Transfer Pricing on the Audit Committee agenda - Part 1 Transfer Pricing on the Audit Committee agenda - Part 1

Audit Committees often treat transfer pricing relatively lightly. Due to the impact that transfer pricing can play in an organization, it is advisable to ensure the AC has an overview, potentially prepared with the support of data analytics tools, of the group’s current transfer pricing status.

Audit Committees (“ACs”) have many responsibilities within a group, ranging from oversight of the external reporting (in particular financial reporting), internal control systems (“ICS”), their working, external compliance, etc.

Transfer Pricing (“TP”) can have an impact on the AC responsibilities, e.g.:

• TP has an impact on external reporting, such as in the context of tax provisions;
• The ICS should also deal with TP topics, even though in reality there is still a considerable number of groups that do not pay sufficient attention to TP in their ICS, considering the size of potential risks in TP, both in monetary terms (e.g. reassessment of the transfer prices by the tax authorities with the consequent increase in taxes due) and reputational terms (e.g. the image of a company might be damaged by potential claims of tax avoidance);
• TP has also a compliance angle. In fact, in many countries there is an obligation to prepare TP documentation. Furthermore, certain countries request additional reporting such as TP returns, and virtually all countries have adopted a country-by-country reporting system and respective notifications.

Considering these points, it becomes clear that TP is a topic that should not be overlooked by ACs.

In many instances, TP is perceived as a mere compliance topic that is usually dealt with in the CFO’s area of responsibility, e.g. by a Head of Tax or Head of TP or sometimes Head of Controlling. Only in exceptional cases, and specifically in smaller groups, CFOs get involved in this topic directly.

Often, ACs are not very interested in TP as it is perceived as a very specific topic with numerous details and for the most part a mere compliance obligation that needs to be dealt with in a routine manner.

This perception completely overlooks the far-reaching implications that TP may have for a group, not only regarding compliance and reporting, but also from a reputational perspective. In the past years, numerous multinationals have suffered reputational damage from TP-related topics, such as Google, Starbucks, Amazon, Coca-Cola and more. Their TP policies and structures have been scrutinized by tax authorities or the European Commission (in the context of possible state aid), but especially by the public. The impact of bad press on consumers with claims of tax avoidance may result in lower revenue for these groups.

Furthermore, as discussed below, topics such as a global minimum tax rate and ESG are also likely to affect a group’s TP policy and could contribute to increase the group’s TP-related risks.

A higher level of involvement from the AC would therefore be important and can only be beneficial to a group.

Given that typical ACs often consist of 2-4 members of the Board of Directors who meet a few times per year and given the numerous activities and responsibilities that are on the desks of ACs (also without or with minimal connection to TP), the first question to be addressed is what role the AC could have in the area of transfer pricing. 

Given the abovementioned main responsibilities of the AC that have an impact on TP as well, the following involvement of an AC would – at least – be appropriate:

• Be informed about the main characteristics of the group’s TP system, including an evaluation of the main risks connected to it. This is necessary to ensure that the AC can evaluate whether the risks connected to the current TP system are in line with the organization’s risk appetite;
• Be informed about the compliance status in terms of TP documentation as well as other compliance obligations; 
• Be informed of significant ongoing tax audits in which TP plays a major role. Such tax audits may also lead to wider implications such as reputational issues, and should therefore be on the AC’s radar;
• Have a clear picture of how TP is covered in the ICS, as potential risks may arise both as reassessments of the tax base and reputational risks for the group
• In order to evaluate the coverage in the ICS, the AC also needs to have a proper understanding of the general processes around TP topics in the organization, e.g. how transfer prices are broadly set throughout the year, how the compliance is organized and how the people responsible for TP are involved in change initiatives within the organization that may have a TP impact, such as restructurings, M&A activities, international remote working, etc.
• Based on this information, the AC may then require further concrete information on individual topics that are identified as specific risk areas that require more detailed attention;

The above-listed points are important to ensure that the AC covers the topic of TP with an attention level that is commensurate to the risk level that potential shortcomings or deficiencies in the TP area may bring to the organization. In Part 2 of our blog series on the TP involvement of an Audit Committee, we will look in more detail as to how the aspects described above can be implemented in practice.