Prepare for 2024

The increased scrutiny on transfer pricing results, the ever-changing tax regulatory landscape (e.g., BEPS 2.0 and the newly proposed EU Directive), and the economic uncertainty highlight the importance of ensuring the necessary basis for year-end adjustments, if needed.

For taxpayers that have made acquisitions during the year, it is critical that they understand the applicable transfer pricing policies, identify the needed financial data to apply the policy, and book the appropriate transactions (with the correct related parties and the correct transactions for purposes of VAT and duties). Taxpayers that are able to reflect year-end adjustments on their books for the year would avoid the necessity to perform adjustments after the books are closed and would likewise avoid the secondary adjustment consequences associated with those adjustments.

If taxpayers are struggling to make their year-end adjustments correctly or need to make large adjustments at year-end, they should be exploring operational transfer pricing (“OTP”) solutions. OTP refers to the implementation of transfer pricing policies to effectuate or account for them in an organisation’s financial statements. It includes gathering and wrangling data to apply the policies, setting transfer prices, and monitoring and calculating adjustments. 

Transfer pricing documentation requirements continued to evolve this year, and it is important to assess the impact on compliance for 2024 and future years. Two key examples are (1) the updated U.K. transfer pricing documentation requirements that commenced earlier this year (April 2023) and (2) the complete overhaul of Brazil’s transfer pricing rules and the related compliance obligations.

There have been other important updates around the world, such as transfer pricing disclosures in Saudi Arabia and Kenya, changes to transfer pricing documentation and timing in Malaysia, and adoption of transfer pricing rules in the Seychelles. This will continue to be an evolving space going forward; specific countries to watch for transfer pricing changes include France, Canada, Korea, and Luxembourg.

In the next few years, many taxpayers will need to disclose country-level data in some form. In Denmark, rules have already been passed to implement the EU's public CbC reporting directive, which will come into effect for calendar year 2025. This will impact both Danish and foreign-headquartered taxpayers, as they will all need to submit the public CbC report to the Danish company registry no later than 12 months after the financial year end (assuming they are in scope).

It should be noted that some countries, like Romania, have adopted it early, and Australia's public CbC reporting will apply to periods beginning on or after 1 July 2024.

Simultaneously, compliance with the "original" CbC reporting requirements remains, and taxpayers should ensure that CbC notifications are reported to local tax authorities in a timely manner, typically before year-end.

2024 is poised to be an active year for transfer pricing issues for financial transactions. Despite high interest rates, the M&A market is set to bounce back this coming year, and the boost in capital markets activities is expected to drive up both the volume and depth of leveraged deals.

Taxpayers will have to maintain a fine balance to obtain an efficient capital structure as well as meet the requirements being proposed and imposed by the various tax authorities. For example, several countries across the globe (e.g., Netherlands, Germany, and Brazil) have officially adopted some version of OECD’s Guidance in its TP Guidelines in Chapter X on Financial Transactions. This implies that companies need to pay attention to both sides of any financing transaction, not just analyse the borrower, but also consider the decision making and risk-taking ability of a lender, or the substance in a cash pool header.

Intercompany lending

The Danish Tax Authorities continue to have an increased focus on the selection of interest rates for loans between related entities. Rising interest rates have further complicated this area because companies may have the option to reevaluate their current capital structures, including consider refinancing or arranging new intercompany loans. In that context, companies must consider pre-payment options and covenants included in their intercompany loan agreements. For example, if the loan agreement is explicit about a make-whole clause, then the taxpayer will not have the burden of considering refinancing when rates are lower, while the absence of any early payment penalty provides flexibility for future planning. Any changes to a company’s capital structure should also consider debt capacity (i.e., debt versus equity), potential implication of the substantial modification rules and a company’s internal treasury department guidelines.

Cash pooling arrangements

With a rise in credit spreads, companies would need to reevaluate their cash pool policies and ensure arm’s length returns to all participants, while not over-compensating the cash pool leader.

Factoring

Rising interest rates means factoring can be a relatively more attractive option for short-term funding solutions as opposed to long-term loans or credit facilities and could allow for greater planning opportunities.

Guarantees

Taxpayers could consider using financial guarantees given the increased interest rates.

While the economic challenges of the recent past did not materialise into a recession as many had feared, the markets continue to be jittery, and companies continue to face uncertain economic conditions. Some companies may want to consider adjusting their transfer pricing based on slowdowns – or expected slowdowns – in their businesses. For example, companies expecting system-wide losses should consider where they expect to incur those losses and how they will support those positions. Tax administrations will be reluctant to accept losses, so companies should be well prepared to defend those positions with robust transfer pricing documentation to support extraordinary results. Companies expecting system-wide losses may also want to revisit their structures and explore if alternative structures are better suited.

On 6 September 2023, the Danish Supreme Court overturned a decision of the High Court and upheld the Danish Tax Authority's transfer pricing adjustments with respect to intercompany transactions between the taxpayer, an oil and gas company, and two of its subsidiaries. The Supreme Court’s ruling grants tax authorities an expanded scope to exercise their discretion in assessing the taxable income of companies, surpassing previous boundaries. In instances where tax authorities successfully introduce ambiguity regarding profit allocation within a corporate group under the arm's length principle, this ruling, along with other recent rulings, indicates a shift from the precedents set by the Microsoft and Adecco cases whereby the tax authorities were restricted in their access to discretionary assessments.

The ruling suggests that if tax authorities can substantiate the existence of a transaction (even if disputed by the group) and the group cannot provide documentation supporting a specific industry practice or similar rationale for the applied transfer pricing setup, there is a significantly heightened risk of granting tax authorities the authority to assess income on a discretionary basis.

We are also observing that content requirements for transfer pricing documentation cannot solely rely on a checklist of formal prerequisites. On the contrary, it necessitates a broader perspective and a more profound understanding of the tax authorities' methodology to mitigate associated risks. These risks encompass potential tax audits concerning income allocation, the possibility of income assessments by the tax authorities, the risk of double taxation, potential adverse rulings by Danish courts against the corporate group, and, ultimately, the imposition of penalties.

Companies with high-risk transactions or significant comparability adjustments should meticulously review their documentation. Moreover, they may find it beneficial to explore the integration of corroborative methods, particularly by scrutinising the implications of new or historical transactions that have not been identified by the company already, like no cash flow exists, which many years later or many years to come turns out to be something of value that an independent party would have been willing to pay for. This thorough review can enhance the accuracy and robustness of the documentation process in line with the complexities of high-risk or adjusted transactions.

Companies should assess weaknesses in their transfer pricing setups, strengthen documentation, provide background support, and explore options for advance certainty, such as Advance Pricing Agreements (APAs).

Looking ahead into 2024, it is crucial for multinationals to assess the implications of the OECD's July 2023 Amount B consultation document. Amount B aims to simplify the application of the arm's length principle to "baseline marketing and distribution activities". Although lacking consensus on a few critical issues, the document provides actual Return on Sales (ROS) results for distributors within Amount B's scope by virtue of a pricing matrix. It is expected that the OECD will incorporate Amount B into the OECD Guidelines in 2024. Multinationals are advised to examine whether their distributors fall under Amount B, model the impact on pricing compared to existing transfer pricing, take steps to clarify inclusion/exclusion, determine their position in the pricing matrix, and address operational challenges. Accurate balance sheet data is essential due to the emphasis on operating asset intensity, and some multinationals may need system and process upgrades.

With the global anti-base erosion (GloBE) rules component of Pillar Two set to take effect in 2024 in many countries, nearly all multinationals will face new compliance burdens related to Pillar Two. To prepare, multinationals should explore the transitional CbC reporting safe harbour, which is primarily based on CbC data. This safe harbour reduces the need for detailed Pillar Two calculations in specific circumstances. Multinationals are actively analysing how to qualify under this safe harbour, considering the significance of having a "qualified" CbC report and ensuring confidence in the underlying data.

Looking at a more extended timeframe (or earlier for operations outside the transitional safe harbour), multinationals must secure the diverse data necessary for Pillar Two compliance. This involves scrutinising Pillar Two calculations, identifying data gaps, and collaborating across different functional groups within the company to address those gaps.

As the Pillar Two rules settle, many multinationals are exploring strategies to mitigate their impact. This includes investigating how blending within a jurisdiction can achieve a rate close to 15 percent, maximising the benefit of the substance-based income exclusion. Multinationals may also engage with governments to discuss potential amendments to incentive regimes in the light of Pillar Two. Additionally, restructuring out of jurisdictions that no longer align with their business needs in favour of those better suited may be considered to improve their GloBE outcomes.