The Value of Cost-Allocation Drivers17 May 2023
As winter has turned to spring, I’m suffering from skiing withdrawal. While skiing in Vermont this winter, first time using a Mega Pass to multiple resorts, I couldn’t help but think about how the large multinational company that owns the various mountains—for the sake of anonymity, let’s call it Mega Mount Corp—handles its transfer pricing. What kinds of intercompany transactions does it have? How does it price them at arm’s length?
For those readers who have not been to Mega Mount’s resorts, the level of technology is remarkable. Gone are the days of wearing your paper lift ticket on your jacket as a badge of honor. Now the lifts have RFID gates that scan your lift ticket RFID card and portable RFID guns that employees use to scan skiers’ cards while they’re in line.
Granted, this probably isn’t what most skiers are thinking about while preparing to swish down the slopes, but I’ve just identified at least two potential intercompany transactions—the allocation of HR costs and IT costs from Mega Mount HQ to each property (each of which is a separate legal entity, according to their 10Ks). As with most MNEs, there are centralized costs associated with managing those employees’ benefits and recruitment, and a centralized technology team that develops and maintains the software that makes the RFID pass system run. These costs should be allocated to each property, and the question becomes how to do so in a fashion that is representative of the value, or benefit, that the services provide. Often in transfer pricing, we focus on the mark-up we should apply to services, but the selection of driver of the cost allocation is arguably even more important to be able to justify the arm’s length nature of the transaction to tax authorities.
With this in mind, there is flexibility in what MNEs can use for drivers, as long as they can justify that the drivers do indeed represent an arm’s length representation of the value provided. For HR charge allocations, MNEs usually use a driver such as the headcount supported at each entity. But Mega Mount might also consider the employee-hours being supported at each property. What I learned this year is that many employees such as instructors and information ambassadors at the resorts are part-time—retirees who love to ski free and earn a bit of money at the same time. By allocating central HR costs by employee-hours supported, rather than pure employee count, Mega Mount wouldn’t artificially inflate the cost to a resort that primarily employs part-time people, rather than full-time people. Either way, Mega Mount has a sound driver they can support to tax authorities.
For the technology charges, there are likewise multiple drivers that Mega Mount can use. Our first inclination is to allocate based on the number of scanner guns and RFID gates that must be supported. But instead, an alternative may actually be the number of patrons that are scanned each day/week/month at each resort. Either approach can certainly be justified.
Tax professionals at MNEs must take drivers seriously, as they have a significant impact in the costs that are being allocated. And more importantly, we must always remember that there is room for flexibility and creativity in selecting your cost-allocation drivers, as long as your goal is to pick drivers that truly represent the value being provided in the intercompany service.