18 Jul 2011
The in-house corporate tax function can deliver significant value to a company’s bottom line. In doing so, it must overcome an increasing number of challenges. As with many corporate functions, the competitive landscape and global financial crisis has led to a heavy emphasis on managing and preserving cash.
Globalisation has led to not only larger, more complex business supply chains but has also resulted in an increase of scrutiny by customs and tax authorities. Steadily increasing information and regulatory requirements also place a strain on in-house tax resources, which are in short supply from a global perspective. The tax department’s access to quality information from within the organisation has also decreased resulting in the need to spend a much greater amount of their time collecting, analysing, and validating data. At the same time, board of directors, the C-suite, controllers and external auditors are showing reduced levels of risk tolerance with regard to unexpected tax events and spikes in their company’s effective tax rates.
One of the greatest challenges that tax departments face today is the renewed focus by many tax authorities on so-called “transfer pricing” requirements, which have been adopted by most countries around the world. Massive government deficits are making transfer pricing enforcement the preferred way for governments to try to collect hundreds of millions of dollars in taxes fast. This term embodies statutory and regulatory law worldwide that governs the tax treatment of transaction pricing between related companies or entities under common control. Although these rules do not mandate how related parties must price their transactions, they provide enormous power to tax authorities to allocate income and deductions for tax purposes based on what the pricing would be if the transaction was taking place between unrelated parties on an arm’s length basis. As a result of this renewed focus, multinational companies are being targeted for increasingly aggressive tax and transfer pricing audits. Tax authorities are also rigorously asserting new interpretations of and changes to statutes and regulations, testing the historical foundations of longstanding transfer pricing principles.Knowledge-intensive industries that are experiencing significant business change as well as other industries that are currently rolling out new business models may be disproportionately affected by this renewed focus. In many instances transfer pricing assessments can amount to hundreds of millions of dollars. Companies with transactions involving intellectual property are also of great interest by taxing authorities due to a perceived potential for abuse.
One recent example of such a high-profile court case is the Veritas case that involved a cost sharing agreement between related par- ties in the US and Ireland. The IRS argued that the compensation provided for the trans- fer of intangibles was insufficient by more than $1.5bn. The IRS has also asserted in the Medtronic and Guidant cases, that large payments for transfers of intangibles are due by these companies. In addition, companies engaged in post-merger harmonisation and business restructurings may also experience increased scrutiny from a transfer pricing perspective due to a likely increase in related party transactions between entities of the newly combined group.
So how does the typical multinational company address this renewed focus on trans- fer pricing? Although many companies typically have tax strategies and policies in place to address transfer pricing requirements, unfortunately many struggle with implementation. In order for a company to comply with these requirements, a company should have a comprehensive and proactive strategy to prevent and manage disputes and set and constantly monitor its transfer prices. One weak link in the chain may result in a wide range of impacts including financial exposure for unexpected tax assessments, interest, fines and penalties, and even double taxation. Other consequences may include management disruption caused by a complex and prolonged tax dispute as well as negative impact to the firm’s corporate brand and reputation.
A key element to implementing a global transfer pricing strategy is the effective management of company staff and resources. Multinational companies should take proactive steps to identify, fund, and maintain adequate resources including in-house tax staff and external tax professionals to address transfer pricing requirements. Why?
Transfer pricing requirements can be quite complex to administer, are constantly changing and must be consistently monitored. The evaluation of the appropriate transfer price for tax purposes can require in-depth tax, legal, accounting and economic analyses and careful consideration, such as choosing the correct methodology (the so-called “best method”). It typically requires identifying actual comparable arm’s length transactions such as those between unrelated parties in similar industries.
The transfer pricing analysis must take into account various factors such as where the product is in its life cycle, the appropriate use of discount rates, and industry-specific variables such as a down-turn in the industry which may support lower transaction prices.
The analysis should also include the segregation of intangibles from routine services due to the increased focus on intangible property transactions.
Another best practice is the integration of transfer pricing concepts and requirements into the company’s worldwide financial and operational systems. For example, poorly designed enterprise resource planning (ERP) systems may force the tax function to manage transfer pricing manually outside of the system which can lead to inefficiencies and costly errors.
In addition, accounting records created that do not support the transfer pricing determinations may disadvantage a company when a tax audit occurs.
Fortunately, SAP and other systems can be designed to streamline transfer pricing processes, provide enhanced transparency, and decrease financial and compliance risk. PwC has pioneered the concept of transfer pricing integration or TPi in order to leverage limited tax resources and automate major portions of the self-monitoring that the transfer pricing regulations require. Companies should also pursue the integration of transfer pricing requirements into other organisational functions including contracts, legal, and new business development teams.
Transfer pricing requirements should be considered, for example, when new companies are created by the legal department or when multiple related companies are utilised by the contracts team when producing and bringing a product to market. Legal and contracts staff may assist with the transfer pricing strategy implementation by setting up proper intercompany agreements and ensuring their underlying terms are aligned with the firm’s business operations and tax strategy. This integration of a global transfer pricing strategy from an organisational and system standpoint, coupled with proactive implementation and monitoring, can be a winning combination to help companies reduce financial risk and achieve their long term objectives.
For more information please contact Horacio Peña, email: email@example.com or Tel: (646) 471-1957