David Brightman is director of marketing at BlackLine, a software company that develops cloud-based services that automate the financial close process. He is also a chartered accountant with the ICAEW. Views are the author's own.
Most organizations see intercompany financial issues as a zero-sum game because they are effectively buying from and paying themselves—a common analogy is to move money from your left pocket to your right.
In reality, it is not so simple. For multinationals that deal with millions or billions of dollars of intercompany charges, various complexities—process, tax, and regulatory—can wreak havoc on an enterprise’s performance. Reduced operational productivity, tax leakage, and diminished statutory positions are just a few of the costly challenges arising from intercompany issues.
This article explores a new approach to those issues called Intercompany Financial Management (IFM) which multinational corporations are using–or should be considering–to automate and better manage their intercompany financial transactions.
One of the greatest pain points of intercompany billing is the process itself, which is undeniably manual and loaded with risks. Organizations growing at a global scale can’t afford to get it wrong. Of intercompany professionals recently surveyed by Dimensional Research, 43% said they were at risk of an SEC investigation, and 38% responded that the potential for tax penalties negatively impacted their overall business outcomes.
When organizations have individual entities based in several countries, and all those entities interact, the accounting and tax landscape quickly becomes complicated. While tax laws vary widely by country or region, they also vary by type of service rendered, and tax authorities expect internal transactions to be treated with the same design rigor and diligence as transactions to unrelated parties.
The greater scrutiny from jurisdictional authorities puts more pressure on multinationals to move up the defensibility scale and toward more financial transparency concerning the composition of underlying costs. For many, intercompany transactions are already enormous, with total dollar volumes reportedly a factor of 10 or more of external revenue. With cross-border mergers and acquisitions (M&A) on the rise, finance organizations need to connect the strands of intercompany transactions quickly and accurately across a spaghetti-like architecture.
Avoiding tax, pricing missteps
Not managing intercompany transactions properly means a company might fail to spot transfer price markups occurring on the same charge based on the charge’s pass-through nature, resulting in double or even triple transfer pricing markups. Or a flawed process could result in base erosion and anti-abuse tax, known as BEAT, a punitive tax in the U.S. simply because an entity outside the country isn’t aware that such taxes exist or how to avoid triggering them.
While it’s common for global companies to consolidate intercompany costs in one country, then allocate them to the entities involved, that approach can result in a 10% BEAT tax in the U.S. On a $1 million transaction, the resulting $100,000 penalty might not immediately get attention. But if it happens on multiple transactions, the costs can become quite steep.
Having oversight of the intercompany function enables a company’s financial executives to spot these escalating costs and alter the process to avoid BEAT penalties and the costly loss of a tax deduction.
Automating to a clean close
IFM is a new and holistic approach that expands further afield within finance. Combining business process re-engineering with technology, IFM integrates, orchestrates, and automates multi-functional intercompany processes and transactions. It is designed to prevent messes at the critical close period by netting out intercompany balances in real-time while reducing global compliance and tax risks.
Companies can now automate the intercompany reconciliation equation and reduce up to 90% of valuable accounting hours on financial closing processes. They can also improve operational efficiencies by unifying and optimizing intercompany accounting, vendor invoicing, tax enrichment, reconciliations, settlements, and journal entry booking.
While accounting is an obvious benefactor, tax, FP&A, and treasury workloads are now optimized. Tax teams can stay abreast of increasingly complex tax and regulatory environments on the horizon while increasing indirect tax deductibility, minimizing tax leakage, and hardening tax compliance and defensibility.
Intercompany is, on average, close to 50% of a company’s total liquidity. The opportunity is ripe for leaders to take steps to gain real-time visibility to cross-country netting rules for settlement and significantly enhance liquidity. The opportunity is ripe for leaders to take steps to gain real-time visibility to cross-country netting rules for settlement and significantly enhance liquidity.