Regulatory requirements impacting healthcare vs. the arm's-length standard

ARTICLE | November 13, 2023

Authored by RSM US LLP

Executive summary: Understanding healthcare considerations when determining inter-group allocations

When considering tax ramifications of intercompany transactions, it is critical to consider the interaction of tax law with any regulatory requirements that may also apply to the resulting intra-group allocations. Specifically, this intersection of tax and regulatory requirements can frequently be encountered in the healthcare industry.

When companies (or branches of companies) engage in intercompany (or intra-company) arrangements, it is necessary for management to carefully consider the ramifications of the pricing associated with their intercompany, or intra-company, activity, to the extent that they deviate from specific regulatory requirements.The arm’s-length standard.

Regulatory requirements impacting healthcare vs. the arm’s-length standard

The arm’s-length standard

Arm’s-length pricing is an important concept to consider when transacting with affiliates within the same group of companies, whether domestically or internationally. The arm’s-length standard is the primary principle underpinning transfer pricing rules and regulations, the objectives of which are to ensure that transactions between enterprises under effective common control do not result in the artificial shifting of revenue or expense. The U.S. transfer pricing requirements are codified in Internal Revenue Code section 482 and the treasury regulations issued thereunder.

Regulation section 1.482-1(b) states, “To make a proper determination of taxable income of a controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer.” Additionally, the same Regulation further declares that “[a] controlled transaction is deemed to be conducted in a manner consistent with the arm’s-length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances.”

Below is an example seen in general practice:

Company A engages in the provision of executive management and back-office administrative support services for Company B, and both entities are subsidiaries of the same holding company and, thus, are under effective common control. Company A is effectively a “cost center”, employing the group’s management and administrative personnel and, thus, does not earn or record third-party revenue. In contrast, Company B operates as a customer-facing entity and earns third-party revenue. However, Company B does not employ management or administrative personnel and relies on the strategic management and overall operational support from Company A. This is a common scenario in practice; one that transfer pricing advisors review and analyze frequently.

In this example, transfer pricing advisors would refer to Company A as the “tested party”; broadly speaking, this is the simpler entity in the intercompany relationship, in terms of its functions, risks and assets, and thus the entity that can be most reliably benchmarked against third-party taxpayers. The taxpayer’s transfer pricing advisors would then proceed to benchmark the financial results of comparable third parties and utilize these conclusions to analyze the results of the “tested party”. The purpose of this exercise is to demonstrate that intercompany transactions occur at arm’s length and that management is not manipulating intercompany pricing in a way that could be argued to be artificially shifting profit or loss amongst the entities.

Regulatory requirements impacting the healthcare industry

As noted, analysis of the interaction of tax law with any regulatory requirements that may also apply to the resulting intra-group allocations is critical. In one recent example, a U.S. taxpayer provided management and administrative services to various related parties that operated as Medicare-certified institutional providers in the healthcare sector. As such, the service recipients are required to submit an annual cost report to a Medicare Administrative Contractor (MAC). The annual cost report contains Medicare-certified provider information including, but not limited to, facility characteristics, utilization data, cost and charges by cost center, Medicare settlement data and financial statement data.

The hospital ensures that the information provided is accurate, complete and comprehensive at the time of submission and this data is subsequently reported in the Healthcare Provider Cost Reporting Information System (HCRIS). Centers for Medicare and Medicaid Services (CMS) contracts with the MAC to subsequently audit this data provided by the hospitals.

Due to the aforementioned cost reporting requirements, company management will need to carefully consider the ramifications of their transfer pricing policies to the extent that they deviate from these regulatory requirements.