Three-tiered transfer pricing documentation approach of a master file, local file and a country-by-country report will arm tax authorities with greater ammunition
With the financial crisis of 2008, the phrase ‘new normal’ gained widespread acceptance. The new normal necessitates new approaches to address it. In the tax world, there is no area greater than transfer pricing that testifies to this truth. Next year may be dominated by the following themes requiring new thinking.
Governments across the world continue to increase reporting requirements and tighten disclosure norms. This is expected to give them access to large amounts of corporate information, financial and operating data and tax strategies. Measures like the three-tiered transfer pricing documentation approach of a master file, local file and a country-by-country report (CbCR) are going to arm tax authorities with greater ammunition. This in turn will be used to gain more insights into businesses and build stronger cases for a share of the global tax pie. Strengthening cross-country collaboration and information exchange between tax administrations also underscore the growing importance of transparency. Companies, therefore, need to prepare for this pro-actively with a clear understanding of what their respective data looks like, the story it presents, how consistent it is across different countries they operate in and what it means for business from a tax-risk standpoint.
Optimal risk and resource management
In EY’s survey of 623 transfer pricing executives in 36 countries across 17 industries (2016 EY TP Survey), 75% of respondents indicated ‘tax-risk management’ as their top transfer pricing priority. The Base Erosion & Profit Shifting (BEPS) recommendations reduce the threshold for a business to constitute a permanent establishment, require companies to demonstrate greater substance, align actual conduct to legal contracts, shift the spotlight on development, enhancement, management, protection & exploitation (DEMPE) functions related to inter-company intangibles and service flows. These collectively are expected to increase risks for companies through more controversy and longer dispute resolution timeframes.
Unresolved TP disputes will also imply heightening reputational damage and public focus on corporate brands. Hence, companies should identify pressure points and prepare well. They should also determine resource allocation to markets where they anticipate greatest risks. In the aforementioned survey, India remained one of three most frequently cited nations where transfer pricing policies got examined by the tax authorities with around 79% cases being adjusted. The developing economies like India, African countries, countries in Latin America are likely to be more unpredictable and prone to controversy than the developed world requiring more focus and resources to fight disputes.
Companies faced with rising controversy will need to decide on how to exit this whirlpool to avoid being sucked into a never-ending spiral of adjustments, appeals and tax demand cash-flow management. It is essential to consider advance pricing agreements (APA) or bilateral competent authority proceedings to deal with tax controversy. The Indian APA program, for one, has delivered outstanding results and helped more than 100 companies to obtain certainty on their inter-company pricing. Among users of APAs, more than 70% of the respondents to the 2016 EY TP Survey reported satisfaction with the process and its results. More multinational groups are likely to weigh the cost-benefit of traditional dispute resolution channels vis-à-vis these alternative controversy management options and opt for swifter means of reaching a resolution and eliminating uncertainty.
Operationalising transfer pricing
A significant part of the transfer pricing puzzle today, is the uncertainty created internally within companies due to manual transfer pricing adjustments, lack of automation, inconsistency in methods and processes, insufficient alignment of data with the operating model, and inadequate monitoring controls. This will hamper their progress towards a uniform transfer pricing policy across countries and the articulation of a consistent methodology supported by reliable real-time data. One out of five respondents in the 2016 EY TP survey said their organisation lacks operational readiness to adapt to changing transfer pricing conditions. In a telling statistic, only 21% of the survey respondents said they are fully compliant in every country. This suggests companies will have to concentrate on their information technology and reporting systems underlying their transfer pricing policies and its implementation. They will have to ensure that the operational personnel understand the overall transfer pricing design and adhere to agreed-upon frameworks. Deviations to policies should be minimised and such instances tracked and addressed immediately to avoid post-facto solutions that may undermine the original TP design. This will possibly require embracing more technology and automation in bringing the TP policy and its narrative to life.
Albert Einstein famously said, “We cannot solve our problems with the same thinking we used when we created them.” In response to these changes, taxpayer will need to introspect on their current models, identify risks, develop new strategies, apply digital means of implementation and governance and make available proper information to tax authorities. This is the advent of Transfer Pricing 2.0. and will require quick adoption and adaptation.
The author is tax partner, EY India. Views are personal