that work on a regular basis outside their home country for other group companies. Depending on the specific circumstances, for international mobile staff, a (partial) cross-charge of costs, could lead to a shift in the power to tax their remuneration.

This interaction between HR tax and transfer pricing is illustrated by a court ruling of the Court of Zeeland-West-Brabant of 19 December 2019 in which a Dutch tax resident had a formal employment contract with a UK entity (a Limited company) but was effectively performing activities in the UK, the Netherlands (from a home office) and Germany (for a GmbH) for the benefit of the group entities located in each of these countries. The Dutch tax resident had an international management function (Managing Director/CEO) and reported to the US parent company (an LLC). A management service agreement was concluded between the Limited company - as the service provider - and the GmbH company - as the service recipient – in which a service fee was charged that combined all the services provided, e.g. management, finance and marketing. The Dutch tax resident requested, in his personal income tax declaration in the Netherlands, the exemption of the income taxed elsewhere. The court case concerned the requested exemption of income realised in Germany and it raised two key questions:

  1. Who was the material employer, i.e. who had a relationship of certain authority?
  2. Was there a cross-charge of the labour costs?


Relationship of authority (material employer)

From a corporate tax and transfer pricing perspective, the Limited company had cross-charged a service fee to the GmbH that consisted of the salary costs of the Dutch tax resident and other costs related to various services provided. The service fee as such was not discussed in the court case, but the relationship of authority was relevant for determining whether either a service had been actually provided for which profit-related remuneration might be due (mostly via a mark-up on costs) or that solely the labour costs should have been cross-charged to the company that was the material employer (i.e. either the Limited company or the GmbH).

From a personal income tax perspective, the relationship of authority is crucial for determining in which country the income taxes on the salary received are due. The criteria for determining the material employer are stricter for personal income taxes than for corporate tax. One common key factor is that ‘substance over form’ prevails and so the legal employer is not necessary the material employer.


Cross-charge of the labour costs

The Court assessed another element that was whether the labour costs were effectively cross-charged i.e. a difference might be made between an overall service fee, on the one hand, and the cross-charge on an individual basis, on the other hand.

The Court decided that – based on the updated 2017 OECD-commentary on Article 15 ‘concerning the taxation of income from employment’ of the OECD Model Tax Convention - it was not necessary to examine whether the salary costs had actually been individualised, but whether the salary paid had been charged to the right entity, which was the case here (through the service fee).

While this court ruling confirmed this more traditional transfer pricing viewpoint, it, however, should be noted that this is only one perspective on this topic. The jurisprudence in Belgium is different to that of its neighbouring countries; therefore, care must be taken about how to structure such cross-charges in practice as there might be an impact on the personal income tax of the respective employees involved; for example, if their salary costs are not cross-charged on an individual basis but are an integral part of an overall service fee between associated enterprises.

Share-related benefits

Another aspect requiring multidisciplinary assessment between HR tax and transfer pricing is that of share-related benefits granted by a foreign parent company to the employees of another group company. This can be illustrated with the example of employee stock option plans in which employees are remunerated via the option of acquiring shares on favourable conditions.

Transfer pricing could come into play, for instance, if a parent company grants stock options to employees of another associated enterprise that is resident in another tax jurisdiction. Some of the questions that come up in this context include:

  • To what extent should there be an amount cross-charged to the legal employer of the benefiting employees or can it be argued that this is only a benefit for the parent company issuing the stock option plans?
  • Do the stock option plans have an impact on the transfer prices set for controlled transactions entered into between the issuing entity and the associated company that employs the benefitting employees? It is worth reflecting on whether stock option plan-related costs should be part of the cost basis e.g. for a mark-up that is applied in providing services, or to be taken into account when assessing whether an entity’s targeted operating margin has been realised or not.

Therefore, a significant interaction between HR tax and transfer pricing exists, with important consequences arising, when deciding to issue stock option plans within a group context. Tiberghien economics can assist in the valuation of such stock options and/or the underlying shares to determine an arm’s length value.

Tiberghien and Tiberghien economics’ close cooperation concerning these two domains enables both to supply a broader view and to provide hands-on, client-tailored integrated advice on transfer pricing and HR-tax matters.

 

For more information on this topic, please contact the authors of this article:

Tine Slaedts - Partner Tiberghien economics (tine.slaedts@tiberghien.com)

Sarah De Wilde - Senior Associate Tiberghien (sarah.dewilde@tiberghien.com)

Heleen Van Baelen - Senior Manager Tiberghien economics (heleen.vanbaelen@tiberghien.com)

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