5 minutes on the tax implications of evolving operating models within financial services

In this edition of ‘Five minutes on…”, we sat down with Richard Murray, Partner and Head of FS Transfer Pricing, KPMG in the UK, to discuss how digitalization is driving new operating models and evolving existing ones in the financial services industry, how clients are responding to this change and the resulting issues to consider. 

Financial service businesses are evolving in various ways and one of the key drivers of this is digitalization. More and more often we’re seeing financial services businesses 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. 

It’s really three themes. The first comes when a client is setting-up a new business line or a new value chain within their organization. Of course, tax is only a part of this question, but it’s an important part.

The second question we’re seeing is around 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.

Important decisions to make early will likely be how group companies involved in the new business and the transactions between them should 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 should be borne from day one.

One important tax area, which is my home base, is transfer pricing. Transfer pricing is about how you 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 should also be assessed.

The optimal operating model for clients should cover strategic, regulatory, legal and capital efficiency issues, as well as the various elements of tax. That is why KPMG firms have built a global community of people across service lines to help focus on operating model questions across the financial services industry.

The most important thing is for Tax 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?

When it comes to it, it’s also important to determine your operating model priorities. What is the appropriate time horizon for you to assess various options you may have against your priorities? This will vary based on the profile of your group and the time horizon within which you're building a strategy.

And finally, our KPMG operating model community can help. Businesses should consider all aspects across service lines, including tax. KPMG professionals can leverage our experience within financial services and across the rest of the business, specifically as it relates to technology. A lot of our work in recent years has been with fintechs, who tend to be agile in designing optimized digitally-focused operating models from the start.

Throughout this post, “we”, “KPMG”, “us” and “our” refers to the global organization or to one or more of the member firms of KPMG International Limited (“KPMG International”), each of which is a separate legal entity.