The challenges of ESG, sustainability and transfer pricing
by Nico Demeyere
Many companies consider it important to be sustainable, taking into account the Environmental, Social and Governance (ESG) objectives set by various international organisations and NGOs. This is a set of non-financial objectives that a company seeks to meet in order to contribute to the society in which it operates. Financial and large listed companies will be required to report on how they are meeting their ESG objectives, in addition to their financial performance. This will be a major challenge for many companies.
New intra-group services may be created, existing arrangements may need to be amended or restructuring may be required. Transfer pricing should not be overlooked in this process. Transfer pricing is the pricing of services or goods between subsidiaries of the same parent company.
Transfer pricing
Implementing an action plan to achieve ESG goals also has a number of tax implications. For example, one of the objectives is to pay taxes fairly. A coherent transfer pricing policy that complies with the arm's length principle is an important element of this. A correct transfer pricing policy should result in the company's profits being effectively taxed in the countries where it has its main activities.
Central ESG department
Achieving ESG objectives requires an overall strategy defined at the group level. To ensure a coordinated approach and follow-up across all group companies, some groups decide to set up a central ESG department. This department then provides a service to all group companies. A market-based fee should be charged for this service. This fee should also be calculated using traditional transfer pricing methods. If group companies benefit from the service, a service fee should be paid. Depending on the importance of ESG to the group, this will be a support service or more likely to be considered strategic management advice. The more important ESG is to the company, the higher the service fee will be.
In some cases, the ESG department may only be responsible for reporting at group level. In such a case, the tax authorities may take the view that there is no benefit to the group companies, but that there is a transfer of so-called shareholder costs. These are costs arising from obligations imposed on the group as a shareholder. The OECD Transfer Pricing Guidelines state that such shareholder costs cannot be passed on.
Restructuring
Producing in a new, more sustainable way may require restructuring. For example, centralising production in one location to avoid CO2 emissions from transporting semi-finished products, or resourcing activities because a supplier cannot guarantee to meet ESG targets. We sometimes see valuable know-how or intellectual property rights being transferred as part of these internal shifts. In this case, there may be restructuring from a transfer pricing perspective. Again, due care must be taken to ensure that the transfers are made at arm's length. Furthermore, significant internal restructurings should normally also be reported in the transfer pricing documentation.
Do you have any questions about ESG or transfer pricing? Our experts will be happy to tell you all about it!
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Nico Demeyere
Manager International nico.demeyere@vdl.be
Disclaimer
In our opinions, we rely on current legislation, interpretations and legal doctrine. This does not prevent the administration from disputing them or from changing existing interpretations.
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