Transfer pricing risk management, which in past years concerned mostly tax departments in multinational corporations, should today be on the strategic agenda of every board of management. Is it on yours?
A major side effect of recent economic crises has been the increase in tax risk faced by multinational corporations as tax authorities, particularly in Europe, seek to reduce their debt deficits and burdens through the enforcement of existing tax legislation. One of the most straightforward aspects of taxation that authorities may utilise to increase tax revenues – and thus one of multinational corporations’ greatest areas of tax risk – is transfer pricing. Since 1994, the number of tax authorities with effective transfer pricing documentation requirements has increased from five to 63, with 25 of these implementing the effective documentation requirements from 2008. The number of tax authorities that have enacted legislation around transfer pricing during the latest financial crisis is much greater than in other periods.
The areas of transfer pricing that tax authorities focus on have also expanded, as they attempt to close tax-efficient planning opportunities and protect their taxable base. When the Organisation for Economic Cooperation and Development (OECD) first issued the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (the Guidelines) in 1995, the core focus was on intra-group transfers of tangible property and (to a lesser extent) the provision of intra-group services. Today, the focus has expanded to include intra-group transfers of intangible property – as evidenced by Working Party Number Six of the OECD’s current efforts on intangibles and business restructuring. At the same time, tax authorities in the UK, Canada and South Africa, to name just a few, are increasing their audits in the area of intra-group finance. A transfer pricing survey of top multinationals conducted by Ernst & Young in 2010 revealed that 66 percent of respondents had undergone an audit in 2010 (compared to 52 percent in 2007), and that one in five audit adjustments had triggered penalties (compared to one in 25 in 2005).
A proactive approach
One way to gain greater control of the risks is to take a more proactive approach to transfer pricing; working with external advisors is certainly part of this, but it doesn’t end there. Many multinational corporations are expanding their internal capabilities, acquiring expertise in the area of transfer pricing and providing the necessary infrastructure in support of this function – information and technology tools such as those provided by Bureau van Dijk and the International Bureau of Fiscal Documentation. In fact, Bureau van Dijk’s tools are used by over 60 tax authorities around the globe for transfer pricing risk assessment and audit – a key reason that many multinational corporations’ tax departments require such tools for managing transfer pricing risk.
However, implementing a more proactive transfer pricing management strategy presents great challenges. The main challenge involves obtaining support from internal stakeholders. Business unit managers need to see the importance of transfer pricing risk management; upper management needs to ensure their tax departments are involved in key issues like business restructuring, mergers and acquisitions and changes in the business offerings as these often have an impact on the global transfer pricing structure. Other challenges include the decentralisation of the transfer pricing compliance process, which can lead to misaligned policies and an increased risk of transfer pricing adjustments.
Overcoming the risk
Nonetheless, these challenges can be overcome with investment in the development of internal (personnel) and external (information and software) resources, and by centralising the management and oversight of transfer pricing risk. Creating automatic internal processes to support compliance preparation is also vital, as is ensuring that remuneration of business unit managers and transfer pricing policies are aligned. However, the most important aspect is convincing treasury, operations and finance department heads for the need to involve the tax departments in key strategic decisions that have an impact on the international procedures of the business.
Bureau van Dijk currently works with the tax departments of approximately 200 large multinational corporations. These companies’ strategies for managing transfer pricing risk vary, depending on their internal resources and expertise. At one end of the spectrum, there are multinationals with teams of in-house, ex-‘Big Four’ transfer pricing professionals, who fully manage and prepare their global compliance, and who periodically conduct planning and audit defence work. At the other end of the spectrum, there are multinationals with one-to three-person tax teams, who rely more heavily on their external advisors to manage and prepare their global compliance. These multinationals, however, conduct periodic ad-hoc analyses and monitor their international operating structure for potential risks to minimise the likelihood of transfer pricing adjustments.
Whatever strategy these multinational corporations have adopted, it is clear that they understand the need for a proactive, centralised approach to transfer pricing risk management, and their shareholders are better off for it.