KPMG report: Transfer pricing and the audit committee agenda

Adapted from a report prepared by the KPMG member firm in Switzerland

Adapted from a report prepared by the KPMG member firm in Switzerland

Audit committees often treat transfer pricing relatively lightly. However, because of the implications that transfer pricing can have in an organization, audit committees need to be prepared and have an overview, potentially prepared with the support of data analytics tools, of the group’s current transfer pricing status.

Areas of responsibility for audit committees in relation to transfer pricing

Audit committees have many responsibilities within a group—ranging from oversight of the external reporting (in particular financial reporting), internal control systems and their functions, and external compliance among others.

Transfer pricing can have implications for the responsibilities of the audit committee, including:

  • Transfer pricing can affect external reporting, such as in the context of tax provisions.
  • The internal control systems also need to deal with transfer pricing topics (even though in reality, there are multinational groups that do not pay sufficient attention to transfer pricing in their internal control systems) considering the size of potential risks in transfer pricing, both in monetary terms (reassessment of transfer prices by the tax authorities with a consequential increase in taxes due) and reputational terms (the reputation or image of a company could be damaged by potential claims of tax avoidance).
  • Transfer pricing also has a compliance angle. In many countries, there is an obligation to prepare transfer pricing documentation. Furthermore, certain countries request additional reporting such as transfer pricing returns, and virtually all countries have adopted a country-by-country reporting system and related notifications.

Considering these points, transfer pricing is a topic not to be overlooked by audit committees.

What does the situation look like at the moment?

In many instances, transfer pricing is perceived as a mere compliance topic that is usually dealt with by the chief financial officers (CFOs) as an area of responsibility (or by a head of tax or head of transfer pricing). Only in exceptional cases, and specifically in smaller groups, do CFOs actually get directly involved.

Often, audit committees are not very interested in transfer pricing because 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 transfer pricing may have for a group—not only regarding compliance and reporting, but also from a reputational perspective. In the past years, numerous multinational entities have suffered reputational damage from transfer pricing-related topics. Their transfer pricing policies and structures have been scrutinized by tax authorities or by the European Commission (in the context of possible state aid), but especially by the public. The implications of reports of tax avoidance in the press may affect consumers and possibly 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 transfer pricing policy and could contribute to increase the group’s transfer pricing-related risks. A higher level of involvement from the audit committee, therefore, could be important and beneficial to a group.

What could such involvement look like conceptually?

Given that the typical audit committee often consists of two to four 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 audit committees (also without or with minimal connection to transfer pricing), the first question to be addressed is what role the audit committee could have in the area of transfer pricing. 

Given the main responsibilities of the audit committee that could also have an impact on transfer pricing, the following involvement of an audit committee would be appropriate:

  • To be informed about the main characteristics of the group’s transfer pricing system, including an evaluation of the main risks connected to it. This is necessary so that the audit committee can evaluate whether the risks connected to the current transfer pricing system are in line with the organization’s risk appetite.
  • To be informed about the compliance status in terms of transfer pricing documentation as well as other compliance obligations.
  • To be informed of significant ongoing tax audits in which transfer pricing plays a major role. Such tax audits may also lead to broader implications such as reputational issues and need to be on the audit committee’s radar.
  • To have a clear picture of how transfer pricing is covered in the internal control systems because potential risks may arise both as reassessments of the tax base and reputational risks for the group.
  • To have a proper understanding of the general processes around transfer pricing topics in the organization, such as how transfer prices are broadly set throughout the year, how the compliance is organized, and how the people responsible for transfer pricing are involved in change initiatives within the organization that may have transfer pricing implications such as restructurings, M&A activities, international remote working.

Based on this information, the audit committee may then require further information on individual topics that are identified as specific risk areas that require more detailed attention.

KPMG observation

The brief discussion above lists important considerations for audit committees with regard to transfer pricing and thus may merit the attention of the audit committee, a level of attention that is commensurate to the level of risk that potential shortcomings or deficiencies in the transfer pricing area could bring to the organization.

Read an April 2022 report prepared by the KPMG member firm in Switzerland

 

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