How the push for digital tax consensus could upend transfer pricing as we know it.
After a slow and tentative start, the OECD’s push for a solution on how to allocate and tax the profits from digital business is gathering momentum.
Following consultations, initial proposals from earlier in the year have now been crystallised into a twin-pillar framework and series of detailed options within it (referred to in this article as the ‘OECD programme of work’).
The G20 has endorsed The Organisation for Economic Co-operation and Development’s (OECD’S) roadmap for resolving the ‘tax challenges arising from the digitalisation of the economy’ (BEPS Action Plan One) and is committed to working toward a consensus-based long-term solution by the end of 2020.
While global consensus is clearly preferable to today’s fragmented approach to taxing digitally-derived revenue, the OECD’s search for a solution could end up heightening the risk of double taxation for all businesses rather than just Big Tech giants.
And under the reallocation of profits and minimum tax proposals that have emerged following a recent round of consultations, the arm’s length principle that has governed transfer pricing for decades could become obsolete, with all the upheaval that would result.
So, what does the OECD have in mind and what are the implications? Will the proposals survive the political realities of sovereign state control over tax policy, and the entrenched national interests that go with it?
You could also like to read
Next article
Updated on October 11, 2023
The franchise business model is very popular with Quebec entrepreneurs. The world of franchises does have special tax characteristics however.
This article presents a number of aspects that franchisors and franchisees should know to maximize their tax situation.
Tax treatment of advertising funds
For a new entrepreneur, the franchise business model offers the possibility of joining a network and brand that the general public is already familiar with. As a result, some advertising is often carried out for the franchisees by a central service coordinated by the franchisor.
Generally, the franchisees pay an annual contribution that is goes into an advertising fund. This fund is then used by cover advertising activities on behalf of the group.
Is the franchisee’s contribution to the advertising fund a deductible expense? What about the franchisor who receives the contribution?
The franchise agreement often provides information to better understand the franchisee’s and franchisor’s control of the advertising fund. The Canada Revenue Agency expressed its opinion in a technical interpretation (9819787 Redevances à recevoir, Fonds de publicité) to clarify the appropriate tax treatment for franchisors and franchisees.
The franchisor has no control over the contributions
When neither the franchisor nor the franchisee controls the advertising fund, contributions to the advertising fund are deductible expenses for the franchisees, since they are incurred to earn income. The expense is therefore deductible in the year it is paid or payable.
In the franchisor’s case, if the franchisor made a contribution to the advertising fund, the contribution is deductible, as it is for the franchisee. Since control of the advertising fund is not among the franchisor’s various obligations towards the franchisees, it can be concluded that, even though the franchisor receives the contributions, the franchisor is independent of the fund and the expense is deductible.
For the same reason, the contributions will not be included in the franchisor’s income, since they are not owned by the franchisor. It should be noted that, from an accounting stand point, transactions affecting the advertising fund are generally recognized exclusively on the balance sheet and have no impact on earnings.
The franchisor has control over the contributions
If, based on the facts of the franchise agreement, the franchisor controls the advertising fund, the franchisees’ contributions must be included in the franchisor’s income. Accordingly, if there is a surplus at year-end for future services, the franchisor could set up a reasonable allowance for advertising services to be provided after year.
Additionally, unlike the situation where the franchisor does not control the funds, the franchisor’s contributions are only deductible when the expenses are actually incurred. The franchisor’s contributions are, in fact, amounts reserved for future expenses and are therefore not deductible at the time the contribution is made. The tax treatment for the franchisees’ contributions is the same as in the first situation.
Royalties and management fees
Royalties and management fees are not exclusive to the franchise sector, but they are often an integral part of the franchise agreement.
Royalties are amounts which franchisees pay to the franchisor for the use of certain assets (e.g. trademarks, patents). For the franchisee, the royalty payment is a deductible expense and, for the franchisor, it is taxable income.
In a franchise situation, management fees are often charged for certain services which the franchisor provides to the franchisees (e.g. negotiations with suppliers, inventory management). Since management fees are often used in a corporate group context, the tax authorities often challenge them, particularly in non-arm’s length transactions.
Generally, for an expense to be deductible from a taxpayer’s income, it must be reasonable and incurred to earn income. The first criterion is usually easy to satisfy in a franchise context, because the franchisees’ business objective is to earn income to increase the business’s value for shareholders.
However, the Income Tax Act does not define what constitutes a reasonable expense. The tax authorities positions and case law in this respect provide a number of factors that can be considered in a reasonableness analysis. As a rule, the tax authorities consider management fees to be reasonable if they are representative of the fair market value of the services provided.
If the fair market value of the service is easily comparable, it can serve as a basis to support the reasonableness requirement. Additionally, when the franchisee and franchisor deal at arm’s length, it is more difficult to allege that the transactions would have been carried out at values that differ significantly from the fair market value, since the franchisee and franchisor have different economic interests, that is their respective business’s profitability.
Franchisors often offer a format where they take care of a number of administrative tasks. Combining these tasks often results in significant savings for the franchisees and allows them to focus on their current operations.
The franchisor can charge fees to the franchisees plus a maximum mark-up of 15%, which is usually considered to be reasonable.
The reasonableness of management fees is a question of fact that must be analyzed on a case-by-case basis to ensure that the franchisee can deduct the expense. Special care is required if the separate economic interests of the parties or whether they are dealing at arm’s length is not clear. Additionally, the franchisor should ensure that it has up-to-date documentation to justify the management fees charged.
This article was written in collaboration with Marie-Danielle Roy.
19 Aug 2019 | Written by :
Next article
Under the commodity tax regime, an individual is entitled to claim an input tax credit (ITC) with respect to the purchase of goods and services only if they are used in connection with commercial activities (i.e., in the provision of taxable and/or zero-rated supplies).
A holding corporation whose sole activity is to hold investments could, therefore, not claim ITCs on its expenses since it does not carry on commercial activities because financial services are considered to be an exempt activity.
However, Section 186 of the Excise Tax Act (ETA) provides that a holding corporation that does not make any taxable supplies may claim ITCs on goods and services to the extent it is considered that they were acquired for consumption or use in relation to the shares of capital stock or indebtedness of another corporation that is at that time related to it, if that other corporation carries out commercial activities exclusively (i.e. 90% or more).
Application of this provision has led to considerable discussion with respect to the question of whether a good or a service acquired by a holding corporation can reasonably be considered to be acquired for consumption or use in relation to the shares of capital stock or indebtedness of another corporation.
Next article
Private and public sectors are both entering the era of cloud computing. The security of their operations should be ranked among their top priorities.
Digital technologies create extensive data confidentiality and information system security challenges for both governments and businesses. However, these developments also offer numerous benefits.
Easier management
Implementing cloud technology is helping governments to improve business flexibility despite their back-end silo systems. This makes it easier for experts and stakeholders to collaborate.
Adopting cloud technology makes it easier for organizations and businesses to manage digital technology and IT security.
Security first and foremost
Operating in the field of cyber security requires the correct implementation of security standards and world leading best security practices to meet clients’ expectations.
Peace of mind in the cloud
What we are offering is similar to a car rental service. It’s simple and efficient and meets your needs, whereas owning a car requires additional costs: maintenance, new parts, etc. This adds costs, is time-consuming and, in the end, defeats the purpose. It’s the same for cloud migration technology.
Businesses and organizations do not want to allocate a complete department’s resources to create their own technology and servers, just as someone who only needs a car for a week of vacation doesn’t want to purchase a brand new vehicle.
You just need to access the technology and that’s what we are offering to the government. Easy, simple and secure. We take care of the security, so clients can focus on their core business.
Our in-house team members offer a completely holistic cybersecurity practice committed to delivering security solutions from system conception to disposal, safeguarding your most crucial organizational assets and enabling you to fulfil your obligations.
Our solutions
We offer cloud migration business services to governments and public companies. That includes unique methodologies, system architectures, communications and reports that quickly and easily put you in the picture, in detail and within the larger context of your operation, identifying gaps and risks, and proposing effective mitigation measures.
Our team of experts will help you solve your challenges by designing and implementing a matrixed, holistic cybersecurity program that meets your expectations.
About Raymond Chabot Grant Thornton Consulting Inc.
RCGT Consulting Inc. provides a comprehensive range of services. Our primary focus areas include: internal audits, cyber security, audits of contributions, digital forensics and forensic accounting, management consulting, and other general consulting services such as cost reductions and process improvement. Our client base includes the federal government, provincial governments, municipal sectors, universities and colleges, and medium to large enterprises.
09 Jul 2019 | Written by :
Marco Perron is a Partner at Raymond Chabot Grant Thornton. He is your expert in assurance for the...
See the profile