Author: Nilanjan Nag, Transfer Pricing Manager, PKF Finconta
Transfer pricing in the modern times should be perceived as a business opportunity rather than simply a tax challenge. By incorporating transfer pricing into financial and corporate planning it helps to mitigate the risks for companies competing in a global economy.
Although tax and financial managers and directors realize the importance of transfer pricing, it is rather unfortunate that not always do we have a situation when transfer pricing is incorporated into strategic decision making. For companies which effectively manage their transfer pricing, they gain coordinating lever over their global operations. Thus, transfer pricing can and should become an indispensable strategic tool to increase earnings and in measuring performance. It is not simply a tax compliance issue. It is a business opportunity to be seized at the highest executive levels.
The concept of Transfer Pricing
Taxing jurisdictions naturally seek to tax their fair share of global profits. Most countries have adopted an "arm’s length standard" to protect their revenue base in evaluating the transfer prices of companies which operate within their country. Under the arm’s length standard, inter-company prices are judged against the prices that would have been charged for each transaction if the companies were negotiating at arm’s length, that is, if they were unrelated.
Many countries, including Romania, have adopted the arm’s length standard through very detailed rules specifying various methods to be applied in different circumstances. These methods attempt to measure prices or results from comparable unrelated transactions to benchmark the related company transactions. Many countries including Romania also impose requirements to formally document transfer pricing policies, the absence of which subject a taxpayer to penalties if the transactions are deemed to be non-arm’s length.
The international environment for Transfer Pricing
Companies might expect that if inter-company transactions are undertaken at arm’s length, they should be respected by revenue authorities on all sides of the transaction. Unfortunately, there is no consensus nor consistency in the transfer pricing rules or their application across tax jurisdictions, even though nearly all major industrialized countries embrace the arm’s length principle. It is not uncommon for a given arm’s length method acceptable in one country to be unacceptable in another country, even where revenue authorities have entered into formal agreements to share taxpayer information amongst themselves and have in fact compared notes in the process of arriving at their respective adjustments on an organization.
The benefits of Transfer Pricing management
Greater transfer pricing risk in the current global environment is accompanied by greater opportunities for effective tax management and planning. The first step is to use global transfer pricing management. There are four key advantages to adopting the global approach to transfer pricing.
· Consistency – Given that different tax jurisdictions have different interpretations of the arm’s length standard, adopting a global approach allows a multinational company to frame each local transfer pricing study within the context of the overall global transfer pricing strategy thereby avoiding the risk of inconsistent transfer pricing reports.
· Cost effectiveness – Strategic global transfer pricing analysis affords firms the opportunity to reap economies of scale that maximize consistency and minimize cost compared to separate localized efforts.
· Certainty – Undertaking a global transfer pricing analysis allows a firm greater certainty in risk management of tax costs.
· Improved performance measurement – In many cases, transfer pricing policies which are not arm’s length adversely influence the measurement of performance of different business units on each end of a revenue stream.
Opportunities in the strategic approach of the Transfer Pricing
In practice, good faith application of the tax laws and regulations requires an investment in time and effort. To solve the transfer pricing problem, a company must understand its value drivers and economic contributions made by the related members of the group, as well as how these value drivers differentiate the company from its competitors.
In addition, a company must identify and value its intellectual property and determine how well that intellectual property is exploited throughout the world. With information on infrastructure gained from a principled global transfer pricing approach, companies can incorporate transfer pricing to operational and financial strategies. The activities undertaken to effectively manage transfer pricing compliance act as a springboard to earnings opportunities.
Transfer pricing tax planning plays a key role in structuring cross-border operations and investments. Transfer pricing offers a methodology for the strategic location of economic activity in the context of global tax planning. By identifying functions and risks which can be in tax favored jurisdictions, transfer pricing can play a key role in minimizing worldwide taxes and thus increase earnings.
Alternatively, similar results may be achieved by entering co-development agreements with related companies in tax favored jurisdictions, known as "cost sharing arrangements". Under a cost sharing arrangement, technology development is jointly funded and owned, regardless of where the development activities physically take place. Payments may be made for the use of proprietary assets or methodologies developed offshore. Fees can be paid into a finance company or other foreign holding company, where the foreign entity performs services for other members of the group.
If an offshore entity performs functions or bears risk, economic analysis can support the allocation of a portion of worldwide profits to these entities. Careful structuring and planning for the placement of functions and risks can minimize effective tax rates worldwide and increase earnings.
Of course, any transfer pricing planning must occur in the context of other international tax rules, some of which can severely limit the benefits of allocating profits to tax jurisdictions. The ability to gather information and effectively monitor processes often leads companies to modify or refine supply chain operations.
Operational restructuring presents clear planning opportunities to align tax and legal structures in the business operation. Transfer pricing should be a key element in achieving new operational business objectives. Tax planning strategies that influence the location of activities can also create opportunities for minimizing VAT and similar taxes, customs duties, and other indirect taxes because these taxes are triggered by the receipt of goods or services measured by the value of the goods or services.
The tax planning strategies outlined above offer examples of transfer pricing being used as an integral part in business strategy. For maximum benefits to be realized, transfer pricing needs to be part of early strategic planning rather than an after the fact consideration.
Transfer pricing has become an increasingly important tax issue for multinational corporations, as revenue authorities around the world have increased their scrutiny of transfer pricing transactions. As tax authorities have individually and not necessarily consistently interpreted the arm’s length standard, multinational companies increasingly have grasped the value of a comprehensive and proactive global transfer pricing management strategy. As companies use transfer pricing planning to increase earnings and reduce risks around the world, transfer pricing has transcended being simply the tax issue and is becoming a strategic business tool.
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About PKF Finconta
For more than 23 years, PKF Finconta is one of the 10 leading professional services companies in Romania. Since 2006, we are a member of PKF International Limited. PKF International is a leading international business advisory organization. The company grew consistently over the years, forming a Group of four companies: PKF Finconta, PKF Finconta Consultanta, PKF Finconta HR and Finconta Consulting SPRL, members of national professional organizations CECCAR, CAFR, CCFR, and UNPIR. We provide a wide range of business advisory and related specialist services. We have seven core areas of expertise and within these areas, we tailor our services to your business and your needs: audit, corporate finance, tax, bookkeeping and accounting advisory services, transfer pricing, payroll and personnel administration, and insolvency.
About the author
Nilanjan Nan began his career in 2007. He has a degree in accountancy and a master’s degree in management. Nilanjan has over 10 years of professional experience in Transfer Pricing, having worked with PwC and Deloitte in India. He has extensive experience working on Transfer Pricing compliance, planning engagements and transfer pricing audit. Nilanjan has also worked on Global Documentation engagements and has experience of intellectual property valuation. www.pkffinconta.ro