Increased scrutiny on transfer pricing
While many of China’s payments organisations are in the earlier stages of developing more comprehensive tax strategies, the reality is that few emerging organisations or industry sectors tend to place a very high focus on tax planning in the first few years of their growth. Indeed, in many cases, it is not until a serious tax challenge or a dispute with a tax authority arises that minds are finally crystallised towards the real risks and reputational damage that can stem from this area of the business.
All evidence suggests that these types of disputes are becoming more common. In part, this is because China’s tax authorities have become increasingly focused on transfer pricing. In fact, having carefully studied transfer pricing approaches in other parts of the world, China is rapidly developing one of the most comprehensive regimes in the region.
China’s transfer pricing compliance obligations are also rather robust. For example, almost all cross-border enterprises are required to prepare, and in most cases also to submit, formal transfer pricing documentation on an annual basis (whereas in many other jurisdictions this step is only required when a formal audit is launched). However, in reality, few cross-border payment organisations possess either the resources or the experience to fully document their transfer pricing for related party dealings and, therefore, potentially leave themselves open to significant risk of tax authority challenge.
Creating advantage and reducing risk
While few payments organisations seem to have developed truly mature transfer pricing strategies, fewer still have implemented forward-looking tax strategies to mitigate their tax exposure, reduce risk and create a competitive advantage. This is a shame. Significant benefits can be achieved when internationally active payments organisations implement smart transfer pricing strategies, particularly with regards to their technology and IP assets or their treasury and foreign exchange revenue.
For example, take the development and operating costs for a payment platform. One common approach can be to create a type of cost sharing arrangement where every operating company contributes to the implementation. But while this approach may seem straightforward to structure and maintain, it also brings certain complexities. For one, how is true market value determined in situations where new operating companies join or depart from the arrangement? How are these cost contributions centrally recorded? What are the risk-sharing implications of the arrangement to the ownership of the developed payment platform?
Another approach could entail a royalty based structure through an IP holding company that charges licensing or royalty fees to users. There are wide opportunities to derive tax efficiencies from such an option if development of the IP, operational and ownership structure is well considered in advance. There is generally less flexibility for change when the development of IP and operational structures are finalised or well progressed. Of course, tax opportunities can still be achieved through certain operational changes and by migrating existing intangible assets into a new holding company. However, these can also trigger tax implications and, particularly in China, may attract challenges from tax authorities keen to retain the IP and royalty payments within their jurisdictional reach.
Planning an effective tax strategy
Unfortunately, there is no ‘silver bullet’ for transfer tax planning in the payments sector and each organisation will need to develop their own strategy to meet their unique situation and circumstances.
What is certain, though, is that payments organisations must start thinking about and planning their tax strategy right away, while those organisations with an existing tax strategy may want to consider conducting a transfer pricing ‘health check’ on their organisational arrangements considering the current tax climate.
The bottom line is that careful and thorough tax planning is key to not only ensuring that transfer pricing arrangements can withstand the increasingly complex web of regulations now emerging around the world, but can also create a competitive advantage through greater tax efficiency.