Transfer Pricing Implications of Remote Working Arrangements

Remote working used to be something used infrequently by companies and workers, the exception rather than the rule. Then COVID-19 restrictions almost instantly made remote working the norm. In many cases, working remotely has worked better than anticipated, to the point that many businesses will allow their employees to either work remotely full-time or will institute a policy where they can work remotely most of the time or part of the time.¹ Although this has become a viable work solution for many companies as evidenced during the pandemic, it does cause complications for employees and employers from a tax perspective where employees are employed in one country and have sheltered in place in another country. As a result, countries around the world have entered into temporary agreements between each other agreeing that no adverse tax consequences would be triggered during this unique period. These agreements are temporary and have been extended multiple times as the pandemic has lasted longer than anyone has anticipated. However, what happens after the pandemic when these employees want to continue working remotely from another country?

Companies could face a variety of transfer pricing risks ranging from simple transfer pricing adjustments related to support services to higher impact adjustments such as profit splits if the functions based outside of the country of employment are deemed to be value-adding as laid out in the OECD’s base erosion and profit shifting (BEPS) project.² Specifically, would some of these functions rise to the level of a value-adding development, enhancement, maintenance, protection, and exploitation (DEMPE) function that requires a non-routine return?

With regards to establishment, there have been local country rulings that have stated that the functions based outside of an employee’s country of employment do not rise to the level of a permanent establishment due to several factors. In a recent case in Denmark, where two Danish nationals moved back to Denmark from Sweden while still employed by their Swedish employer, the Danish Tax Agency ruled that this did not raise to the level of permanent establishment because it was the choice of the employees to move back to Denmark; the nature of their function did not need to be performed in Sweden, and the functions themselves were neither managerial nor were they customer facing.³ The ruling is interesting and could potentially be a template for similar fact patterns in other countries. However, it’s doubtful that a similar conclusion would’ve been reached if the functions were more senior and/or value-adding in line with a DEMPE designation.

If the functions located outside of their country of employment are value-adding in nature, then profit would need to be attributed to them. The BEPS project anticipated that a profit split approach would be the best method to provide an appropriate share of returns to the entities managing and controlling significant DEMPE functions. This would most likely be the method to determine the profit to allocate if the DEMPE functions are deemed permanent establishments of the employer in the country of residence of the functions. This would also be the case if the functions were employed (i.e., transferred) to an entity in their country of residence and deemed to not be a permanent establishment but are considered non-routine and thus should receive a share of the profit of their former employer.

DEMPE was designed to ensure that allocation of the returns from the exploitation of intangibles, and allocation of costs related to intangibles, is performed by compensating multinational group entities for functions performed, assets used and risks assumed in relation to their responsibilities. In cases that a multinational would have multiple cases of employees working remotely in a plurality of different countries, this could prove to be a complicated and burdensome endeavor.

For example, consider the following hypothetical facts: a multinational group with an intellectual property (IP) hub in Country X acquires another multinational with an R&D center in Country Y. The acquirer transferred the acquiree’s IP into Country X’s IP hub, which manages and controls R&D globally. Several of the top R&D directors in Country Y were relocated to Switzerland following the acquisition. Post COVID-19, however, these directors now work from their Country Y homes or even at the R&D center in Country Y. It would be an uphill battle to convince the Country Y tax authorities that Country Y should not receive a share of non-routine profit.

As is the case with many other challenges caused by the pandemic, the expansion and permanence of remote working will also potentially change the transfer pricing and tax landscape on where value resides and how to allocate profit. One of the tenets of the BEPS project was to ensure that transfer pricing outcomes are better aligned with value creation in multi-nationals. The focus was on the contribution by entities within a multinational’s group, but now with the effects of the pandemic, it could be extended to functions spread across multiple countries where a multinational may or may not have a legal presence.

Read The Compensation of DEMPE Control Functions in Post-BEPS Transfer Pricing

 

Sources
¹This is the Future of Remote work in 2021, Forbes, December 27, 2020
²OECD/G20 Base Erosion and Profit Shifting Project – Aligning Transfer Pricing Outcomes with Value Creation, Action 8-10 – 2015 Final Reports
³Danish Customs and Tax Administration, Tax Council Decision No. SKM2021.412.SR