2013 Global Transfer Pricing SurveyJuly 30, 2013
Transfer pricing continues to be a significant source of controversy between the world’s tax authorities and multinational enterprises (MNEs).
Since our last transfer pricing survey, the pace of globalization has increased, and businesses have been working hard to adapt by better managing their cross-border activities.
They’re struggling to comply with unfamiliar and frequently changing tax and statutory requirements in new markets, examining the tax efficiency of supply chains and administering a vast array of indirect taxes – including value added taxes (VATs), customs duties and goods and services taxes (GSTs).
At the same time, tax authorities worldwide have stepped up their enforcement, and they are paying special attention to transfer pricing. Transfer pricing has also taken on a bigger profile with non-tax stakeholders, who are acutely aware that according to the OECD, “around 60% of world trade actually takes place within multinational enterprises.”
Many companies are facing increasing exposure to new transfer pricing inquiries on a much broader scale. Our survey of international tax practitioners and C-suite executives in 26 countries confirms that controversy and double taxation are on the rise. It also confirms that companies around the world are reacting to the new pressures.
Most notably, 66% of companies identified “risk management” as their highest priority for transfer pricing, a 32% increase over surveys conducted in 2007 and 2010. Correspondingly, the percentage of companies identifying cash tax or effective tax rate optimization as their highest priority fell by nearly one-third — to 17% — from just three years ago.
Tax risk management increases as a priority
Supranationals foster the debate
This growing focus on transfer pricing is driving an increasing amount of work by supranational organizations. This is evidenced by the current OECD project on BEPS that has intensified the activity of tax authorities to harmonize their approach to eliminate what they perceive as inappropriate tax avoidance.
The first BEPS report chronicles changes in how companies do business in the global economy and states that tax systems may not have kept pace. It also acknowledges the importance of tax sovereignty and recognizes that governments continue to offer incentives as part of an effort to build a competitive business environment that attracts investment.
The recently issued BEPS Action Plan details where the OECD intends to focus its energies on cross-border taxation issues in the near term. Three of the fifteen action areas apply specifically to transfer pricing: intangibles, risk and overcapitalization. Several of the other action areas also have implications for transfer pricing.
Current developments and the survey responses indicate that taxpayers may need to reassess or reorient their priorities throughout the transfer pricing life cycle.
Potential actions include:
Planning: To avoid unpleasant VAT and customs surprises, make sure that your transfer pricing practices take into account indirect tax implications.
Implementation: Pay more attention to how you implement and account for intercompany transactions, rather than concentrating exclusively on documenting your transfer pricing policies. Processes and outcomes matter and will be tested as much as underlying policies.
Documentation: Align your transfer pricing resources to respond to increased transfer pricing documentation requirements and controversy in rapid-growth markets that may have been lower priorities in the past.
Preempt difficult technical disputes over marketing intangibles, location savings and the source and exploitation of customer relationships through more rigorous transfer pricing documentation.
Controversy: Bolster your transfer pricing defense by developing high standard documentation in a wider range of countries than ever.
Be aware that your intercompany pricing may be affected by a broader array of enforcement mechanisms, such as permanent establishment provisions and anti-avoidance rules.
Dispute resolution: Mutual agreement procedures are increasingly under strain. Be prepared to rely on other channels of resolution, including those you may not have considered to date, such as advance pricing agreements and arbitration.
Keep in mind the reputational risk that the public debate over transfer pricing generates and engage in a dynamic way with internal and external stakeholders to minimize the possibility of unfavorable outcomes.
To understand and mitigate your risks, consider taking the following steps:
Take a view of your intercompany transactions in their totality
Recent OECD developments, such as the BEPS report and the OECD Intangibles Discussion Draft, indicate tax authorities will increasingly wish to review your transfer pricing based on the totality of intercompany transactions. As a result, it will soon no longer be good enough to simply make sure your individual intercompany transactions satisfy a checklist of technical requirements.
Tax authorities are signaling that they will be taking a holistic view of taxpayers’ intercompany transactions to assess the total profit shifted from their jurisdictions, without specific regard to the individual transactions that shifted it.
Tax authorities are also using non-transfer pricing provisions, such as permanent establishment and general anti-avoidance rules, to supplement their transfer pricing review powers.
Ensure your systems are capable of handling your transfer pricing processes
Year-end or post-year-end adjustments continue to create indirect tax exposures. These challenges can be particularly severe if you operate in an industry where tangible goods are a significant portion of the value chain.
But as attention begins to shift to how taxpayers implement and adjust prices, taxpayers in all industries should make sure that they have the people and systems in place to undertake frequent reviews and adjustments to transfer prices in order to eliminate uncertainty of outcomes.
The inability to evaluate the system profit on a product-byproduct or intangible-by-intangible basis may limit your ability to assess how profits are currently allocated across your business and leave you open to tax authority challenge.
Consider the perspectives of the rapid-growth markets
In the past, your chief intangibles considerations may have started out from the value given to the intangibles from the developed markets’ position. That issue is in sharper focus than ever, but tax authorities in developing countries may also conclude that intangibles have been developed locally that you haven’t acknowledged, much less compensated.
Only a rigorous and current analysis of functions, risks and intangibles across your organization can assist in uncovering where your risks may lie. Similarly, if you have related-party service providers in an emerging market, be aware that an unenhanced cost-plus markup to those affiliates may not reflect what local tax authorities consider sufficient compensation for what the market offers.
Your risk assessment may need updating
If, like most taxpayers surveyed, you use a risk-based assessment to determine your documentation and planning needs, it may be time to update it. Documentation requirements are in place in markets that may never have been on your radar screen in the past.
And the requirements in those jurisdictions may be more onerous and individualistic than what you are accustomed to in mature markets. Remember that the risk you face may not be just the risk of additional tax, penalties and interest, but real damage to your company’s reputation.
Our survey leaves little doubt that companies are struggling to meet their heightened obligations in a rapidly changing world. We have every reason to believe the current environment will remain difficult for the next several years, and companies should take some steps to prepare.
Read more: 2013 Global Transfer Pricing Survey
Questions or comments? Contact T Magazine and Ernst & Young