As we approach the year-end, companies are often already thinking about the issues related to financial year closing. Year-end adjustments are one of the typically recurring transfer pricing issues. Companies want to ensure that actual financial results match what is defined in transfer pricing policies and intercompany agreements. As such it is a wide-spread and convenient instrument with some negative side effects.
Year-end adjustments are simple to execute and as such still a very popular instrument used by many Swiss and international headquarter companies. While its use is convenient, there are certain challenges to year-end adjustments:
Year-end adjustments for the benefit of the receiving company, e.g. a Swiss headquarter company making a true-up payment to a foreign limited risk distributor (LRD) to achieve its target margin may not be challenged from the foreign tax authorities, they could still be challenged from a Swiss tax perspective. This is the case when a loss position of a LRD is not caused by transfer prices but rather local mismanagement. Companies should therefore carefully review the extend to which year-end adjustments are made and not use this instrument carelessly. In any case it is recommended to clearly document the reason for any year-end adjustment.
Year-end adjustments to the detriment of a foreign company, e.g. a LRD making a payment to its Swiss headquarter company to bring its profitability down to a certain benchmarking range, are often heavily scrutinized by local tax authorities. Tax authorities challenge if such payments reflect third party behavior even though the result of such year-end adjustments might be in line with third party results. It is recommended to avoid these types of year-end adjustments. If such year-end adjustment is executed, companies are advised to check if intercompany agreements allow for such true-down payments and document the specific case accordingly.
While there can be challenges from tax authorities, year-end adjustments often trigger a need to correct customs declarations which can be a burdensome and time consuming process as year-end adjustments may have to be allocated to single transactions.
How to avoid year-end adjustments
In order to prevent challenges from tax and customs authorities, year-end adjustments should be avoided or at least minimized. The basis for this is a clear process that helps to monitor actual transfer pricing results and allow companies to implement prospective transfer pricing adjustments rather than year-end adjustments. While analytics tool can help to better monitor transfer prices on an ongoing basis and take appropriate actions throughout the year, the most important action is to investigate the reasons for deviations from TP policies and the need for year-end adjustments. There can be various reasons why companies cannot avoid year-end adjustments. Typical reasons might be data limitations, lack of resources and responsibilities. However, many challenges can be addressed and solved in a step-by-step approach for continuous and incremental improvements. Therefore, start by analyzing the reason why you must make adjustments at the year-end – KPMG can help find the right solutions, and even small things can bring significant improvements.