In recent years there has been an increasing focus on transfer pricing, in line with the proliferation of transfer pricing requirements from a growing number of countries around the world, and the OECD’s project on Base Erosion and Profit Shifting (BEPS).
Now more than ever, multinational enterprises (MNEs) should rely on technology solutions to better manage the increased volume of work relating to transfer pricing compliance management, and to better control the risks associated with transfer pricing altogether.
The number of countries with transfer pricing documentation requirements has increased from five countries in 1995, to approximately 70 countries in 2015
As a topic, transfer pricing has evolved substantially over the past few decades. Fundamentally an accounting concept, it helps take into account the transfer of goods, services, intangibles or financing between and among entities belonging to the same consolidating group. From an accounting perspective, transfer pricing has a zero effect in the financial results of a consolidated group, as the effect of it is usually eliminated upon consolidation of the financials of the corporate group. It was first identified as a tax issue in the US in the 1930s. This is due to its potential for abuse as a mechanism to shift profits from higher-tax to lower-tax jurisdictions. Since then, transfer pricing has become more of a tax and legal topic than the accounting topic it inherently is.
Documentation has become tax authorities’ main tool for controlling the risk of MNEs’ use of transfer pricing for improper tax purposes. The OECD has been at the forefront of this practice. Its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations – first issued in 1995 and updated in 2010 – provide a framework for managing and documenting transfer pricing. Its current project on BEPS is the latest in a chain of best practice guidelines, which many OECD-member and non-OECD-member countries have adopted into law or used as the basis for their local legislation. This has made transfer pricing for MNEs grow in scope and complexity.
For MNEs, the growing number of countries with transfer pricing requirements and the growing scope and complexity of the topics tax authorities examine have meant an increase in the burden and cost associated with managing transfer pricing and documenting policies for compliance with all these countries. The number of countries with transfer pricing documentation requirements has increased from five countries in 1995, to approximately 70 countries in 2015.
Despite this growing complexity and growing requirements, most of the countries with transfer pricing requirements tend to adopt OECD guidelines, or conform their legislation to concepts that are largely in line with the OECD guidelines. This means that most countries with such requirements have many similarities in terms of what constitutes documentation, and in terms of what methodologies can be used to establish transfer pricing policies.
This also means there are great opportunities for technology to play a more important role in helping MNEs manage this growing burden and increase control over their compliance costs.
A challenging process
Some of the key challenges to MNEs, when it comes to transfer pricing management and compliance, include: gaining internal buy-in from stakeholders within their organisation to understand the impact business decisions have on transfer pricing; collecting factual information from relevant stakeholders within their organisation in order to properly understand and document the facts around the various intra-group relationships within the business; collecting financial information (often at a transactional, rather than business-unit level) from disjointed or de-centralised accounting systems across their organisation; the variety of legal entities that can exist within a given tax jurisdiction, and the variety of intra-group relationships; understanding what (if any) internal comparables exist with unrelated third-parties, which could prove useful in establishing an ‘arm’s length’ transfer pricing policy; the growing proliferation of transfer pricing requirements around the world; and the increased volume of documentation requirements expected from the OECD’s BEPS project.
Some of these challenges require changes in the corporate culture of the organisation. However, many can also be addressed by investing in technology solutions. In actuality, there are a number of facts that allow technology to play a greater role and provide practical solutions to MNEs. Transfer pricing documentation follows a specific process, which doesn’t change from company to company or from intra-group transaction to intra-group transaction. In particular, the process includes:
- Gathering financial information – technology can be used to automate the collection of the relevant financial information into pre-defined templates that automatically calculate charges and adjustments, and produce reports that form part of documentation.
- Gathering factual information around intra-group transactions – technology can be used to produce, share and store questionnaires or conduct web-based interviews with stakeholders to understand all the functions and risks involved in these intra-group relationships.
- Carrying out functional analyses based on the information collected – this element of the process cannot be automated. However, technology solutions can help provide the interfaces where these functional analyses can be stored and updated on an ongoing basis.
- Conducting economic analyses to establish arm’s length standards for the various intra-group transactions and transfer pricing policies – technology can help streamline and automate the economic analysis process, as well as maintain and update the economic analyses on an ongoing basis.
Documenting the facts in transfer pricing reports – technology can help prepare, assemble, store and maintain the various reports MNEs must create and submit to the various tax jurisdictions in which they have operations.
There are also similarities in the circumstances, requirements and content of the process. Most intra-group relationships within MNEs are extremely similar across countries, and often across divisions, product lines or service lines. In this instance, technology can help leverage the collection, characterisation and analysis of the information around these intra-group transactions, and replicate them across the business in a streamlined manner.
Most countries with transfer pricing requirements follow the OECD guidelines, and technology can be used to leverage these similarities to facilitate the application of concepts, methodologies and economic analyses to multiple legal entities that share the same fact patterns. Most countries also require by and large the same elements of information in their transfer pricing documentation. Here, technology can be used to leverage these similarities to assemble multiple transfer pricing reports from a limited bespoke set of documents or elements, and produce documentation on a mass scale.
The methodologies used to substantiate the arm’s length nature of MNEs’ intra-group transactions are also recognised across most countries with transfer pricing requirements, and applied similarly – technology can be used to automate much of the economic analyses, and each of these economic analyses can be applied to multiple legal entities with similar intra-group transactions across countries that recognise the same transfer pricing methodologies.
All these similarities in circumstances, requirements and content mean technology solutions can be used to reproduce documentation for multiple legal entities engaged in similar intra-group transactions across countries with similar documentation requirements, based on a pre-defined specific set of documents.
From one year to the next, much of the factual information on which the functional analyses, economic analyses and documentation are based remains constant. Updating and maintaining documentation on an annual basis, thus, involves confirming the validity of the facts, making minor changes to the prior-year documentation and updating the financial information on which the economic analyses are based – technology can help automatically roll forward and update many of the elements of documentation once there is a framework in place, reducing the overall burden and cost of transfer pricing compliance.
Companies like Bureau van Dijk – a leading publisher of databases and software used, among other things, in transfer pricing – offer off-the-shelf, scalable solutions like TP Catalyst Document Manager that help MNEs with many of these challenges. MNEs, for whom transfer pricing represents high-risk areas, can also work with external advisors and companies like Bureau van Dijk to create custom-built solutions that can also prove a valuable investment in the context of BEPS and country-by-country reporting.
MNEs that realise the potential of technology solutions to help manage transfer pricing risk will be better positioned to deal with the increased burdens around documentation as countries begin to adopt the recommendations from the BEPS project. MNEs that take advantage of technology are likelier also to gain greater cost efficiencies in the long run.
Most importantly, MNEs that implement technology solutions will benefit from stronger risk management, greater collaboration among stakeholders within the business, and internal expertise in this important area of tax.