What is Digital Transfer Pricing?
The Aibidia Manifesto
Transfer pricing is not a new concept. In fact, it dates back to the 1960s, when the US tax authorities issued the first comprehensive transfer pricing legislation. The practice of transfer pricing has evolved over time with changing business models, increased global competition and pressure on corporate tax rates.
The Golden Age of transfer pricing started in the 2010s with the rise of global supply chains and increased awareness of tax avoidance risks. The Base Erosion and Profit Shifting OECD project was the tipping point, which introduced standardized transfer pricing reporting requirements now implemented in more than 150 countries around the world.
Despite fundamental changes in the business models and compliance requirements, the way multinationals handled the transfer pricing did not change that much. Still, most companies focus on the mere compliance and reactive handling of tax authorities’ requests. Transfer pricing specialists primarily use Excel, Word and emails to handle the documentation, as they have done since the late 1990s.
We are here to change that. Like many other industries, transfer pricing is going through a massive digital transformation, and we are leading the way. We are building the new digital transfer pricing category.
How do companies approach transfer pricing?
Transfer pricing can be done in various ways. We have compiled a list of approaches to transfer pricing, starting from the most basic ones and going to the most advanced. We called them “levels”:
Level 0 – “Ostriches” – a reactive approach focused on compliance. No standardization and structured process. Reliance on external resources and expertise.
Companies at this level still don’t see transfer pricing as a critical element of their cross-border business planning and compliance. They don’t have a holistic picture of their related-party arrangements don’t have any formalized transfer pricing policies and processes. Companies at Level 0 usually ignore transfer pricing until they are requested for the documentation or challenged during a tax audit. Then, they hire external consultants to prepare the documentation once there is a need. Since there is no control over cross-border related party arrangements, companies don’t have an idea about their transfer pricing risks. Gaps in the legal frameworks, accounting systems and process documentation make transfer pricing compliance an excruciating and expensive process.
Such a company is an “ostrich”, as it hides its head, hoping that no transfer pricing challenge arises. Surprisingly, even in 2022, most of the companies are still at this level.
Level 1 – “Turtles” – centralized, structured and standardized manual transfer pricing process.
At this level, companies recognize the importance of transfer pricing. They have a structured approach, and they try to proactively manage all transfer pricing lifecycle: from TP planning, implementation, and monitoring towards TP compliance and audit defence. There are formalized transfer pricing policies and local file templates in place, and the finance function is aware of transfer pricing’s importance. However, the reliance on manual processes and traditional tools (essentially Excels and Words) make it very resource-intensive and cumbersome. The control over transfer pricing is complex, and getting insights and proactively managing TP risks is problematic.
Such companies are “turtles” – they are relatively well-protected but slow and inefficient.
Level 2 – “Armadillos” – semi-automated transfer pricing process.
Companies at this level are one step ahead of turtles. Point automation solutions manage some parts of the transfer pricing lifecycle, most often the documentation. As a result, companies become more effective in some of their processes, though still heavily relying on manual steps and human control. They start getting valuable insights into their transfer pricing arrangements; however, there are significant limitations since only some parts of the transfer pricing are automated.
We call them “armadillos” – they are well protected and relatively quick.
Level 3 – “Eagles” – digital transfer pricing process.
Companies that enabled digital transfer pricing are in a very different position. Instead of enhancing their transfer pricing specialists’ traditional way of working with point automation, such companies redefine their transfer pricing approach on the digital grounds. They deploy the transfer pricing data model that automatically connects to company data sources (such as ERP and HR systems). They use digital transfer pricing solutions and applications that enable them to do any TP process or documentation automatically. As a result, they have full control of their transfer pricing landscape, get valuable insights and proactively manage any transfer pricing issue or risk. Compliance costs are significantly reduced, and the tax model is fully integrated with the business.
Such companies are “eagles”, as these birds calmly fly in the sky most of the time; they see what’s going on and what’s ahead. But when they need to act, they act rapidly and flawlessly.
Our mission is to make every company an eagle, no matter at which level they are now.
The main building blocks of digital transfer pricing
Data is crucial for digital transfer pricing, as in any other industry facing digital transformation. It’s impossible to gain insights and automate anything without appropriately structured data. And that was always the problem in transfer pricing – most of the transfer pricing requirements are written as a “word” legislation or international textbook guidance. Even humans find it difficult to read tax laws, and the famous OECD Transfer Pricing Guidelines is one of the most complex texts in the world (as our software developers say). So how can we even try to digitalize transfer pricing, if its fundamental rules and requirements are so unstructured and challenging? The answer is – taxonomy.
What is taxonomy?
If you google “taxonomy”, you’ll probably see pages about biology. Indeed, taxonomy emerged as a science of classifying living organisms – animals, insects or plants. But nowadays, taxonomy has its applications in all areas of human life (even in transfer pricing!).
In Aibidia, we’ve built the first transfer pricing taxonomy. It means we read and researched all transfer pricing laws, rules and regulations and classified all possible information that is used (or can be used) for transfer pricing purposes. We’ve built a complete map of information necessary to create, manage and report transfer pricing. In other words, we converted unstructured plain text legal requirements to machine-readable standardized data points and structured taxonomy.
How did we build the transfer pricing taxonomy and data model?
Let’s take the transfer pricing local file as an example. The local file is a transfer pricing report that most of the companies need to have and provide to tax authorities. In contrast to other common tax reports (like tax returns), the local file requirements are not structured – it is just the content list, and every company decide how to fulfil it. For example, the OECD requires taxpayers to include “a description of the management structure of the local entity”. It doesn’t specify the information to be included, and it doesn’t require any specific format. This makes interpretation, data gathering, analysis and presentation difficult. Essentially, every transfer pricing specialist should interpret and complete it the way they believe is the best. That’s why you can often hear that transfer pricing is rather an art than science.
We disagree with this. We believe that transfer pricing IS a science. And here is what we did.
We analyzed every element of transfer pricing compliance requirement and identified the questions that need to be answered. For example, to be able to provide “a description of the management structure of the local entity”, we need to answer the following questions:
At this point, it becomes much easier to meet the local file requirement, as now we know the exact questions we need to answer. However, we did not stop there.
As a next step, we identify particular data points that we need to answer each question. In other words, we determined structured information that needs to be collected to answer these questions, usually in the format of the data table:
Now, imagine you have all data tables to answer all of the transfer pricing questions. And then, you start connecting the dots and see the interrelations. For example, related party transactions data is not just used for a local file but also for the country-by-country report. If you have this data in one place, though, you can easily reuse it. You don’t need to collect, clean and enrich the data multiple times. Moreover, you can use this data for advanced analytics and insights.
That’s what we’ve built in Aibidia – the complete transfer pricing data model.
Applications
The data model is a fundamental building block of our transfer pricing platform, but users don’t interact with it directly. To enable the value for our customers, we build the applications on top of the data model that allow users to interact with it. For example, dTP Doc is the solution that allows preparing local files and master files in a few clicks. When it comes to applications, our goal is to optimize the user experience and give all necessary tools to make transfer pricing work easy. But since all the applications are connected to the same data model, you quickly get efficiencies and unique insights, which are not available in so-called “point solutions”.
Where are we now, and what’s next?
At Aibidia, we develop the first end-to-end digital transfer pricing platform. Here are the three strategic directions we are working on right now:
- Transfer pricing data model enhancement – for example, we include new local transfer pricing taxonomy and models in our platform, making it possible to generate very local-specific TP reporting in one click.
- Applications and transfer pricing ecosystem – we develop multiple new applications that will help our clients with particular steps of the transfer pricing lifecycle. For example, we are building the group services cost allocation solution that is fully integrated with our data model and other applications. Our ambition is to create an ecosystem where our customers would be able to create and share their own TP apps (the same way Apple App Store works).
- Going beyond transfer pricing – in essence, transfer pricing is just one aspect of cross-border business. And there is much more there than just TP – you need to manage customs, local compliance requirements, licensing, and many other issues. Our mission is to eliminate billions of dollars of redundant transaction costs, and transfer pricing is just the beginning.
We invite professionals, companies and consultants to join us in this journey.
