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Tax implications of shared service centres

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11th Jun 2010
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Deloitte's Richard Syratt and Julie Park share their top ten tax tips for companies operating or setting up a shared service centre (SSC).

1. Understand its purpose
The aim of setting up an SSC is to create a large-scale, efficient function that reduces costs, increases quality and improves control. A whole host of activities including payroll, HR and finance processes can be found in SSCs around the globe. SSCs are a great way to manage risk, but companies don’t expect to make huge tax savings from them. In fact, in many cases the tax charge rises as costs are removed from the business to increase profit. More profit often means greater tax charges. The set-up and operation of the SSC should be considered from a tax perspective early in the process to ensure that the overall cost saving benefits are not diluted by unnecessary tax charges.

2. Ensure a tax deduction is obtained
Failing to obtain tax deductions can easily eat into the cost savings generated by the SSC. Good governance, in particular relevant and correct documentation, plays a critical part in achieving the required tax deductions as companies often have to prove to the authorities that the service was actually of some benefit and not simply a disguised reallocation of profit. Particular care should be taken with setup costs as inefficiencies may otherwise arise through aborted projects and capitalised amounts. A cost sharing agreement is often the most practical way of dealing with setup costs, but needs to be in place from the start.

3. Don’t overlook systems design

Where a finance SSC is being set up or undergoing a transformation programme, it is imperative that the right system is in place to provide good quality data to support tax decisions and calculations. Tax professionals will be relying on the information provided by the SSC teams at the point of data entry for many of their analysis and decision-making processes (e.g. identifying disallowable expenditure or qualifying capital expenditure). With experienced tax input into the system design and training processes, significant cash savings can often be achieved by enhancing data quality. If the right information is too hard to obtain, ‘prudent’ judgements that result in additional tax can be taken. This might not amount to much in a single return, however with a similar judgement in every return in every country, the costs soon add up. Another crucial consideration is the level of system automation and controls in place to ensure that compliance is achieved. SSCs often deal with multiple jurisdictions with different tax requirements so, for example, automation of the VAT calculation process within the accounting systems should reduce error rates and the risk profile of the SSC.

4. Get local staff on board

The higher the fees charged by an SSC, the more tax authorities are likely to examine them and their benefit locally. When local teams don’t understand why they are being charged a central recharge and how it is calculated, they will often struggle to defend pricing policies when they are tested by local authorities. The importance of buy-in from local staff shouldn’t be overlooked in structural change, to enable local teams to support pricing positions.

5. Know your tax treaties

The main tax issue with locating a SSC is often withholding tax (WHT). The impact of WHT will not only depend on where the SSC is located but also on the invoice flows, so it’s important to get it right. Consider, for instance, an oil field services company with an SSC in the UK providing services to an operation in Indonesia. The charges for the services were levied on Indonesia by a group company in Bermuda, however there is no tax treaty between these two countries. Under Indonesian law there is a 20% WHT on management fees. Better knowledge of the treaties involved would have suggested that the group charge directly from the UK rather than incurring the additional WHT.

6. Explore the implications of the scope of services provided

The activities carried out by an SSC can have a big impact on its VAT status which can be costly. What may seem like simple contractual terms can have significant consequences. If an SSC is set up in the Czech Republic to process sales and purchase orders, and recharges the parent company for providing these services, then no VAT or customs duties apply. However, if the SSC takes title to the goods and then sells them on to other business units with a mark-up, it potentially needs to be registered for VAT in a number of locations depending on the flow of goods in the supply chain. It may also incur customs duties.

7. Engage with local authorities where necessary

The earlier discussion regarding the set up of SSC pricing models begins, the better. An SSC of a large global oil company, for instance, charges services at cost with no mark-up, which is usual in a sector where mark-ups are often not permitted by the country receiving the service. If the tax authorities had insisted on a mark-up to reflect arms length rates, it would have resulted in an absolute tax cost for the group. Intense negotiations were entered into with the local authorities to clarify this position up front. Early discussions provide an incentive for local authorities to negotiate as they want businesses to set up operations in their jurisdiction. Had the company located the SSC prior to negotiation, it would have been in a much weaker position.

8. Align high value services with low tax jurisdictions
Where SSCs will be carrying out high value-added services such as procurement, the pricing model will reflect the value added by the SSC and more profit will be generated. While tax is rarely the ultimate deciding factor in choosing a location, in these instances locating the SSC in a jurisdiction with a favourable tax rate can become as significant as many of the operational considerations.

9. Get the SSC charging structure right

There is no standard SSC charging model, but certain types will be more suited to the group’s circumstances than others. Companies tend to choose between three main options:

  • Charging by client turnover: If a business unit has $500m of sales it will incur double the charges of a unit with $250m of sales. This method is probably too simplistic and open to tax authority challenge as the number and complexity of transactions is not taken into account.
     
  • Charging by the number of people in the SSC working for a particular country business unit: The logic here is that the SSC is a proxy for the local country people replaced by it, but this is also flawed because the SSC is function-focused rather than country-focused.
     
  • Activity based charging: This is probably the best pricing method as it allows the complexity of the task to be taken into account. Processing an electronic invoice, for example, might cost just a quarter of the price of processing a paper invoice, but is understandably more complex and therefore the SSC has to be setup with this sort of charging mechanism in mind.

10. Stay involved
As the SSC model develops and matures, perhaps even moving towards spinout, it is important for the tax function to ensure that the tax strategy is sufficiently flexible to adapt to the evolving model, whilst continuing to be effective.

Richard Syratt is international tax partner, and Julie Park is indirect tax director at Deloitte.

This article is republished with kind permission from TaxExec magazine, a biannual publication from Deloitte.
 

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