KPMG report: Digitalization driving new operating models for financial services industry; transfer pricing consideration

Taxpayers in financial services sector respond to digitalization

A KPMG report on digitalization driving new operating models

Digitalization is driving new operating models and evolving existing ones in the financial services industry.

This brief discussion looks at how taxpayers are responding to this change and certain issues to consider. 

How are financial service businesses changing and what does it mean for tax?

Financial service businesses are evolving in various ways and one of the key drivers of this is digitalization. More and more often, financial services businesses are innovating and looking to monetize their own intellectual property, often for the first time. This includes software-as-a-service, new platform-led operating models, and other data-driven business lines.

Many banks and financial service institutions have set up their own in-house fintech activity or looked to mergers and acquisitions deals to gain access to new platforms, new markets, and new customers—all of which is intended to enable them to license or monetize the technology that they have invested their time and money in.

Tax is one of various areas impacted by these developments. Tax models need to keep up as the business changes. Planning ahead can be the difference between an effective model and an inefficient set-up that brews up potential tax concerns in the future. 

Most common questions

There are three themes overall. The first is when a taxpayer is setting-up a new business line or a new value chain within their organization. Tax is only a part of this question, but an important part.

The second concerns how existing business models and value chains have changed. Most groups have existing tax and transfer pricing models that have been in place a while. Has the increasing role of technology changed how value is created, with implications for the group transfer pricing? Will booking models and transactions need to be different in future?

The third relates to costs, which is a common first question. Groups are investing and often spending large amounts of money to build new and innovative platforms and business models. With such high costs as well as uncertainty as to which entities can potentially benefit, taxpayers can struggle to push costs out to other operating companies in the group. In many cases, this third question leads back into the first two, and a deeper examination of what is changing and the new and evolved value chains that these costs are supporting.

What tax issues would organizations need to think about if setting up a new digital business?

Important decisions to make early will likely be how group companies involved in the new business and the transactions between them need to be characterized.

An early question is whether to adopt a central or a decentralized operating model for the new digital business. Will developed intellectual property be owned in one location or in multiple locations? Where will key decision making functions need to be? First and foremost, commercial factors and regulatory compliance is central to the overall structure of any financial services venture. In some cases, there are options for the tax model and an important decision needs to be made—one that can determine which entity bears investment risks and where costs need to be borne from day one.

One important tax area is transfer pricing. Transfer pricing is about how to allocate profits within different parts of the multinational group, and it relies on a deep understanding of how businesses operate. As well as transfer pricing other local corporate tax rules, indirect taxes, and potential access to tax incentives across locations also need to be assessed.

The optimal operating model for would cover strategic, regulatory, legal, and capital efficiency issues, as well as the various elements of tax. 

Where to start?

The most important thing is for tax functions to stay close to the business as things change. This is best done by monitoring changing strategic priorities, but also by monitoring costs. Is there any research and development? What is it for, and does it neatly fit into an existing tax model?

It is also important to determine what are the operating model priorities. What is the appropriate time horizon to assess various options against the taxpayer’s priorities? This will vary based on the profile of the taxpayer group and the time horizon within which the strategy is built. 

KPMG observation

Businesses need to consider all aspects across service lines, including tax. KPMG member firms have built a global community of people across service lines to help focus on operating model questions across the financial services industry, and KPMG professionals can leverage their experience within financial services and across the rest of the business, specifically as it relates to technology. Experience in recent years reveals that “fintechs” tend to be agile in designing optimized digitally focused operating models from the start.

Read an August 2021 report prepared by KPMG International 

 

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