Movie buffs will hopefully get the joke intended in this week’s newsletter title, however, if not our other title is “10 things you need to know about TP”.
Transfer pricing (“TP”) is progressively seen as the key tax risk area for multinational businesses. TP is not like “normal” tax, it is seen as difficult and quite subjective. It deals with complex technical aspects because it always involves satisfying compliance and reporting requirements in more than one jurisdiction and the arm’s length standard is subject to interpretation.
Companies should aim to minimise its TP related tax risks and prevent situations arising where TP becomes a major pain point:
Raising the Red Flags:
- High-value transactions and significant inter-company transactions: If your transactions are high value, either standalone or in the context of your business, you are a likely audit target. It is crucial that evidence of arm’s length pricing is compiled.
- Intangibles and Intellectual property (IP): All intangibles should be properly identified and adequately documented to avoid unnecessary and burdensome questions from the tax authorities. Furthermore, you need to ensure you are not inadvertently developing economic IP in jurisdictions, other than you may intend.
- TP inconsistency and misalignment of legal agreements: Making sure that TP reports, financial data, tax returns, and legal agreements are aligned with TP policies that are appropriately implemented, is a basic TP must. In practice, however, this is a common problem. Reconciliation of data is key, and mismatching data and fact patterns are an easy red flag for any tax authorities.
- TP models not supported by an appropriate level of substance: Significant people functions and substance, are increasingly being challenged, particularly in low tax jurisdictions. Ensure economic substance has been considered in both your TP model, narrative, and practice in your business.
- High-interest rates/quantum of related-party debt: One of the OECD’s BEPS recommendations is that tax relief on debt should be restricted. This could cause significant increases in tax liabilities, especially for highly geared businesses. Interest rates and (often forgotten) guarantees also need to comply with TP rules and be properly supported.
- Lack of annual TP documentation (Master file / Local file), benchmarking, and supporting evidence: TP documentation is required to support the pricing of related party transactions. Without TP documentation (including benchmarking studies), it is close to impossible to discharge the taxpayer’s burden of proof. TP Documentation, that doesn’t explain your business and commercial practices, is potentially as bad as none.
- Procurement structures are being increasingly challenged: Procurement hubs (or centralised hubs of any nature) can be highly value-adding for Groups, but appropriate structure and TP models are key to reaping the true value from the supply chain.
- Limited-risk entity structures: Even though limited-risk entities generally earn a low stable guaranteed return, COVID might have had unintended impacts on profitability. Proving you are indeed Limited Risk, has just gotten more complicated if suddenly you are experiencing reduced or volatile profitability.
- Business Restructuring: Whether you are dealing with a M&A, debt restructuring, change in supply chain, disposal, or change in the functional/risk profile of a Group entity, a restructuring should automatically trigger a TP review. This often-overlooked chapter of the OECD Guidelines is getting more attention, as tax authorities catch up before businesses.
- Increase in TP disputes: Hungry tax authorities are getting busier, with a significant increase in TP controversy across the board. Make sure you are defence ready, as if you think TP Documentation is painful and costly, you may get a real land entering the TP dispute space.
It has never been more important to manage TP risk effectively. TP audits are lengthy, expensive, and resource-intensive processes. Getting it right up-front can be a substantial cost saving and reap wider commercial benefits.