In the dynamic field of transfer pricing, one of the most challenging aspects is determining the appropriate remuneration for high-value activities of executives and top employees within multinational enterprises. The question of whether these intra-group services should receive an above-median mark-up or a share in profits and losses is often not immediately clear and uncertain. This question arises because a high-value activity in one multinational group may not hold the same significance in another. As a result, the choice of the method for determining arm's length remuneration by choosing a mark-up with a higher margin or a profit-split needs to be applied on a case-by-case basis. 

This article is written by Michael Kratz ([email protected]) and Hendrik Bastiaans ([email protected]). Hendrik and Michael are part of RSM Netherlands International Tax Services with a focus on Transfer Pricing.

We think the answer lies in identifying the true profit and value drivers within the organization. Understanding these drivers allows for a more precise evaluation of whether a higher mark-up or a profit split is justified for specific high-value activities of executives of top employees. The focus must be on determining whether these activities are central to the creation of value within the group or if they are supportive functions that, while important, do not directly drive profitability.

Evaluating High-Value Activities in Different Contexts

Consider the example of a multinational coffee company headquartered in the United States, where brand identity is a key profit driver. The Chief Marketing Officer (CMO) employed by the Dutch subsidiary is responsible for all brand development and maintenance activities across the group. This CMO has a demonstrated history of success in significantly enhancing brand value through innovative methods and approaches. 

Contrast this with a global logistics company also headquartered in the United States where operational excellence, rather than brand identity, is the primary profit driver. In this case, while marketing remains an important function, it is not the key driver of above-market returns. Instead, the company's success is largely attributed to enduring supply chain synergies. 

Determining Appropriate Remuneration

The examples above highlight the importance of the specific business context when determining the appropriate remuneration for high-value activities.

In the first example where brand identity has a central place in the group's financial success, the CMO's role could be considered a high-value activity that justifies a remuneration structure beyond an increased mark-up. In this scenario, a profit split may be more appropriate to reflect the CMO’s bright-line activities that contribute to the core of the brand value driver and therefore also fundamental to the group’s overall profitability.

In the other example, the CMO’s role, though valuable, does not directly influence the primary value drivers to the same extent. Therefore, from a transfer pricing perspective, the CMO's services may be more appropriately remunerated with a mark-up on costs, albeit at the higher end of the quartile range, rather than through a profit split.

In cases where an activity is central to the creation of value, such as the CMO's role in the coffee company, a profit split may be necessary to achieve an arm's length intra-group remuneration. However, in situations where the activity, though important, does not directly drive profits, as seen in the logistics company, a cost-plus remuneration with a high mark-up may suffice.

Forward Thinking in Transfer Pricing

Multinational enterprises need to adopt forward-thinking strategies when remunerating key employees involved in high-value activities. Transfer pricing remuneration policies must reflect the correct role of the value drivers within the organization. RSM stands ready to assist companies in developing and implementing transfer pricing remuneration policies that are aligned with the latest standards in the OECD Transfer Pricing Guidelines. By carefully considering the context and value drivers within each group, companies can be sure that their transfer pricing policies are compliant enough to pass a tax authority audit while simultaneously supporting business growth.

RSM is a thought leader in the field of Transfer Pricing.  We offer frequent insights through training and sharing of thought leadership based on a detailed knowledge of industry developments and practical applications in working with our customers. If you want to know more, please contact one of our consultants.