Several benefits arise from digitalizing your transfer pricing processes in addition to the obvious financial savings: improved management practices, control over the process, reduced PR risks through better compliance, and preparedness for upcoming legislative changes. These are factors that every company should consider in addition to direct economic impact.
Advanced technologies and data analytics have been widely used in other aspects of business, especially in accounting and auditing. There are many reasons why groundbreaking transfer pricing technologies have not been developed until now. One reason may be that large consultancies, which have been responsible for the vast majority of transfer pricing processes and documentation for companies, have not been willing to give up a profitable business. At the same time, other players, let alone companies themselves, do not have the skills or resources to take over the digitalization of transfer pricing.
One of the practical reasons for MNEs not to adopt technologies in transfer pricing is the challenge of selecting or building the transfer pricing tool. Acquiring and implementing a new solution requires significant resources. Tax or transfer pricing functions might not be the top priority for businesses to invest in, as they are not often seen as value-creating processes. In addition, transfer pricing is a niche topic. The international standards for transfer pricing documentation were only developed in 2015 as a part of the BEPS project and remain relatively unstructured and vague. As a result, investing in transfer pricing management is often not seen to have a very high return. However, the value of potential tax risks or savings from tax optimization might be substantial. In addition to direct advantages, companies can save a remarkable amount of time and money due to efficiency gains and reduced consulting fees.
A company's investment is usually determined through financial analysis, such as a net present value (NPV) analysis. Calculating the net present value of a tax technology solution for transfer pricing would be based on the current intercompany transaction flows, volumes between entities, and the tax rates applied. Analyses of historical fluctuations in profits, together with the customs and income tax consequences, provide a reference framework for the expenses recurring annually from the existing transfer pricing practices. At the same time, there are many unknowns. The transfer pricing risk is often discovered when it is too late, and the tax auditor makes adjustments and assigns penalties.
That's why we believe that companies often underestimate the potential benefits of digital transfer pricing applications. They are not only about time savings and cutting consulting fees but also about gaining a unique level of control and insights. [1]
Stages of transfer pricing digitalization
Stage 1
The first thing you need to do is to analyze your current transfer pricing process and identify its shortcomings. Introducing the advanced technologies will not help if you do not have appropriate transfer pricing policies and strategies. The GIGO syndrome, "garbage in, garbage out", applies to digitalizing transfer pricing: poor design and inadequate policies will not improve, no matter how much technology you pour over them.
As we have introduced previously in our blog, there are different approaches to managing transfer pricing (or "levels", as we call them). On level 0, there are Ostriches, who hide their heads in the sand and hope they never have to deal with transfer pricing issues. Ostriches would not find much help from digitalizing, as there is nothing to digitalize - so building appropriate transfer pricing policies and processes should be a priority. Turtles on level 1 have acknowledged the importance of transfer pricing and have some structure and formalized transfer pricing policies; they are protected but very slow and inefficient. Turtles are ready to implement automation in their processes and reach level 2, the Armadillos. Armadillos are both safeguarded and relatively quick and agile. Getting to level 3 and becoming an Eagle enables end-to-end digitalization of the whole transfer pricing process, with integrated reporting and compliance.
If you want to climb up a level, keep reading!
Stage 2
Once well-thought-out transfer pricing policies and processes are in place, it's time to digitalize. Instead of manual calculations and repetitive tasks, many processes can be automated. From price-setting to monitoring and adjustments, operational transfer pricing is often based on quantitative data, which allows for a more data-driven and technical approach.
As transfer pricing is a cross-management function involving several teams, such as operations, finance, HR, and tax, technology interoperability is crucial for effective control and management of the transfer pricing function. Isolated IT systems within different functions only create unnecessary and often contradictory data, but harmonizing the actual solutions might not be practically possible. The answer could be a centralized data warehouse, data lake, or data lakehouse, where all the data is stored for different purposes. To use the centralized data efficiently, data mining can be used to structure the data for specific needs. Technology can improve the process's efficiency and certainty by enabling teams to work together, exchange information, and take action when necessary. A real-time and interactive digital transfer pricing system provides interoperable proactive insights between different teams. Business decisions can then be made faster and based on accurate data. Unlike traditional transfer pricing, where different departments communicate, collect, and analyze data only once a year to produce transfer pricing documentation, discrepancies between pricing policy and actual performance only become apparent at the end of the year.
You can read more about digitalizing operational transfer pricing and why you might want to do that before implementing documentation tools in our previous blog post.
Stage 3
Having digitalized your operational transfer pricing, establishing your compliance on top of it is relatively easy. The data and processes exist, and all you need to do is generate that into a report. There are many ways you can implement technology into your documentation process, starting from the simple documentation generators, leading up to automated data-driven documentation that is constantly up-to-date and audit ready.
The simplest way to introduce automation in transfer pricing documentation is to use modular templates. A modular approach will eliminate manual steps from the process by automatically connecting different sections or modules of the documentation. For example, different transfer pricing models or descriptions of entities and their functional analyses can be easily connected based on the actual transactions. Manually compiling the document increases the risk of human error, which simple automation can dramatically reduce. A template solution can improve document quality and workflow by providing control and ensuring the requirements are met. This is something an Armadillo would use; it helps cut some of the manual work but is still an independent process prone to errors.
Eagles have, however, implemented more advanced technology, with documentation being an integrated part of the process. Technology provides the agility to monitor results on an ongoing basis, which can be real-time, monthly, quarterly, or semi-annually, reducing the risk of year-end transfer pricing adjustments. Technology enables a data-driven objective analysis, improving control and visibility over the process. Additionally, the documentation is prepared consistently using the same data across all local entities, ensuring high quality of the reporting. The processed data is stored in an enterprise data warehouse, where it is ready to be used for document creation, analysis, or other desired output. Having structured and parameterized data enables leveraging different technologies and processes, from financial analytics and transfer pricing documentation to creating supportive reports for an audit.
Why should you care about digitalizing your transfer pricing processes?
Improving the quality of transfer pricing processes and documentation should be a high priority for MNEs. The global tax reform and the rise of controversy and changes in enforcement behavior are some of the critical trends in transfer pricing. The best way to prepare for changes is to ensure that the end-to-end process is efficient and under control. Tax administrations already have comprehensive access to a broad scope of taxpayer information, as jurisdictions have introduced stricter reporting requirements, automatic exchange of information, and CbC reporting based on the OECD BEPS standards. In addition, tax administrations are increasingly focusing on how and why transfer pricing strategies and policies are set up in a particular way rather than simply testing the outcomes of an arrangement. As a result, MNEs must have a consistent reporting and documentation approach. The pressure of exhaustive transfer pricing audits makes data availability and consistency increasingly important. Using an appropriate digital transfer pricing solution can help you be constantly ready for an audit by providing a single platform for data collection, classification, analysis, validation, and documentation across the group.
To read more about how Kemira has cut hundreds of hours of work by automating transfer pricing calculations and now monitors profit levels in real-time with Aibidia's technology.
