Navigating transfer pricing - business benefits beyond risk mitigation
One of the more challenging issues facing modern businesses is the fact that a company of virtually any size can find itself operating as a multinational business, in multiple tax jurisdictions. Transfer pricing is usually the number one global tax issue facing such businesses.
With a smartphone in every pocket and access to the internet from virtually anywhere, 21st century companies can be in constant contact with customers, suppliers and business partners in almost any country in the world. Products fabricated or purchased in one jurisdiction may be stored in another jurisdiction and sold to customers in a third jurisdiction. Any business may enter into a partnership, joint venture or cost-sharing arrangement with allies in other countries. Support functions like accounting, marketing or research and development, may be located in one place and provide services throughout the organisation.
The challenge for such global businesses is how to determine the amount of profit earned in any given jurisdiction – and how to protect the company from aggressive tax authorities that may challenge the prices set for the sale of goods or services between businesses.
Benefits of a transfer pricing study
A transfer pricing study is a thorough review, usually conducted by an outside party, of the company’s pricing policies and related documentation. Such a study can produce a number of benefits. These include:
- reducing taxes and penalties by ensuring that the company’s transfer pricing policies comply with all requirements in the local jurisdiction, including meeting local documentation rules
- providing support for transfer pricing related deferred tax assets and deferred tax liabilities recorded in the company’s financial statements
- identifying opportunities to reduce the company’s global effective tax rate by restructuring multinational operations
- identifying ways to increase global supply chain efficiency by relocating operations or reorganising legal entities.
Enforcing transfer pricing rules
The goal of most transfer pricing regimes is to ensure that the income taxed in a particular jurisdiction is determined using sound economic and business principles. No government wants to allow businesses to evade taxes by inappropriately sourcing profits to low-tax jurisdictions, or so-called tax havens, as its tax base then suffers as a result of businesses using questionable transfer pricing policies.
Almost all advanced economies around the world have transfer pricing rules that allow tax authorities to adjust items of income, expense, credit or allowance in connection with related party transactions. Most jurisdictions with transfer pricing regimes require businesses with related party transactions to develop and retain documentation supporting the arm’s length nature of these transactions. Such documentation must be prepared in a prescribed format that may vary by jurisdiction. Often it must be completed by the time the tax return is filed to reflect the related party transaction. If an adjustment is made and the required documentation is not available, the company could face significant penalties.
Be clear on your obligations
All governments worldwide are looking for ways to expand the tax base without raising nominal tax rates. Businesses operating in multiple jurisdictions should expect pressure from tax authorities to justify the allocation of revenue and expenses among jurisdictions. It is uncertainty about transfer pricing positions that creates a high proportion of financial reporting and tax disclosure issues for businesses operating cross-border.
Transfer pricing is an issue that no business can ignore. There are strict reporting and compliance obligations, significant exposure to additional taxes and penalties, and a very real possibility that the same profits will be subject to tax in two or more jurisdictions.
A transfer pricing study is a tool that can minimise these risks. By using such a tool, combined with sound international tax planning, a company may be able to lower its overall tax obligation, reduce the effective tax rate reported in its financial statements, fully comply with reporting obligations and manage the profitability of its business operations in every location throughout the world.
For more information, contact:
James Wall, JD, LLM