Transfer pricing compliance is a crucial part of any multinational company’s business. Yet, it is hard for many companies to determine and follow an appropriate approach to ensure global compliance and minimize risks. Also, raising and maintaining awareness of the importance of transfer pricing compliance among company leaders can be challenging for in-house professionals. Therefore, developing a structured, transparent compliance approach is an essential task for every multinational.
This article goes through three possible approaches, their pros and cons, and practical advice on implementing each. We are focusing on local files here, assuming that the country-by-country report and master file are a must in any scenario.
Full compliance is when the multinational group prepares local files in all countries for all subsidiaries. Local files cover all transactions, no matter how material and risky they are. This approach usually involves outsourcing compliance to external consultants, as developing a massive internal transfer pricing compliance function can be a problematic organizational task. It has traditionally been the preferred approach by some multinational companies that want to minimize their risks as much as possible.
One of the most significant benefits of full compliance is the protection against penalties. In recent years, transfer pricing fines have significantly increased, with more and more countries introducing transfer pricing documentation requirements and penalties for non-compliance. Another benefit of full compliance is it provides a uniform level of audit readiness across subsidiaries. This, in turn, can minimize the cost of an audit and allow for quicker, more accurate, and more efficient use of the transfer pricing information. An additional benefit is that while preparing the documentation, companies can identify deviations and risks, therefore being able to take proactive measures to minimize them.
However, full compliance is time-consuming and costly in practice. The annual cost of maintaining local files can reach tens of thousands of dollars per country, and the compliance check for multinationals with a global footprint can reach millions. In addition, full compliance can be challenging to achieve in practice. Building an internal in-house function with such a capacity is problematic from an organizational and staffing perspective, and outsourcing often results in a lack of control and visibility over the process. Moreover, it requires a massive investment of time in developing compliance practices and processes, which is rarely achievable.
Limited compliance is when the multinational group prepares local files for a limited set of countries or only for a limited set of subsidiaries/transactions. Typically, this approach is based on the requests of tax authorities - when the request comes, the documentation is getting prepared.
The benefit of limited compliance is that it only requires a minimum amount of resources. Also, this approach can sometimes have limited risks, mainly when the company is small, and transactions are immaterial.
However, limited compliance is not a good long-term strategy. The main reason is that it does not allow quick and effective identification and management of tax risks. Additionally, limited compliance can be problematic when audits are conducted without prior notice, or the deadline to provide documentation is short. For example, in some countries like Poland, companies have only 7 days to provide the local file - and it is impossible to prepare reasonably good documentation in such a short time. In other words, a limited compliance approach can give some short-term benefits but will almost always lead to substantial penalties and accumulation of unknown risks long term.
Risk-based compliance is when the multinational group prepares local files for countries/legal entities with the highest value/risk potential. This strategy aims to minimize the compliance cost while maintaining a good level of readiness and limited risk potential. Similar to full compliance, this approach can also limit exposure to penalties and increase the effectiveness of monitoring and control measures. It also allows for identifying and addressing high-risk cases before they become a problem.
The main challenge with this approach is its implementation and maintenance. Determining which countries and legal entities are the most significant from a transfer pricing perspective is not a trivial task, and you need to dynamically monitor compliance requirements and company transactions and activities globally. Also, some residual risks remain when using this approach. While this approach focuses on high and medium-risk countries, for example, an audit in a low-risk jurisdiction can reveal hidden risks and introduce additional audit costs.
Approach ->Full complianceRisk-based complianceLimited complianceDescriptionThe company prepares local files for all legal entities and transactions in all countries.The company prepares local files for countries/legal entities that have the highest value/risk potential.The company prepares local files only for a limited set of countries/entities based on tax authorities' requests.Direct costsHighMediumLowRisksLowMedium/lowHigh/very highProsComplete protection against documentation penalties, enhanced audit readiness, and better control over general TP risk.Best value for money, coverage of the main risks, and is easier to control.Low cost in the short-term, no need to allocate resources and time.ConsCostly and time-consuming, challenging to achieve in practice without technology.Some residual risks remain.No control, high risks that are often unknown before it’s too late
How can the technology help with implementing full and risk-based compliance strategies?
Technology can be a great help in implementing both full and risk-based compliance strategies.
First, technology can help to reduce the time and cost of compliance. With the help of automation and pre-built templates, companies can quickly and easily generate and maintain accurate documentation. This is especially helpful for companies with a large number of subsidiaries or transactions.
Second, technology can help to identify and manage risks. With powerful analytics and reporting tools, companies can quickly identify and address any potential transfer pricing issues. This can help to ensure that companies remain compliant and minimize their risk of penalties.
Finally, technology can help to ensure consistency and accuracy across countries and legal entities. With the help of automation, companies can ensure that all of their transfer pricing documentation is up-to-date and accurate. This can help to ensure that companies remain compliant and consistent across their global operations.
About the author:
Borys Ulanenko is a Digital Transfer Pricing Category Lead at Aibidia. Borys has more than 9 years of experience in transfer pricing with a background in industry and consulting. In addition, Borys is the founder of the educational platform StarTax Education. At Aibidia, he focuses on developing new transfer pricing applications and contributes to marketing and business development.