A multitude of tax issues can arise from secondment arrangements.
New UK rule creates transfer pricing challenge
by Arthur Mendoza
Summary: Transfer pricing issues arise when companies send an employee on assignment from one group to another temporarily. You can avoid certain tax consequences if you pay close attention to the work arrangement description.
Given the complexity of the issues around secondment arrangements, companies should review their international secondments from various tax and transfer pricing perspectives to ensure that the position taken for one area does not internally contradict the position taken for another area.
What is a secondment?
Definition: A secondment refers to the deployment of an employee from one related party (i.e., home employer) to another related party (i.e., host employer) on a temporary basis. Many financial services organizations use secondments to fulfill various resource needs within the company.
A seconded employee, or expatriate, typically does not change payrolls, in part to accommodate various non-tax employment concerns of the employee. Instead, the host employer reimburses the home employer for the expatriate’s employment costs.
A multitude of tax issues can arise from secondment arrangements, including employment, corporate and international tax issues1 such as transfer pricing.
How does cost allocation impact transfer pricing tax regulation?
Based on transfer pricing regulations, the home employer may be required to cross-charge the expatriate costs to the related party benefiting from the expatriate’s activities.
Who benefits when an expatriate comes to a new post?
Depending on the work completed, those benefiting from the secondment may be:
- Host employer
- Home employer
- Both the host and home employer
- The home office only if the expatriate’s activities are deemed to be in the nature of stewardship for the overall organization.2
The transfer pricing allocation of expatriate costs will depend on the facts and circumstances of the secondment. Key items to consider include:
- The purpose of the secondment; whether there is an “embedded intangible” for high-value functions
- Working out the recharge, what costs can be included under local tax law
The transfer pricing allocations can be complex, due to the underlying structure of expatriate compensation. Many companies offer equity compensation and stock options to employees. This equity compensation is part of overall employee costs and must be considered for purposes of transfer pricing allocations. However, certain taxing authorities may disallow the deduction of stock options under their local laws.
The impact of local tax authorities
If the expatriate’s costs exceed those of a comparable hire in the country of the host employer, the secondment may be deemed by tax authorities to implicitly benefit the home employer because there appears to be a premium associated with the expatriate’s activities.
This may result in a non-deductible portion of the expatriate’s costs for the host employer. This situation arises under rotational assignments where a home employer is in an economic region with a higher standard of living than the host employer.
Under rotational assignments, employees of a home employer are regularly sent on secondment for the purpose of learning a particular trade or skill-set by performing a standard job function while with the host employer.
Market benchmarks are generally available under rotational assignments because local hires perform similar tasks. Consequently, it may not make much sense for a host employer to pay more than these market benchmarks.
Alternatively, there may be no market comparables for an expatriate with a specific set of skills and experience in the country of the host employer. This may be the case under secondments of more experienced professionals that fill a specific business need of a host employer.
If someone with a similar skill-set and experience cannot be hired from the local market, the host employer may be able to bear all expatriate costs relating to the secondment, including moving and relocation costs.
Is your secondment arrangement a service contract or something else?
Another key consideration for transfer pricing purposes is whether the characterization of the secondment arrangement (i.e., supply of staff) can be sustained or could instead be re-characterized as an intercompany service (i.e., supply of service).
Note that the basic structure of a secondment arrangement is similar to an intercompany service in that the employee remains on the payroll of the home employer/service provider while conducting activities that are related to another related party (i.e., host employer/service recipient). Although based on similar facts, the ultimate characterization of the arrangement would have a profound effect on the transfer pricing analysis.
For example, an intercompany service arrangement may warrant an additional markup on the employee’s costs or the application of some other transfer pricing methodology that may attribute a greater return to the service provider. The characterization of the arrangement depends on a number of factors, including:
- Which entity benefits from the arrangement
- Which related party exercises control of the employee
- The contractual form of the arrangement among the related parties and the employee
Should you be concerned with permanent establishment risk?
Another important tax issue to consider is whether the secondment may give rise to a potential permanent establishment (PE) of the home employer in the country of the host employer, thereby bringing a portion of the home employer’s business profits into the tax net of the host employer’s jurisdiction.
The mere fact that an expatriate remains on the home country’s payroll while conducting activities on the soil of another taxable jurisdiction warrants some PE analysis. Certain secondments, however, have greater PE risk than others. For example, certain expatriates may conduct activities that may be deemed to be preparatory or auxiliary in nature according to the OECD model tax treaty,3 potentially mitigating any PE risk in the host country.
However, other expatriates may have management-level responsibilities across geographies, resulting in greater PE risk. A potential PE exposure can arise if those responsibilities bind the home employer in a trade or business while in the country of the host employer.
Under some countries’ rules, a PE can be established through the provision of management services. Prudent management of these secondments would provide operating guidelines to these types of expatriates to mitigate the potential PE risk.
Are your VAT charges subject to reverse charge?
According to the UK’S value added tax a (VAT) rules, effective 1 January 2010, all cross-border supply of service arrangements (with some minor exceptions) are subject to reverse-charge VAT in the country of the European Union (EU) service recipient. For many financial services companies, some of the VAT may be non-recoverable.
An EU home employer, however, should not charge any VAT on activities typically associated with expatriates under supply-of-staff arrangements. With respect to non-EU service providers or home employers, the position depends on local VAT rules. Thus, there could be cases of double taxation.
1 Spielman, C.and Kovalchuk, T.,“Accidental Expatriates May Present Various Tax and Non-Tax Issues.”
2 See Treas. Reg. §1.482-9(l) for the US Internal Revenue Service’s (IRS) latest definition of stewardship.
3 Organization for Economic Co-operation and Development’s Report on the Attribution of Income to Permanent Establishments, Part I, para. 1, 2008.
