🤖 Testing GPT’s Capabilities in Tax Efficient Treasury Operations Scenario: Lessons Learned
As part of my ongoing exploration into how AI can be leveraged for use in in-house corporate tax departments and strategic decision-making, I recently put the exciting new GPT o1 model to the test in a scenario commonly faced by in-house tax departments: efficiently redeploying cash from one place in the org to another.
While the scenario below may be straight forward to experienced tax practitioners, it has been impossible to get a correct one-shot answer from the AI. Since this new GPT model is supposed to have significantly improved reasoning capabilities by using “Chain of Thought”, I gave it something where multiple threads of thinking and steps were required.
Here’s how it went and what I learned.
The Prompt:
I posed the following problem to GPT:
“I need to move cash from a US sub to a Belgian Sub.
___
Context: Canadian Parent company named Canco is profitable.
US Sub is an LRD and collects cash from Canco’s US-based customers.
BE Sub is a cost-plus R&D entity that requires monthly funding for operations.
___
What options do I have? Please make a recommendation.”
I was looking to see if GPT o1 would recognize the complexities of the tax structure, consider the transfer pricing involved, tax-efficient cash repatriation and funding. However, the initial responses were off the mark, focusing on standard solutions like intercompany loans and dividends—without fully considering the role of the Limited Risk Distributor (LRD) or the captive R&D nature of the Belgian sub.
The Redirection Process:
After each attempt, I had to redirect GPT back on track:
- 🚫 First Miss: GPT suggested an intercompany loan between the US sub and the BE sub. This option didn’t consider the cost-plus model of the Belgian sub, which couldn’t repay a loan.
- ⚠️ Second Miss: GPT then recognized that cash first had to get to Canco and then to the BE sub, recommending an upstream dividend and capital injection route. While better, it still didn’t take into account that the US sub, as an LRD, couldn’t retain the excess cash and could repatriate it to Canco through normal operations.
- 💡 Third Realization: Only on the third attempt, after telling it to consider TP charges, did GPT correctly identify leveraging the cost-plus arrangements as the best pathways for moving cash. By refocusing the model’s attention on the constraints of US sub, the structure of the BE sub and its role in the value chain, GPT finally recommended a cash redeployment strategy using transfer pricing lanes that properly reflected the economic realities.
This redirection highlights that experienced and knowledgeable human intervention remains critical to guide AI when addressing even moderately complicated thought processes.
I’ve spared you from all the outputs, but look to the end of the article to see some of the thinking process.
Reflections on Improvements:
This experiment has highlighted both the strengths and limitations of GPT’s capabilities when applied to complex, real-world financial scenarios.
Improvements to the Prompt:
- Precision in the Prompt: Certainly providing additional context (e.g., the fact that US Sub cannot retain more than a fixed return) upfront could have helped steer the model towards the correct solution faster. What’s obvious to me isn’t always obvious to the LLM.
- Explicit Constraints: Specifying financial limitations (such as the inability to take on debt) earlier might have reduced unnecessary iterations.
Improvements for the Model:
- Deeper Scenario Contextualization: The model could improve by more quickly recognizing and applying relevant business rules, like the limited function of an LRD, when faced with detailed economic arrangements.
- Dynamic Recalibration: In complex scenarios, GPT could benefit from more advanced recalibration techniques, allowing it to respond more dynamically when presented with financial structures involving multiple legal entities.
Conclusion:
This experiment was a great reminder that while AI models like GPT are powerful, they still rely heavily on human judgment and guidance to navigate complex issues. The good news is that your skills and expertise are still required, we still need experts! With some improvements in both how we prompt AI and in the AI’s ability to understand business environments, these tools will become even more effective in tackling real-world financial challenges.
Curious about AI’s role in strategic decision-making? Share your thoughts below! 👇
#AI #GPT #FinancialStrategy #TransferPricing #BusinessDecisionMaking #TaxStrategy #LLM
APPENDIX
“Thinking Steps” of GPT-01:
Here’s a breakdown of how GPT iterated through its responses:
First Response: The model proposed an intercompany loan, assuming that the Belgian sub could repay the amount. This didn’t consider the nature of the R&D entity.
[14 seconds of thinking]
- Assessing subsidiary needs
- I’m gathering information on the cash transfer, considering the US subsidiary’s cash flow from Canco’s US customers and the Belgian subsidiary’s operational funding needs.
- Navigating cross-border flow
- I’m piecing together the options to transfer cash from the US Sub to the BE Sub, considering intercompany loans, dividends, and capital injections. All with a view to legal, tax implications, and practicality.
- Assessing transfer options
- I’m thinking through transferring cash from a US subsidiary to a Belgian one. Legal, tax, and administrative aspects make this a nuanced decision.
- Evaluating options
- I’m working through intercompany loans and dividends. Loans simplify cash flow but come with tax implications and documentation needs. Dividends align corporate structure but involve taxes and administrative challenges.
- Paying for services
- I’m thinking through how the US Sub can compensate the BE Sub for services rendered, considering benefits like taxable income reduction and costs such as transfer pricing documentation.
- Advancing R&D funding
- The US Sub might pay BE Sub for future R&D services, matching the commercial needs and evaluating transfer pricing and tax implications.
- Balancing capital adjustments
- Balancing capital shifts between subsidiaries involves legal forms, practicality, and tax effects to ensure equity adjustments and avoid tax stress.
- Weighing options
- I’m analyzing the pros and cons of assigning receivables to BE Sub, considering complexity and feasibility. Now, I’m leaning towards an intercompany loan for direct cash movement, while ensuring it aligns with market interest rates and compliance.
- Evaluating tax implications
- Considering Belgium’s withholding taxes on interest payments, recognizing potential reductions through tax treaties or EU directives. Interest expense deductions in Belgium Sub are also explored for their impact on taxable income.
Second Response: GPT shifted to suggesting an upstream dividend from the US sub to the Canadian parent, followed by a capital injection into the BE sub. Again, this failed to account for the fact that the US sub, as an LRD, has limited rights to retain cash.
[28 seconds of thinking]
- Revisiting the recommendation
- Taking a closer look, the BE sub’s inability to repay suggests finding a more viable financing solution.
- Assessing options
- OK, let me see. Considering moving cash from US Sub to BE Sub despite BE Sub’s inability to repay a loan, I’m looking at intercompany service fees and upstream dividends or capital injections.
- Navigating funding strategies
- I’m exploring various options to fund BE Sub, considering intercompany payables and direct funding from Canco, given the subsidiaries’ roles and relationships.
- Revisiting payment strategies
- Considering an upstream dividend from US Sub to Canco, then Canco funds BE Sub. Tax implications and constraints need thorough analysis.
- Evaluating financial strategies
- OK, let’s see. The intercompany loan is off the table due to BE Sub’s inability to repay it. I’m looking at upstream dividend and capital injection to efficiently transfer funds from US Sub to BE Sub.
- Evaluating payment methods
- I’m looking at the most suitable approach for US Sub to pay BE Sub. The upstream dividend and capital injection method meets the constraints effectively.
- Assessing feasibility
- Given the captive nature of BE Sub as an R&D service provider and its inability to repay a loan, an intercompany loan from US Sub to BE Sub is deemed not feasible.
- Streamlining funding
- By having Canco directly fund BE Sub and utilizing US Sub’s cash reserves, the approach maintains proper corporate governance and accounting practices, in line with the corporate structure.
- Evaluating strategies
- I’m weighing the benefits of Canco’s capital injection into BE Sub. This approach sidesteps loan repayment issues, enhances tax efficiency, and ensures compliance with Belgian corporate laws.
- Understanding tax implications and compliance
- First, I’m thinking through how Canco will handle dividend income and foreign tax credits. Then, I’ll ensure compliance for the US and Belgian subsidiaries, and finally, I’ll make sure intercompany transactions are properly reflected in consolidated financial statements.
- Navigating exchange rates and clearing administrative hurdles
- OK, let’s prepare for possible currency fluctuations and plan for necessary documentation. We’re weighing intercompany service agreements as a smoother payment method, ensuring compliance and addressing regulatory scrutiny.
- Consultation and planning
- I’m mapping out the next steps: engaging with international tax advisors, seeking legal advice, securing corporate approvals, and preparing extensive documentation to ensure smooth transactions across jurisdictions.
Third Response: Finally, after some very pointed redirection, GPT correctly focused on the cost-plus arrangement, allowing cash to flow from Canco directly to the Belgian sub to fund operations without debt or excessive cash retention by the US sub.
