Transfer pricing is a complex area that requires careful consideration and documentation to minimize risk. Recently, we held a webinar on the future of transfer pricing compliance, and this is a summary of it.
There are various risks associated with transfer pricing and it is important to have robust documentation in place.
There are five key elements of transfer pricing risk that businesses need to be aware of:
Overall, transfer pricing documentation is not just about compliance with tax authorities. It provides businesses with the opportunity to explain their commercial operations in the context of intergroup relationships and can help to minimize risks. While the specific requirements for transfer pricing documentation vary by country, all tax administrations recognize the importance of obtaining such documentation as part of the fact-finding process. By taking the time to create robust transfer pricing documentation, businesses can protect themselves and their reputations.
One crucial issue to consider is the burden of proof. In some countries, such as India and the US, the burden of proof lies with the taxpayer, not the tax administration. This means that the taxpayer must be able to demonstrate that their transfer pricing is consistent with the arm’s length principle. In the UK, there are currently no specific statutory requirements for transfer pricing documentation, but records must be kept that enable the taxpayer to deliver a correct and accurate corporate tax return.
Another issue to consider is penalties and scope. Many countries have established a link between their penalty regime and transfer pricing documentation. In the UK, penalties for failure to keep or produce documentation records are currently derived from general record-keeping requirements. There are two main types of penalties that may apply: a fixed penalty for failure to keep or produce documentation records, and a tax-geared penalty for careless or deliberate error. The fixed penalty for failure to keep or produce documentation records is currently £3,000.
At the same time as applying penalties, tax administrations often limit the scope of documentation requirements. For example, some countries exempt domestic transactions from documentation requirements completely or exclude enterprises that only engage in limited transactions. This is something that businesses need to be aware of when preparing their transfer pricing documentation.
For example, the UK tax authority, HMRC, has introduced an exemption from transfer pricing documentation requirements for small and medium-sized enterprises (SMEs). To qualify for the exemption, a business must have fewer than 250 employees and either a turnover of less than £50 million or gross assets of less than £43 million. Despite this, it is still considered best practice for SMEs to consider drafting minimum inter-group agreements and a policy paper.
Timing and submission of transfer pricing documentation are also important. The most common approach is to prepare documentation when filing the tax return. Some countries, such as Australia and Italy, also require disclosures on whether documentation exists to be submitted with the tax return. In the UK, a taxpayer must be able to provide HMRC with the necessary documentation within 30 days, and the documentation must be preserved until the later of six years from the end of the period concerned or the date on which any inquiry is completed.
In recognition of the compliance burden that transfer pricing documentation can impose on taxpayers, the OECD introduced a three-tier approach consisting of a local file, a master file, and a country-by-country report. Not all tax administrations have adopted this approach, however, and some have introduced different thresholds for its introduction while maintaining the requirement for other country-specific documents.
In the UK, HMRC has set out its own guidance on the likely structure of a transfer pricing report, stating that a detailed functional analysis is a core to transfer pricing documentation. As a result, it is advisable to seek the advice of a professional services advisor and to carefully review HMRC guidance and other relevant legislation.
The language and form of transfer pricing documentation can also vary depending on the capacity and resources of the tax administration. The EU Code of Conduct recommends that country-specific documentation be prepared in the language or languages prescribed by member states but those tax administrations should be prepared to accept that the master file, for example, is in a commonly understood language in the member states concerned and to require translation only when strictly necessary and upon specific request. In addition, tax authorities are increasingly turning to electronic filing for data processing and analytics purposes.
From April 2023, large businesses will be required to maintain a master file, local file, and a new document called a supporting summary audit trail (SAT). HMRC has confirmed that the 30-day time scale for the provision of these documents will remain in place. The purpose of the master file, local file, and SAT is to support the transfer pricing policies underlying the filed corporate tax return, and as such, they need to be prepared in advance of the annual filing.
Where a group self-assesses that all of its international or domestic related party transactions are immaterial, HMRC does not intend to require it to complete a local file or make an annual declaration. Instead, HMRC expects groups to keep a record of any analysis undertaken to support this self-assessed position and provide it upon request within the 30-day time scale.
For large businesses, failure to maintain relevant records or to produce them on request will result in the presumption that inaccuracy is careless. This means that taxpayers will be automatically considered careless from a penalty position, even before potentially submitting their documentation. The only way to displace this presumption is by providing the documents and evidencing the underlying TP information that was prepared before filing the corporate tax.
Being considered careless also means that disclosure and discovery will come into force. This allows tax authorities to investigate a wider period of time for transfer pricing. Tax-geared penalties depend on whether an inaccuracy is considered careless, and carry a maximum penalty of 30% of potential loss remedy.
The requirements for a local file are similar to the expectations set out in HMRC’s current guidance. It would therefore be advisable for businesses to prepare a transfer pricing report that follows the local file template, even if they do not fall within the definition of “large” for the April 2023 changes. The only difference would be that the report does not necessarily need to be prepared right before the tax return is submitted, but it should at least be started.
Businesses with a group revenue between 50 million euros and 250 employees, and below the 750 million threshold, should prepare transfer pricing documentation and be mindful of the questions raised in the SAT when compiling their documentation.
Transfer pricing documentation is often seen as a tedious task only completed to meet local transfer pricing requirements. However, adopting a different mindset toward completing transfer pricing documentation can actually be highly beneficial.
If documentation is continuously maintained and updated, it is more relevant to the current state of the business and its commercial reality. This can help to identify and deal with potential transfer pricing issues immediately, reducing transfer pricing risk for the organization. From the perspective of the CFO, this provides more control over the risks of the organization and the compliance obligations to shareholders and other stakeholders.
On the other hand, leaving transfer pricing documentation until the last minute or only revisiting it every few years makes it difficult to make adjustments to emerging issues, can cause problems with remembering details, and can create issues during a due diligence process if the business is looking to sell or exit.
One way to make the process easier is to automate it. This can help to streamline the process and make it more efficient.
Question: Can local files prepared in other jurisdictions be useful when preparing the UK documentation?
Answer: Yes, multinationals can use the local files from other jurisdictions in the UK as a basis. If the functions of a distributor in the UK are similar to those of a distributor elsewhere, there is no reason why the same local file cannot be used for UK purposes. However, the local file may need to be adjusted to include financial information for the UK entity and to address any differences in the UK market or broader market differences.
Question: What do you think about benchmarking studies? Do you need to do country-specific benchmarks, or is HMRC OK with using Pan-European studies?
Answer: HMRC prefers local studies, such as UK studies, because the UK database is more extensive and provides more information for benchmarking. However, they recognize that there may be times when it is necessary to use a European or global set. In these cases, they will expect to see some UK comparables within the set, as UK data is readily available.
Digital transfer pricing and technology for managing transfer pricing compliance are important topics for businesses to consider. With the rise of digital platforms, tech companies constantly collect and analyze our data. This same level of detail is now being sought by the tax administration to better understand the habits and practices of businesses.
In recent years, we have seen an increase in local transfer pricing legislation, particularly in emerging markets, as well as a reduction in the number of times businesses have to present documentation during audits. This shift towards real-time information gathering is likely to continue and will impact compliance in various legal and tax areas.
Mexico is an excellent example of how governments implement real-time information gathering, specifically concerning VAT.
Case law also plays a role in the changing compliance landscape, with documentation being a critical factor in resolving transfer pricing cases. This, combined with the increasing number of countries implementing transfer pricing legislation, means that companies will need to be prepared to provide real-time information to tax authorities.
To comply with these changes, companies need to consider a range of factors, including documentation, forms, DAC directives, transfer pricing adjustments, and TP attributes. They also need to be aware of the impact of Pillars One and Two, MAPs, APAs, and day-to-day business decisions on transfer pricing.
One way to manage these compliance requirements is to use technology to automate the process. This can help to streamline the transfer pricing process, reduce the risk of errors, and provide real-time information to tax authorities. It can also help to identify potential transfer pricing issues and deal with them immediately, reducing transfer pricing risk for the organization.
As a global transfer pricing manager for a large multinational, it can be challenging to prioritize work and ensure compliance in all jurisdictions. One way to approach this is to conduct a risk assessment and identify potential issues in specific countries. This can be done through analysis of CBC reports, as well as value creation analysis to identify discrepancies in functions, assets, and risks.
It is also important to keep track of local and global filing requirements and ensure that documentation is up-to-date and ready to be presented during an audit. Technology can be a useful tool in managing these processes, particularly through the use of dashboards and structured data to track the status of documentation.
It is crucial for multinationals to stay on top of compliance issues and proactively manage their transfer pricing risks. Technology can be a valuable resource in achieving this goal.
For CFOs in particular, it is important to be aware of potential risks and transactions that may raise red flags for tax authorities. This includes understanding the countries with a history of more aggressively pursuing transfer pricing issues, as well as transactions such as IP and R&D that may be subject to more scrutiny.
In the current climate of economic uncertainty and rising inflation, the OECD’s push for the implementation of Pillar 2 is likely to create additional challenges for businesses. This makes it even more important to use technology and analytics to stay on top of compliance and manage potential risks. By being proactive and understanding the company’s appetite for risk, CFOs can help ensure the organization is prepared for any challenges that may arise.
About the author:
Borys Ulanenko, Digital Transfer Pricing Category Lead at Aibidia
Borys Ulanenko is a Digital Transfer Pricing Category Lead at Aibidia. Borys has more than 10 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.
Kirsty Rockall, Partner, Head of Transfer Pricing at Grant Thornton
Kirsty leads the Transfer Pricing practice in the UK at Grant Thornton. She joined Grant Thornton after 22 years at KPMG, where she was a partner in their Global Transfer Pricing Practice.
Brigitte Baumgartner Garcia, Digital Transfer Pricing Advisor at Aibidia
Brigitte Baumgartner Garcia works as a Digital Transfer Pricing Expert at Aibidia. She has more than 10 years of experience in transfer pricing with a background in government, industry and consulting.