The economic shock of the pandemic will leave an enduring mark on companies across all industries, including technology. However, some technology subsectors such as software as a service, container as a service, health tech, and cybersecurity could see robust growth amid this otherwise perilous economic environment. The Organisation for Economic Co-operation and Development’s recent decision to delay its proposed measures on digital services tax to G-20 until later this year may be a blessing in disguise for the technology industry. Here are some cash flow and tax strategies for all types of international technology companies, whether they are faring well or struggling in the current economic environment.
Immediate considerations for global technology companies
- Cash repatriations to aid liquidity. Foreign subsidiaries of U.S. technology companies operating on a consistent profit margin—such as research and development hubs, service resellers, or royalty or license collectors under back-to-back royalty arrangements in foreign jurisdictions—may have accumulated a significant amount of cash that could be available for repatriation.
- Often the subsidiaries’ accumulated earnings have already been taxed in the United States under section 965, subpart F or the global intangible low-taxed income provisions, and as a result, these earnings may be remitted without triggering additional U.S. federal income. Foreign withholding tax may still apply upon actual distribution of the earnings.
- To avoid withholding taxes, consider a cross-chain sale of foreign subsidiaries. In some cases, a U.S. parent of multiple foreign subsidiaries can sell one foreign subsidiary to another for cash effectively resulting in a repatriation of cash from one of the subsidiaries, potentially free of foreign withholding tax.
- Pledge the stock of foreign subsidiaries. U.S. companies can pledge stock of foreign subsidiaries that own valuable assets to securitize loans. Following the Tax Cuts and Jobs Act, U.S. corporations can now pledge the stock of foreign subsidiaries without triggering federal income tax.
- Local country tax relief. Many foreign countries also offer pandemic-related economic support packages. Technology companies with foreign subsidiaries may take advantage of immediate credits or payment deferrals related to payroll, withholding tax on payments such as royalties, license fees or payments for services.
- Intercompany royalties, license and service fees. There may be opportunities to make immediate changes to intercompany payments and/or other recharges that could affect a company’s cash flow. For example, the royalty payments may be disrupted in one or more markets due to the pandemic justifying reduced or no royalty payments. Similarly, downward adjustments to intercompany services payments for routine functions should be made now rather than after year-end, as retroactive adjustments can be extremely difficult or permissible in some jurisdictions.
- Immediate value-added tax relief
Tax authorities worldwide have announced efforts to provide companies relief, ranging from deferring tax filing and payment deadlines to suspending penalties and expediting the repayment of refunds. Tech businesses should take advantage of VAT-related opportunities while continuing to timely report and pay import VAT and customs duties (e.g., 13th Directive refund claims in the European Union). Other opportunities for potential relief include:
- Submitting repayment VAT returns as soon as possible
- Applying for EU VAT refunds early (commonly seen where servers are imported into a country)
- Shifting to monthly returns to expedite refunds
- Applying for deferment accounts and customs warehousing
- Considering accruals for VAT on purchase invoices dated in a certain period but processed after that period
- Issuing invoices to customers early in a VAT period or when payment is expected
- Renegotiating the payment schedules where possible, to ensure VAT is not overpaid
It may be that some tech businesses have seen increased activity and revenues from new jurisdictions in light of shelter-in-place requirements around the world. Tech businesses should closely monitor all jurisdictional expansion to sales as they can create VAT registration obligations, particularly in the case of business-to-consumer digital services.
Opportunities for tax liability reduction or optimization and risk management
- Recalibrate profits and losses. Review of supply chain and intercompany transactions will be necessary to recalibrate global profit or loss allocations and potentially push profits or losses to jurisdictions that can produce the most tax benefit. For example, where a parent company incurs losses, there may be an opportunity to reduce profits of subsidiaries previously operating at a set profit margin, or push losses to the parent jurisdiction where generous net operating loss carry-back opportunities exist. RSM’s national transfer pricing team has developed an algorithm that supports pricing adjustments for distributors and manufacturers in 2020 based on the impact of the last global recession from 2008 to 2009. The algorithm results are agnostic across different regions (i.e., North America, Asia and Europe) and can support immediate adjustments for transfer pricing.
- Review of compliance obligations. Review changes to business processes and how they affect compliance with intercompany payments, associated withholding taxes, VAT registration and compliance.
- Permanent establishment risks. As a consequence of the worldwide sequestration, tech company employees may be temporarily stranded in locations other than their home sites, unintentionally creating permanent establishment exposure in the jurisdiction where they are sheltering in place. Many countries and the OECD have issued guidance providing relief from the creation of accidental or temporary permanent establishment. Nonetheless, tech companies should take note of displaced employees and assess the permanent establishment risk, especially if the tech business remains profitable during the pandemic. Not all countries may adhere to OECD guidance and those that do not may see an opportunity to increase their tax receipts by pursuing pandemic-induced permanent establishments.
- Tax incentive and savings planning. Many technology companies have increased their innovation and research and development spending in response to the current economic environment. Understanding which jurisdiction offers the most advantageous R&D tax incentives, which jurisdiction is best to host developed intellectual property, and where profits from the exploitation of newly developed IP should be located can provide long-term opportunities. For example, whether the foreign-derived intangible income tax incentives provide a greater benefit than reduced GILTI inclusions may be discerned through financial modeling.
While the COVID-19 crisis has created enormous economic challenges, it may also give companies a chance to address cash flow concerns and consider potential tax savings and cash-tax optimization strategies. For businesses faring well in this environment, it is imperative to align tax strategy with business and operational needs. RSM’s international tax team can provide comprehensive and efficient services to all sectors of the technology industry.