Transfer pricing can be an easy target for tax authorities

With increased enforcement efforts by tax authorities globally to ensure that multinational companies pay their fair share of taxes, transfer pricing and an adjustment to taxable income can be seen as an easy target, with intercompany arrangements more likely to be challenged. This is the view of Mazars international tax and transfer pricing partner Claire Healy.

Transfer pricing is essentially the pricing of transactions between connected companies, with the aim of the transactions being undertaken at an arm’s length or market price, she explains. “Transfer pricing is the substance-focused pricing tool which multinational groups use to allocate profits in their global operations. The increasingly complex regulatory and tax environments that multinational organisations are operating in has made it a top tax priority for organisations.”

To discourage profit shifting, transfer pricing is governed by significant documentation requirements with penalties for non-compliance. And those requirements and penalties can be more far-reaching than many presume.

To minimise risk, it is essential that organisations actively manage, regularly review and update their transfer pricing policies and documentation

“Normally perceived as something that only applies to very large groups, the thresholds for inclusion apply on a global basis, meaning that even a small local subsidiary of an international group can fall within their scope and require supporting documentation,” Healy points out. “Failure to satisfy local obligations can result in penalties not only for the company but potentially for the directors as well.”

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Transfer pricing can be an easy target for tax authorities

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And the level of scrutiny is only going in one direction. “Countries are looking for ways to increase their tax revenues to fund years of Covid measures,” she notes. “This is resulting in an ever-increasing number of transfer pricing audits, not all of which are for large household names.

“To minimise risk, it is essential that organisations actively manage, regularly review and update their transfer pricing policies and documentation. As we have seen from the media attention in the Apple, Amazon and McDonald’s France transfer pricing disputes, for example, transfer pricing planning and documentation can also be valuable tools in managing tax-related reputational risks.”

As the effective tax rate under these rules is looked at on a country-by-country basis, transfer pricing and how the profits of the group are allocated between countries is fundamental

Much of the current debate around international tax and transfer pricing is dominated by the OECD’s initiatives to address the tax challenges arising from the digital economy. Reform of taxation of the digital economy is top of the OECD’s agenda and Pillars I and II are its proposed solutions.

According to Healy, Pillar I will redefine how profits are allocated within large multinationals under transfer pricing rules. It will employ a formula to reallocate a portion of profits to market jurisdictions where users and consumers are located, even in the absence of the physical presence of the multinational. “This signals a move to a global formulaic approach to profit allocation,” she points out.

Pillar II seeks to set a global minimum effective tax rate of 15 per cent for large multinational companies. This proposal consists of a mix of measures allocating taxing rights of low-tax group companies to the group’s ultimate parent or group entities and requiring top up tax payments to be made.

“As the effective tax rate under these rules is looked at on a country-by-country basis, transfer pricing and how the profits of the group are allocated between countries is fundamental,” Healy explains. “These proposals may limit the tax efficiency of existing structures, reinforcing the need for multinationals to review their transfer pricing policies in light of these proposals.”

Failure to satisfy local obligations can result in penalties not only for the company but potentially for the directors as well

The ESG agenda needs to be considered as well, she adds. “There is a focus on achieving sustainable business practices and this is often viewed from a supply and value chain perspective, but not necessarily linked with transfer pricing. How a renewed supply and value chain operates from a tax perspective can unfortunately be considered late in the process.”

This means that transfer pricing models and sustainability-driven changes should be linked. “It is essential that multinational companies assess the impact of their ESG initiatives on how their global assets are employed, functions performed, risks assumed, and how intellectual property is created in the context of their existing group transfer pricing policies,” says Healy.

“Existing transfer pricing models should be adapted or updated to ensure that the allocation of profits takes account of ESG initiatives, and that the sustainability transition is aligned with the company’s tax strategies and models. If this is not done, opportunities may be lost, and the company could be exposed to tax risks and liabilities.”

Transfer pricing is likely to remain a key area of focus for some time to come, given the constantly changing international tax environment. “Multinationals must be proactive, and continually review and adapt their transfer pricing systems to ensure compliance and tax efficiency,” Healy concludes.