Your task as the treasurer of a multinational is to secure that the business has sufficient cash available at all times, against minimal financing costs. The OECD’s Base Erosion and Profit Shifting (BEPS) Project will make managing net financing costs even more challenging. These are the 3 steps treasury wants to take to deal with the challenges successfully.
A holistic approach, in which treasury first seeks to understand the BEPS effects, then quantify the effects and finally optimize them, is highly advisable. A holistic approach will not decrease the complexities of BEPS. It will however endorse good decision-making and allow optimization of treasury results, albeit perhaps with less ecstatic tax savings than in the past. These are the steps:
1. Understanding BEPS effects
As a first step, the treasurer should seek to understand where BEPS hooks up with treasury. In accordance with its task to ensure minimal net financing cost, treasury should first understand which measures impact these costs. The model below shows how the various measures under BEPS affect net financing cost and how they relate to the economic drivers of finance costs.
2. Quantifying BEPS effects
In the second step, treasury should quantify the BEPS effects on net financing costs in a financial model. This enables to establish the new net financing costs level and to set the “zero position” for future optimization. Taking a holistic approach means that treasury should look at the firm-wide total net financing cost as the quantitative measurement and include transaction costs, such as the cost of maintaining corporate structures.
This approach allows to improve value trade-offs that must be made when it comes to optimizing the net financing cost through tax planning. For example, a business recently chose local bank finance over centrally arranged internal borrowing, although bank finance initially appeared more expensive. The bank net financing cost, however, turned out to be lower than internal borrowing if withholding taxes, interest deduction limitation and transaction costs were accounted for.
The holistic approach will reveal hidden drivers of financing costs and will endorse sensible decision-making.
The treasurer should also consider the time factor by analyzing multiple years rather than only the current year: an operating company may suffer EBITDA limitation in the current year, but may be allowed to carry forward un-used deductions to later years. Negating that effect may entice re-directing financing flows at significant transaction costs, with negligible impact on net financing costs.
Holistic approaches do not mean that every detail requires analysis. Instead, regularly testing sensitivity of all relevant drivers to the overall net financing cost will secure a focus on drivers that really matter.
3. Optimizing BEPS effects
Once treasury knows the new level of net financing cost, it may start optimization. For example, where a treasury company lacks sufficient economic substance to have financial income allocated to it under the new transfer pricing rules, it is worthwhile considering to either re-locate the company to where actual risk management is executed, or re-locate decision-making staff to the company location. Again, treasury should take into account all drivers of net financing costs and should focus on longer term effects of optimization efforts.
In case of staff re-location, not only the direct re-location costs should be calculated, but also the effect on people retention and future recruiting should be considered. In less far-reaching optimization efforts, however, time plays also an important role: fairly simple adjustments to internal debt arrangements, such as extension of loan tenures, may optimize interest rates and push up future EBITDA carry forwards with significant longer term effects.
Self-evidently, treasury should execute the whole exercise in close co-operation with the tax department. Taking a holistic approach that focuses on the aggregate effect of all optimization efforts on net financing cost will secure that the project does not fall into the typical expert trap, in which intellectually exciting exercises absorb all attention with negligible financial effect.
Finally, managing BEPS is a continuous effort, as both economic drivers and tax legislation keep changing constantly.