2025 is Around the Corner: Is your Transfer Pricing in Good Shape?

14^th november 2024

As 2024 comes to a close, multinationals should consider assessing and potentially adjusting their transfer pricing before year-end to avoid potential book-tax differences and other administrative burdens.

Throughout the year, transfer pricing compliance typically involves setting provisional or temporary transfer prices based on benchmarked results. If necessary, to reflect an arm’s length result, a taxpayer may report “final prices” on a tax return that differ from the prices actually charged. Typically, at the end of the year, the taxpayer makes adjustments to ensure that results approximate arm’s-length results, the gold standard in transfer pricing. 

 If the taxpayer makes these “true-up” adjustments after closing  financial statements for the year, the adjustment will create a book-tax difference that requires additional compliance efforts. Therefore, it is a best practice in transfer pricing compliance to consider transfer pricing adjustments during the year and to initiate true-ups before year-end to avoid unnecessary administrative efforts.

The global standard by which transfer pricing is evaluated is the “arm’s length principle. In determining the true taxable income of the controlled taxpayer, the standard to be applied in every case is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. Thus, the arm’s length principle involves comparing the transactions of one of the controlled parties (the “tested party”) to the transactions of uncontrolled parties (the “comparables”) to determine whether the controlled transactions are arm’s length.

Nearly all transfer pricing analysis is ultimately done by way of a “lookback test.” Taxpayers use a provisional transfer price throughout the year to generate intercompany invoices and project that the tested party results fall within the arm’s length range of results developed using comparable information.

However, estimates can be wrong, and taxpayers are required to make adjustments, as needed, to report an arm’s length transfer price (more appropriately worded, an arm’s-length result) in transfer pricing documentation contemporaneous with the filing of a tax return.

If a taxpayer decides that a true-up is needed, the taxpayer can make that true-up either before year-end or after year-end. Before year-end, the taxpayer should be in possession of most of the information about sales prices and volumes and SG&A, although the comparables’ final full-year information would not yet be available for the year in question. The comparables’ him information would be available before the due date of the tax return, but any adjustment after the financial books have closed would be subject to additional administrative complications.

The year end adjustment needs to be reflected in the financial statements and this would normally result in credit/ debit notes being  issued. In this case, both parties to a transaction make an appropriate adjustment to the price of goods sold/ services rendered.

In the case of adjustments related to imported goods, customs implications of the adjustments on the transfer price should also be taken into consideration as TP adjustments can have an unintended effect of creating a risk from a customs perspective. Where the adjustment is an upward adjustment to a price of imported goods (i.e. if an importer is in a payable position), the importer will be expected to disclose and pay the additional customs liability and potential penalties. On the other hand, where the adjustment is a downward price adjustment (i.e. if an importer is in a receivable position), then the taxpayer will have overpaid customs duties. However, in practice, a refund claim in respect of overpaid customs duties may be a lengthy process, and indeed ultimately maybe more of a theoretical rather than a practical possibility.

Pay particular attention to material transaction amounts. Determine whether there are any new intercompany transactions for which a provisional policy was applied.

It is a best practice to periodically evaluate transfer pricing results, preferably well before year-end, such as on a monthly or quarterly basis. Performing evaluations proactively instead of waiting until year-end allows for pricing adjustments to be made and impact profitability during the same fiscal year. This process does require time and resources, particularly for organizations with a complex web of intercompany transactions. Segmentation and other data processing may be required in order to perform reliable analyses.