ISG Software Research Analyst Perspectives | Intercompany Financial Management

ISG Software Research coined the term intercompany financial management to define a discipline for structuring and handling transactions within an enterprise and between its legal entities. IFM is designed to maximize staff efficiency and accounting accuracy while optimizing tax exposure, minimizing tax leakage and ensuring consistent tax and regulatory compliance. Technology has advanced to a point where this approach is feasible and cost-effective. For that reason, ISG Software Research asserts that by 2027, one-half of organizations with 10,000 or more workers will implement IFM for its tax, risk-management and accelerated financial close benefits. Besides previous technology constraints, a major reason IFM is such an obscure topic is that its impact is lost in the weeds of detail and, therefore, invisible to senior executives. Those working at a departmental level rarely see issues that occur between entities. Moreover, each instance of an IFM issue is typically relatively small, but in larger multinational enterprises, the money involved adds up to a meaningful annual cost. Enterprises are made up of multiple entities that frequently buy and sell goods and services from each other. For example, a manufacturer might source parts from different divisions located in various states or countries, export the finished product to a country where it has a distribution center, and then install and service the product in yet another country with its local business unit. There may be recurring payments for the use of intellectual property or parts provided under warranty. These transactions give rise to a mass of paperwork as one corporate entity invoices and the other pays. The transactions also can create tax liabilities arising from those sales and purchases. When tallying up all that bookkeeping to produce the enterprise’s financial statements, all those intercompany transactions are supposed to cancel each other out. Usually, they do, but because each side of the transaction is recorded separately, it is also common for there to be errors, slight discrepancies in volume and price, currency translation differences and other adjustments that must be identified and corrected. And where these transactions cross national borders, multiple complications arise. The transactions may involve different currencies and be subject to disparate import and export regulations as well as tariffs and taxes. When IFM is not properly managed, value-added tax leakage can occur in a cross-border transaction when a corporate entity fails to claim a refund that it is owed. Or a company may be deemed to have a “permanent establishment” in a country and, therefore, have a taxable presence if it is not able to document that the volume of its work in that country is below the legal threshold. These issues can be addressed by centralizing the intercompany accounting function that provides an automated intercompany billing and invoice-management service designed to improve administrative productivity and lower costs while reducing global tax and compliance risks. IFM addresses problems common to enterprises operating in multiple tax jurisdictions with numerous ERP systems. Our Next-Generation ERP Benchmark Research finds that two-thirds of organizations with more than 1,000 workers have more than one ERP system, and 27% have four or more. All those internal buy-and-sell transactions create workloads in each local accounting department, including dealing with errors, reconciling differences in the details of invoices and payments, and filing regulatory and tax documents. These workload issues are compounded when there are multiple countries involved, especially if there are intermediate stops from source to destination, for logistical, regulatory or tax considerations. Larger enterprises often establish a shared service organization to manage intercompany transactions, including presentment and payment of invoices. This approach can be more efficient by centralizing the accounting for the transaction, which often goes beyond simple economies of scale. However, unless the process is well managed, an SSO can cause delays in payments and official filings (which can result in fees and penalty assessments) as well as create unnecessary tax or regulatory issues. In theory, the selling and buying events are simply mirror images, but that is not always the case. The transactions might be booked by their respective accounting departments on different dates, at different prices, with different terms and conditions. The items on the sales and purchase orders also may not agree exactly, or there might be errors in the harmonized system export codes. Enterprises can avoid these potential issues through effective process and data management that scales to volume and geographic requirements. Large enterprises need a system that captures the required attributes of intercompany agreements and streamlines intercompany dispute resolution, as well as handling taxes with an integrated tax engine to maximize tax deductibility by reducing stranded costs. Controlled and consistent tax calculations diminish the possibility of errors and make tax defense faster and easier. Moreover, all multinational activities require filings, and increasingly, national governments are demanding tax-compliant invoices be submitted to tax authorities to limit VAT fraud and errors that reduce revenue. For enterprises domiciled in the U.S., there are complications caused by the base erosion and anti-abuse tax that apply to otherwise deductible payments for interest, royalties and some services used to shift profits to lower-tax jurisdictions. In most areas of business, being strategic means not getting lost in the details. Being strategic in accounting is all about flawlessly managing the details, especially in areas of hair-curling complexity. Being strategic in accounting processes means managing data continuously without human intervention from the start of a process to its completion, one of the pillars of what ISG Software Research calls continuous accounting. Enterprises with large volumes of intercompany transactions should assess the handling of IFM, consider ways to deal with issues and investigate how internal processes, data management and systems can be altered to address problems. It is unlikely that, given the highly technical nature of IFM, organizations will find that internal IT teams can create and maintain effective systems in a cost-effective manner. Therefore, enterprises should consider third-party offerings to manage the workloads and complexity of processes required to match and reconcile these transactions, report on the transactions internally and externally and file documents for regulatory and tax purposes. Regards, Robert Kugel

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