Automotive Original Equipment Manufacturers (OEMs) and their suppliers face major hurdles as their industry continues to transform under the weight of technological disruption, government protectionism policies from the United States (the world's largest automotive market), evolving government views on taxation (including transfer pricing) and new regulations.
Although there's no telling what the future will bring, history indicates that the companies that prepare best for such changes, while also controlling costs, will be the most successful in the end. With that in mind, it's imperative that automobile companies be aware of, and reactive to, the big-picture issues shaping their industry - all of which come at a steep cost.
Record vehicle sales around the world have been motivated, in large part, by expanding global trade agreements that make the buying and selling of automobiles relatively easy. However, increasing government protectionism — notably the U.S. stance on automobiles in the recent NAFTA negotiations, President Trump's view on auto imports from the European Union and Brexit — have thrown into question the free flow of automobiles across international borders.
The Brexit negotiations, for example, have injected much uncertainty into the United Kingdom's auto industry, which may result in some automobile companies relocating their U.K.-based plants elsewhere. However, given the cost and complexity of redistributing manufacturing resources (e.g., property, plants, equipment) across international borders, OEMs would be advised to first examine what changes they can make to reduce the burden of import/export duties should these increase as a result of political changes.
Taxation and transfer pricing
In addition to trade issues, automotive OEMs need to be cognizant of how government finances impact tax policy. Every company must, of course, contend with the cost of taxes. However, as more and more countries face growing deficits, their tax authorities are looking for ways to not only maintain their tax base but also increase their share through more aggressive tax compliance audits.
In the automobile sector, international trade transactions between related parties can create a conflict of interests between companies and tax authorities. For companies that trade across borders within their related group, taxes become an important consideration when tax rates differ materially. Automobile companies naturally tend to want to report more profits in lower tax jurisdictions by placing more functions, assets and risks in such locales. However, automobile OEMs are facing increased audit risks from governments with respect to intercompany profit allocation.
Entities dealing across borders with related parties must face the issue of transfer pricing, which involves the sale or transfer of goods, services and intangibles (such as know-how and trademarks). Most countries have mechanisms to deal with transfer pricing and, in general, follow principles established by the Organization of Economic Cooperation and Development (OECD). These principles, which have been incorporated into the laws of each country that adheres to them, establish where income will be taxed.
In recent years, the OECD has concentrated its efforts on eliminating base erosion and profit shifting (BEPS) to lower tax jurisdictions. New guidelines make the transfer of profits to low tax entities more difficult; however, opportunities still exist without overly aggressive tax planning.
Product/technology development, manufacturing and marketing/distribution
Automotive OEMs are chiefly rewarded for three main activities: product/technology development, manufacturing and marketing/distribution. Transfer pricing becomes an issue when at least one of these activities occurs in a different country than the others. In some cases, these activities are undertaken in many countries, making the allocation of profits even more complex. Add to this mix the acquisition and/or development of very specialized technology and the "legal versus economic ownership" question becomes all the more intricate. Despite these obstacles, where tax is concerned, it's important to know who will report the profits or losses from the technology — and it may not be the legal owner.
Manufacturing automobiles, trucks and the associated parts typically involves large investments in property, plant and equipment — all of which are not easily moved across borders. Accordingly, if governments make changes to import/export duties OEM's will need to examine their product flows to ensure it's cost and tax efficient.
Distribution and technology activities are generally easier to move or assign to another jurisdiction, but this still requires careful planning. Current platforms for distribution and technological development may be well established in a particular country; however, with the current speed of change and the need to acquire new technologies there are increasingly opportunities to reduce tax costs and mitigate the impact of duties.
The location of the technology ownership, along with the ongoing activities related to the technology, will impact where corresponding profits must be reported. These factors also form part of the domestic value of the car for duty purposes.
With respect to distribution, marketing activities tend to be more flexible and allow for some opportunities to shift activities, costs and benefits.
With a general rise in populist sentiment around the world, multinational automobile and truck manufacturers (along with their parts suppliers) are considering where to locate their functions and assets, and which parties will assume the various risks. All of these factors go into determining where the costs and profits from developing, manufacturing and selling cars will be reported and their corresponding taxes paid. The new USMCA does not appear to change materially the provisions within NAFTA (as it applies to Canadian automobile manufacturing and sales) however the difficult negotiation process and the possibility of U.S. tariffs under the guise of national security should give automobile OEM's pause to examine their operations in respect to cross-border transactions.
Gowling WLG works with automobile and truck OEMs, as well as parts suppliers that support OEMs, to help them establish favourable business and tax solutions. Leveraging their deep automotive industry experience, our professionals regularly advise clients on efficient tax planning strategies tailored to reduce costs and tax exposure, avoid lengthy and costly income tax audits, and ensure that all legal issues are addressed.