Vol 6 (2009) - Issue 3

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Cash Generation Through Tax Policy

With recent turmoil in the world’s financial markets, liquidity has become the key priority for most businesses. We are witnessing increased focus on cash flow, cost reduction and revenue enhancement amongst distressed businesses, as well as healthy ones – this is likely to continue for some time. This article considers options available to certain groups that will assist in achieving cash flow savings through tax policy.

Transfer pricing

In 2008, the UK Confederation of British Industry (CBI) referred to transfer pricing (i.e. internal prices charged in relation to transactions between associated groups) as one of the most significant burdens facing business. However, there are many opportunities to generate cash through transfer pricing policy, such as through the following:

a) Acceptable pricing methodologies (most jurisdictions apply the 1995 OECD Guidelines for Multinational Enterprises and Tax Administrations) can be deployed to achieve operational efficiencies and cash generation. Revenue enhancement is a critical issue for groups operating in the most buoyant of markets and more so in the current climate; improving service to sales and optimising intellectual property management and growth are receiving due attention. Entrepreneurial transfer pricing methodologies (in the most basic example, a vanilla return on sales or commission based methodology to reward a particular division or company) can assist with incentivising individuals to follow best practice corporate behavior and to enhance revenue. This should be factored into transfer pricing reviews in addition to compliance with regulatory guidelines.

b) Aligning acceptable transfer pricing methodology with operational cost control – this would involve educating divisions to understand the cost base (for example, with divisional profit and loss reporting that enables relevant costs to be recorded and optimised). The selection and implementation of appropriate pricing structures provides the opportunity for this initiative.

c) Control over tax spend – this can be achieved by leveraging in-house resources and by demanding more from external advisers. In addition to this, the new ‘behavioural’ penalty regime in the UK will enable groups (at least in the short-term) to make a reasonable and proportionate attempt to comply with the legislation as opposed to commissioning an onerous review that will tie up management time and increase tax spend.

d) Many groups are looking at ways to repatriate or transfer cash for deployment to areas of necessity around the group. Intra-group injections of loan capital have historically provided an effective mechanism for repatriation; however, the UK applies an ‘independent lender’ test and corresponding interest deductions (or receipts) on intra-group capital will be restricted (or imputed) where it cannot be shown that an independent or third-party lender would enter into the same injection on the same terms. This is problematic in the current environment in which third-party lending is not readily available – requiring academic pricing of debt, which can be viewed by the tax authorities as highly subjective. Many groups are forgoing interest deductions on intra-group leverage today with a view to refinancing at a later date in a more favourable market. However, there are economic tools that can be applied to demonstrate that it would be reasonable to claim an interest deduction at arm’s length and improve the cash position of the group.