What is transfer pricing and why should I consider transfer pricing?
Discover the importance of transfer pricing with Bates Cosgrave. Learn what it is and why it matters for your business. Expert advice and insights.
How can we define transfer pricing?
What is commonly referred to as “transfer pricing” is the cost of conducting business between the various divisions of a multinational corporation. A multinational enterprise’s (MNE’s) transfer pricing policy will affect the MNE’s pricing decisions for manufactured items, raw materials, managerial, administrative, and technical services, financial instruments, and the use of intangible properties.
An Australian company’s internal pricing mechanism for its goods and services is known as “management/operational transfer pricing,” while the transfer pricing method used to test the company’s transfer prices and/or net profit earned on its goods and services is known as “tax transfer pricing.”
As a transfer pricing policy can significantly affect business profitability, taxes paid, shareholder value, and the entire risk management framework of a company, it is an important and frequently complex issue addressed by MNEs.
Multinational enterprises (MNEs) must oversee transfer pricing in a global economy marked by various taxation rates, fluctuating foreign exchange rates, varying regulatory rules, and intensifying competition among revenue agencies for the valuable tax money.
Why transfer pricing is important？
Many multinational corporations’ primary tax problem is transfer pricing. Companies should be aware that the significant increase in global trade, especially via international inter-affiliate transactions, has resulted in an increase in government concern over lost tax revenue.
In an effort to protect their revenue streams, tax authorities everywhere are getting tougher. Many tax authorities have ramped up their scrutiny of transfer pricing practices, allocating more resources to audits and imposing stricter documentation and enforcement requirements for transfer pricing transactions, as well as harsher penalties for noncompliance.
As a result of numerous high-profile transfer price audits, the number of applications for advance pricing agreements has skyrocketed in Australia and world wide. Therefore, transfer price paperwork can be viewed as a means of mitigating risk.
Penalties related to pricing disputes can be avoided in many countries if businesses have a transfer pricing policy and supporting transfer pricing procedures in place. The expense of completing transfer pricing is an investment in this setting, as penalties can be as high as 50 percent in many nations.
Since the early 2000s, the ATO has been preparing for the inevitable rise of cross-border transactions in Australia’s tax system. Transfer pricing has been an area of Tax Office’s concern for some time, and with globalisation and the dramatically increasing number of related party cross-border transactions, this will continue, as stated by the Commissioner of Taxation in 2003.
Australia’s Parliament approved new legislation in August 2012 to modernise the country’s transfer pricing laws. In addition, the foreign dealings schedule (which replaced schedule 25A) was included in tax returns in 2012 as part of the ATO’s efforts to collect as much information as possible for use in future compliance efforts.
This necessitates additional disclosures from taxpayers in Australia.
The concept of Transfer Pricing Documentation.
There is a need to document transfer prices in many jurisdictions. To properly “characterise” the firm and transactions, transfer pricing documentation necessitates research about the company, industry, and functions (including assets and risks).
Economic analysis (also known as a comparable search) is used to choose and implement a transfer pricing technique after an entity has been “characterised” for transfer pricing purposes.
To determine if the international related party transactions have been handled at arms’ length, the financial data of the firm under consideration is compared with the results of this comparable search.
How should we go about documenting transfer prices?
The specifics of your company’s situation will determine the best way to respond to this enquiry. We are able to provide you with a realistic strategy that your financial team can use on a daily basis. Feel free to get in touch with our international tax specialists to carry on the discussion further.
What is a masterfile strategy?
The masterfile method necessitates the creation of a global and segmented firm, industry, and functional analysis, as well as standardised characterizations and approaches determined by function.
Using this master file as a starting point, country-specific documentation is crafted by compiling relevant data from local businesses, industries, and functional analyses. I conduct the first round of research on the firm and its operations using in-house resources.
A worldwide and segmented company, industry, and functional analysis, as well as consistent characterizations & techniques based on functionality, are all essential parts of the masterfile strategy. Using this master file as a foundation, country-specific documentation is developed by incorporating country-specific information such as business, industry, and functional analyses.
In-person and over-the-phone discussions with finance teams in each country allow us to conduct the preliminary business and function analysis. From among the available groupings of characteriszations, one chooses the one most suitable to the task at hand.
The methodology and characterisation are obviously modified if necessary. The end result is “local” documentation that adheres to a universal standard. The primary database;
- Facilitates the completion of the policy and documentation by establishing efficiencies in the relevant processes. There should be less work for your workers to do and less money spent as a result of these synergies.
- The processes and paperwork must be standardised and made consistent.
- To save time, use analysis and document templates that have already been accepted in other nations.
How do we identify Comparables, and where do we look for them?
Finding “comparable companies” and comparing controlled and uncontrolled transactions using relevant financial data (profit level indicator) constitutes a comparable analysis. A “comparable company” may not be a direct rival, vendor, or client. The following considerations help with making comparisons.
- Traits of owned things and provided services
- Business strategy
- Economic conditions
- Contractual provisions
- Functional analysis
In order to find comparable businesses, it is necessary to do a search of an external database using the correct SIC (and other industry) codes for your business. The “comparable set” is derived from a filtered subset of the original pool of candidate comparable businesses.
Depending on the regulations in each nation, regional comparisons (e.g., Pan-European or Asia-Pacific) may be necessary. The local tax authority in Australia, for instance, will expect a search for Australian comparables rather than Asia Pacific comparables because of the abundance of Australian databases.
When comparing a Transfer Pricing Policy and Transfer Pricing Documentation, what should you look for?
Both the transfer pricing policy and the transfer pricing paperwork contain comparable information, with the policy being developed in advance with a focus on whether international related party transactions (“IRPT’s”) exist, the accompanying functionality, and how the arm’s length margin should be determined.
Whereas transfer pricing documentation is generated post-year-end and focuses on what IRPTs actually occurred, the actual functionality, the amounts involved, and checks this to the comparable set to ensure it is accurate.
Do we need to have both Transfer Pricing Documentation and a Transfer Pricing Policy?
Companies are not obligated to create transfer pricing policies, but doing so can help guarantee that all finance departments have a shared understanding of the company’s transfer pricing methodology.
Creating a transfer pricing assessment mechanism that includes interim estimates to prevent year-end modifications and manage risk would also be part of the policy.
How can the paperwork accommodate all regional requirements?
All international paperwork (not from Australia) will be prepared under OECD standards.
This method will be acceptable because many of the world’s major economies have their own transfer pricing legislation, but these policies often follow the OECD recommendations, including the transfer pricing methodologies utilised.
Review and approval by a country’s local authorities can be arranged if necessary. This is highly suggested for deals that are either unusual or expensive.
For more information around transfer pricing, please contact the international tax consultants at Bates Cosgrave.