Three challenges and a way forward for your Transfer Pricing setup in 2023

This article addresses the importance of accurate intercompany agreements and transfer pricing processes, and provides a summary of supporting TP technology.

Multinational companies have typically a defined transfer pricing system with a written Transfer Pricing (“TP”) policy including a definition of methods, mark-ups and margins. This is often accompanied by a basic or more sophisticated TP compliance approach. But what happens in between the TP policy and TP compliance?

Simply put, companies will have to be ready to demonstrate not only that their actual TP outcomes are in line with their TP policy, but also that they are managing their transfer prices appropriately. 

While seemingly a relatively simple administrative task, intercompany transactions executed without a proper contractual basis or based on outdated agreements can all too easily open the door to challenges from the tax authorities. Typical examples include:

• Intercompany services: tax authorities often try to challenge the benefit of an intercompany service received and thus deny its tax deductibility. While it is challenging enough to convince tax authorities of the benefits of services, poorly written service agreements unnecessarily weaken the taxpayer’s position. Taxpayers are advised to ensure that the actual services provided are covered in the agreement, the stated pricing methodology is still valid and that the form and substance of the intercompany agreement in general meets criteria that would be expected from a third-party service agreement. Continuing to rely on lean, two-page intercompany agreements is not a recommended option. 
• Functional profiles and profitability: intercompany agreements formalize the allocation of functions, risks and assets between related parties as well as the intended compensation for the parties. In practice we have regularly seen that the actual facts and circumstances are not adequately reflected in intercompany agreements, e.g. foreign exchange risks or bad debt risks are in fact borne by the distributor, while the agreement states that these risks are borne by the Swiss parent company. In such situations it can prove to be difficult to argue that losses due to these risks should be tax-deductible in the distributor’s tax domicile. 

While these are straightforward use cases, they illustrate the importance of keeping intercompany agreements up-to-date and of preventing inaccurate agreements creating or increasing transfer pricing risk. For this reason, we recommend as a first step to gain full transparency on the status of your intercompany agreements (are all intercompany transactions covered by agreements or are there any gaps?) and to check whether the existing agreements adequately reflect your current facts and circumstances. Going forward, it is also recommended to establish a process to keep intercompany agreements up-to-date and store agreements in a central location that is accessible to the relevant stakeholders. 

Transfer prices often significantly impact local profit levels and tax payments. For this reason, companies should ensure that the calculated prices, amounts of management fees charges, etc. are correct and that (data) checks and controls have been performed. Having a clear process for all key transaction groups, with proper controls documented in writing, helps improve the accuracy of TP outcomes and is an important supporting element to counter accusations from tax authorities to deliberately shift profits with corresponding consequences.

It is highly recommended to document your key TP processes in case this has not been done yet or review if existing process descriptions are still correct and complete. This is a good opportunity to think about process enhancements and cover new or updated processes in the internal control system or tax compliance management system. Obviously, the larger the amounts at stake, the more important it is to cover your processes and protect your company and employees.

While awareness of appropriate transfer pricing processes has increased within companies, practical challenges may exist in how to approach the issue. In general, a starting point is to have a complete overview of the status quo:

• What are your key transaction groups?
• What are key challenges for each of these transaction groups?
• Is there a good level of understanding of the processes, which teams are involved and what do they actually do? 
• What are the blind spots and unresolved issues?

Such a simple (high-level) overview has been proven to be helpful in approaching this topic and the stakeholders in a structured way and in defining a way forward. While mapping transfer pricing processes may seem like an additional administrative burden, experience from previous projects has shown that discussions with different teams do result in new insights into how things work and in sustainable process improvements.

Referring to part II of our little blog series, well defined processes are the basis for using supporting technology in a meaningful way.

Finance functions, including tax teams, are now expected to add significantly more value to the business than in the past. This increases the pressure not to waste time on routine and repetitive data preparation, reporting and compliance – while at the same time meeting increasing reporting requirements without increasing headcount. This also means that tax teams, as data consumers, cannot rely on other teams to fulfill existing or new requirements as before.

Core systems such as an ERP and other supporting systems may contain all the required data, but often this data is not ready for use. And it should not be expected to ever be. It is highly recommended to explore the current data and technology landscape and how smart technology solutions can be embedded in daily or regular work routines.

Today a variety of solutions are available, each with its distinct positive aspects. What works best for you and your tax departments depends on your specific circumstances. Here are some considerations which solutions can support typical TP activities:

• Data preparation: often, data from different sources needs to be combined and transformed into a consistent data set. This is referred to as the ETL process (Extract, Transform, Load). Here a variety of (no code/low code) solutions exist. A popular solution within tax departments is for instance Alteryx. Typical use cases are the preparation of transactional data for OTP or compliance purposes or preparation of segmented P&Ls. In data preparation, mapping plays a pivotal role, offering insights into processes and guiding better data integration and standardization. Overall, there's a notable advantage in automating repetitive data preparation tasks.
• Data visualization: once the data has been loaded into its destinationsuch as a database or data warehouse, tax teams may want to visualize the data and gain specific insights. Solutions such as Microsoft PowerBI or Tableau may be suitable tools. Amongst others, typical use cases are analytics around CbCR, dashboards with margin monitoring comparing actuals against benchmark study results, or even more detailed visualizations with product profit analytics.

In addition, there are various solutions that can help with other TP challenges. Tax teams may want to consider more than just one solution. They should take a holistic view of how vendors and their products can help:

• Microsoft offers a wide range of products and services. Power BI was already mentioned and is part of the Power Platform. It offers tax departments a variety of use cases including improved collaboration and data gathering, e.g. for automating the internal TP compliance processes. And not to forget the opportunities from easily accessible AI models through the Azure AI platform.
• SAP with its HANA database and S/4HANA ERP provides the backbone system for many companies. Maintaining appropriate transfer prices in the ERP is an elementary task for tax departments. As such the suite of SAP products is interesting for tax teams as well. SAP Profitability and Performance Management (PaPM) can be seen as calculation engine that can be used for TP purposes while SAP Analytics Cloud offers functionalities for analytics and data visualization. 

The solutions mentioned above are a selection of possible and commonly seen products that support TP processes. In addition, there are a number of specialized TP software solutions on the market. All products have strengths and weaknesses and are priced differently. Also, a company may already have a digital and data strategy in place that determines preferred solutions.