Risky Business – 10 things I hate about TP!

Article by: Regan van Rooy

Movie buffs will hopefully get the joke intended in this week’s newsletter title, however, if not our other title is “10 things you need to know about TP”.

Transfer pricingTransfer pricing is a fundamental concept in international taxation that defines the pricing methods and rules applied to transactions between related entities within a multinational enterprise (MNE). In the context of tax regulations, it governs how prices for goods, services, or intangibles (such as intellectual property) are set when these items are exchanged between different branches, subsidiaries, or affiliates of... (“TP”) is progressively seen as the key tax riskTax Risk refers to the uncertainty surrounding the potential financial or reputational impact of tax-related decisions and events on a business or individual. This risk arises due to various factors, such as complex tax regulations, inconsistent tax authority interpretations, or evolving international tax laws. Effective tax risk management involves identifying, assessing, and mitigating potential tax-related threats to prevent financial penalties,... area for multinational businesses. TP is not like “normal” tax, it is seen as difficult and quite subjective. It deals with complex technical aspects because it always involves satisfying compliance and reporting requirements in more than one jurisdiction and the arm’s length standard is subject to interpretation.

Companies should aim to minimise its TP related tax risksTax Risk refers to the uncertainty surrounding the potential financial or reputational impact of tax-related decisions and events on a business or individual. This risk arises due to various factors, such as complex tax regulations, inconsistent tax authority interpretations, or evolving international tax laws. Effective tax risk management involves identifying, assessing, and mitigating potential tax-related threats to prevent financial penalties,... and prevent situations arising where TP becomes a major pain point:

Raising the Red Flags:

1. High-value transactions and significant inter-company transactions: If your transactions are high value, either standalone or in the context of your business, you are a likely audit target. It is crucial that evidence of arm’s length pricing is compiled.
2. Intangibles and Intellectual propertyIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP... (IPIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP...): All intangibles should be properly identified and adequately documented to avoid unnecessary and burdensome questions from the tax authorities. Furthermore, you need to ensure you are not inadvertently developing economic IPIntellectual Property (IP) refers to creations of the mind, including inventions, literary and artistic works, symbols, names, images, and designs used in commerce. It grants creators exclusive legal rights to use and exploit their work, ensuring protection against unauthorised use or reproduction. These rights are critical in fostering innovation and creativity while providing economic value to individuals and organisations. IP... in jurisdictions, other than you may intend.
3. TP inconsistency and misalignment of legal agreements: Making sure that TP reports, financial data, tax returnsA Tax Return is a formal statement filed by an individual or entity that details income, expenses, and other pertinent tax information to a tax authority. Its primary purpose is to assess tax liability, determine refunds owed, or highlight outstanding taxes due. Tax returns may include information about earnings, capital gains, allowable deductions, and credits, depending on the tax regulations..., and legal agreements are aligned with TP policies that are appropriately implemented, is a basic TP must. In practice, however, this is a common problem. Reconciliation of data is key, and mismatching data and fact patterns are an easy red flag for any tax authorities.
4. TP models not supported by an appropriate level of substance: Significant people functions and substance, are increasingly being challenged, particularly in low tax jurisdictionsTax jurisdiction refers to the authority granted to governments or local taxing bodies to impose taxes on individuals, businesses, or transactions within a specific geographical area or based on particular criteria. This concept is a cornerstone of international tax law, determining which countries have the right to tax certain individuals or entities and under what conditions. As businesses and individuals.... Ensure economic substanceEconomic substance is a foundational principle in taxation and business law, ensuring that transactions and corporate structures reflect genuine economic reality beyond their legal form. The concept aims to prevent tax avoidance by evaluating whether a transaction or arrangement has a real business purpose and economic effect other than merely achieving a tax benefit. It ensures that taxpayers cannot exploit... has been considered in both your TP model, narrative, and practice in your business.
5. High-interest rates/quantum of related-party debt: One of the OECD’s BEPSBEPS stands for "Base Erosion and Profit Shifting". BEPS refers to tax avoidance strategies used by multinational enterprises (MNEs) to exploit gaps and mismatches in the international tax system. By shifting profits from high-tax jurisdictions to low- or no-tax locations, MNEs reduce their overall tax burden, even if little to no economic activity occurs in the low-tax jurisdictions. These practices erode... recommendations is that tax relief on debt should be restricted. This could cause significant increases in tax liabilities, especially for highly geared businesses. Interest rates and (often forgotten) guarantees also need to comply with TP rules and be properly supported.
6. Lack of annual TP documentation (Master file / Local file), benchmarkingBenchmarking, within the context of transfer pricing, refers to the process of analysing and comparing financial and economic data from independent companies to establish a fair and arm’s length price for controlled transactions. It is typically conducted using databases that provide details about comparable companies and transactions. The objective is to determine whether the terms and conditions of intercompany transactions..., and supporting evidence: TP documentation is required to support the pricing of related party transactions. Without TP documentation (including benchmarkingBenchmarking, within the context of transfer pricing, refers to the process of analysing and comparing financial and economic data from independent companies to establish a fair and arm’s length price for controlled transactions. It is typically conducted using databases that provide details about comparable companies and transactions. The objective is to determine whether the terms and conditions of intercompany transactions... studies), it is close to impossible to discharge the taxpayer’s burden of proofThe burden of proof is a foundational principle in legal proceedings, requiring a party to demonstrate the truth of their assertions to the requisite standard of evidence. In tax law, the burden of proof often determines which party—typically the taxpayer or the revenue authority—must establish that a transaction, deduction, or tax position is justified. This principle ensures fairness and clarity.... TP Documentation, that doesn’t explain your business and commercial practices, is potentially as bad as none.
7. Procurement structures are being increasingly challenged: Procurement hubs (or centralised hubs of any nature) can be highly value-adding for Groups, but appropriate structure and TP models are key to reaping the true value from the supply chain.
8. Limited-risk entity structures: Even though limited-risk entities generally earn a low stable guaranteed return, COVID might have had unintended impacts on profitability.  Proving you are indeed Limited Risk, has just gotten more complicated if suddenly you are experiencing reduced or volatile profitability.
9. Business Restructuring: Whether you are dealing with a M&A, debt restructuring, change in supply chain, disposal, or change in the functional/risk profile of a Group entity, a restructuring should automatically trigger a TP review. This often-overlooked chapter of the OECDThe Organisation for Economic Co-operation and Development (OECD) is an international organisation comprising 38 member countries, established to foster economic growth, trade, and development on a global scale. Founded in 1961, the OECD provides a forum for governments to collaborate, share policy experiences, and develop solutions to common economic challenges. The OECD's core mission is to promote policies that improve... Guidelines is getting more attention, as tax authorities catch up before businesses.
10. Increase in TP disputes: Hungry tax authorities are getting busier, with a significant increase in TP controversy across the board. Make sure you are defence ready, as if you think TP Documentation is painful and costly, you may get a real land entering the TP dispute space.

It has never been more important to manage TP risk effectively. TP audits are lengthy, expensive, and resource-intensive processes. Getting it right up-front can be a substantial cost saving and reap wider commercial benefits.