High-quality and globally consistent TP documentation has steadily gained in importance. Enhanced compliance can be achieved by implementing a risk-based ongoing process instead of independent short-term projects when preparing documentation reports. This also offers potential time and cost savings.
In recent years, tax administrations have increasingly requested, analyzed and also challenged transfer pricing documentation as part of their tax audits. This increased scrutiny has been accompanied by stricter and more comprehensive local documentation requirements, often with deadlines or the obligation to submit transfer pricing documentation reports pro-actively.
To meet these increased requirements, it is imperative for companies to rethink their documentation approach.
TP documentation definition
At the global level, OECD Action 13 of the Base Erosion and Profit Shifting framework (BEPS) provides guidance on the content and structure of TP documentation. The three-tiered approach includes (i) a Master File, (ii) Local Files, and (iii) (for large multinationals) a Country-by-Country- Reporting (CbCR). One of the main objectives of the TP documentation requirements is to provide tax administrations with sufficient and useful information, enabling them to conduct an appropriate risk assessment and transfer pricing audits1. Therefore, it is recommended and in some cases even mandatory to prepare TP documentation on an annual basis.
1OECD Transfer Pricing Guidelines 2017, Chapter V, Paragraph 5.5, p. 230
Historical approach: TP documentation as a project
In the past and sometimes even nowadays, companies often considered the preparation and maintenance of TP documentation as a series of projects that is only tackled at the request of the authorities or opportunistically when spare resources were available internally. While the Master File in this setting is usually prepared centrally, the local files are prepared on an ad-hoc basis, usually with the help of local advisors. This leads to an often inconsistent and unstructured approach with varying interpretations and levels of detail. Further disadvantages of this approach may include:
- Duplication of efforts, as local advisors do not communicate with each other to leverage similar information;
- Synergies cannot be exploited, which increases costs and reduces efficiency;
- Proneness to errors due to time constraints, as tax administrations only provide a short period of time to provide the requested documentation; and
- Inadequate and unstructured maintenance of the documentation.
In general, resources are allocated according to urgency rather than actual risk or importance. As a result, this approach generally does not lead to high-quality and globally consistent TP documentation that meets the expectations of the tax authorities.
Recommended approach: TP documentation as a process
By implementing a TP documentation process, the above-mentioned disadvantages can be eliminated.
Establishing a TP documentation process means to centralize the management of the TP documentation preparation and maintenance in order to achieve global consistency. This also includes the preparation of standardized TP documentation templates.
Similar to other annual processes, such as the preparation of the annual report and tax returns, a recurring schedule should be put in place. In addition to the various deadlines for delivery, this schedule should also indicate who (i.e. corporate or local management) is responsible for these deliverables.
Corporate management should also consider the company’s risk appetite. For example, in a risk-averse situation, local files for each individual subsidiary would be prepared annually, irrespective of the perceived risk level connected to transfer pricing. However, regardless of the risk appetite established, changes in local regulation and related documentation requirements should be continuously monitored. Furthermore, some countries have specific local requirements that may differ from or go beyond the standardized OECD template. The decision on whether and to which extent to further localize these files can be taken by management based on the company’s defined risk appetite.
The benefits of a regular, standardized annual process are as follows:
- Standardized Master and Local File templates leverage synergies and ensure company-wide consistency;
- A defined data gathering process provides internal clarity and improves documentation quality; and
- Resources can be allocated based on actual risk or importance.
Ultimately, a TP documentation process not only enhances compliance, but also quality and saves time and money.