Companies demand sustainable TP policies, which is as simple as ESG

According to three tax directors from Europe, multinationals must link their ESG and TP policies with current global sustainability initiatives.

According to internal and advisory sources, multinational corporations should assess their intra-group agreements to make sure their transfer pricing plans are compliant with environmental, social, and governance policies.

Companies are becoming more aware of the crucial contribution of these commitments, including their impact on value chains and profits, in the context of a global push by governments, investors, and the general public to focus more on ESG issues.

According to Krishna Gupta, global head of TP at the Dutch health and wellness business DSM, multinational corporations need to immediately examine their intra-group contracts in order to include ESG clauses. 

"For us, this is a regular practice that we have, so we always have a sustainable tax approach built into how we do things," he claims.

Other tax directors who emphasize the necessity for businesses to begin with policy coordination share these opinions.

Companies should start immediately by harmonizing their TP and ESG policies. According to Steven Ouwerkerk, head of tax at loyalty marketing company BrandLoyalty in the Netherlands, they should regard ESG as a value-add for their organizations rather than as a risk.

Regarding the requirement for a shift in thinking and viewpoint among tax professionals, Ouwerkerk states, "It’s not just about tax control, but a tax value framework."

Multinational corporations should consider how their ESG strategies align with their business models as the first step in revising their agreements.

According to Gupta, a company's business or TP model, as well as the location where significant ESG choices are made, strongly influence whether social and environmental norms are included. The majority of sustainability projects and the associated costs fall under the purview of head office in centrally managed organizations.

He continues, "ESG-related activities also enhance the global brand value of an organisation and I see this as a central [business] issue."

The profitability of the local organization or the primary company brand should be taken into account when contemplating decentralized business models.

"All these things need to be considered before saying that costs should be centralised or allocated to different entities and what kind of clauses must be put in the [intra-group] agreement," according to Gupta.

Alternately, if the domestic business was involved in the decision-making process for developing the ESG strategy or reorganizing group operations, expenditures might be attributed to the local organization. The group is likely to be entitled to the revenues and expenditures, nevertheless, if the local business is not involved in making policy decisions.

It is impossible to exaggerate how important these concerns are for MNEs because they might seriously harm all of their entire value creation mechanisms.

Whether or not there is a quantifiable gain, according to Matthias Herrmann, TP specialist at German transportation firm Imperial Logistics International, ESG has economic implications that must be properly allocated.

Herrmann advises treating ESG projects "equally to marketing because it potentially betters your reputation and market position towards customers that pursue and advertise ESG initiatives themselves."

What changes the firm is experiencing as a result of the ESG strategy is another important issue to consider.

It is vital to evaluate how ESG regulations have a cascading effect that modifies a company's value chain and necessitates the modification of intra-group contracts.

When performing an impact study, there are a number of factors to prioritize: 1) The group's ESG strategy; 2) The TP impact associated with the ESG strategy; and 3) whether the company’s cost remuneration policy is still relevant for its needs.

According to a TP consultant at a large four corporation in Luxembourg, modifications to sustainability standards that result in altered value creation can result in higher profits or significant cost savings for organizations.

According to her, this forces companies to decide whether to allocate those higher profits or lower costs. Typically, this entails determining whether the local entity or the group is to blame for the profits or losses.

After conducting this analysis, businesses are better able to understand the risk profiles of the parties involved and what needs to change in response to the ESG strategy.

She continues, "If the entity decides on a local ESG strategy, it may switch from a cost-plus remuneration model to a profit split, for instance."

ESG concepts have been eagerly adopted by several businesses. The problem, though, is that only a small number of companies have actually implemented these steps in their operations.

Regarding companies that have taken the lead in accepting ESG issues and integrating them with their TP norms, the big four consultant in Luxembourg said, "There are some pioneers, but as a general trend it’s still at an initial stage."

Herrmann claims that as part of a current alignment of multiple group TP rules, his organization is beginning to review charges and TP inside its group.

In the course of this alignment, "we will definitely handle ESG and other related programmes the parent entity has in place over the next three months," he says.

During the budgeting process, he advises multinationals to assess and attempt to align their TP, ESG, and other charges on an annual basis.

"If there are ESG initiatives in place then just collect all the documents to be prepared as best as possible for what the tax auditors make of them. But I imagine it could be hard to defend [the fees] ," he adds.

ESG, according to Herrmann, is an intangible because it has the potential to affect a company's reputation. He does, however, draw attention to the challenge of estimating the advantages of such activities.

Regarding notoriously strict German audits, he says, "Auditors always ask what the benefit [of ESG] is for the single entity and how you price it."

However, it appears that not all auditors are as strict.

According to Gupta, there have not been many difficulties for his organization when conducting audits. This is due to not cherry-picking data based on specific years and keeping a high level of consistency in the quality of its information.

He claims that the company has reliable practices in place for document storage that supports its transactions.

The business model of a corporation should be tightly matched with its TP policies. According to Gupta, organizations should retain this connection instead of taking actions that merely benefit tax efficiencies or benefits.

The danger of a worldwide economic collapse makes it more difficult for corporations to retain strong ties between their business models and TP policies.

Companies wanting to apply ESG requirements face both a difficulty and an opportunity as a result of the current geopolitical unpredictability.

Particularly in the current economic context, several businesses adopt these techniques as a way to cut expenses through reduced energy, transportation, waste, and resource utilization.

Herrmann claims that his company has started steps to reduce its carbon footprint, including buying more environmentally friendly trucks and adopting renewable energy as a fuel source.

He continues that there has recently been a big emphasis on encouraging diversity and gender equality inside the organization.

According to him, "These [ESG] ideas come from the holding company, and we then have it potentially charged through the usual management or administrative service fees."

He does, however, voice some apprehensions over how the German tax authorities would respond to these costs during audits: "Service fees are always difficult to defend, especially in German tax audits."

It might be argued that the growth in ESG programmes should be included in the service fees since it is an additional payment made by the group entity to its local entity, he continues.

These strategies are employed by other businesses to get a competitive edge and increase earnings. This is accomplished by taking steps to draw in additional clients, such as raising brand recognition and boosting client loyalty.

Companies must examine their intra-group agreements, but it is unlikely that everyone will find the process simple. It might necessitate extensive analysis, considering frequently complicated and occasionally conflicting possibilities.

But even if it is just for the sake of a long-term, sustainable future, every company should go through this procedure.

By fLEXI tEAM