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For today's global companies, managing global transfer pricing amid changing international tax principles is difficult enough. For financial services companies, the challenges are multiplied as in addition to tax authorities, they also need to satisfy the regulators. Banking and insurance regulators, for example, are just as interested in cross-border inter-affiliate transactions as tax authorities, but they look at transfer prices from an entirely different angle.

Dealing with both types of stakeholders wherever financial services companies operate means they need to devote significantly more effort and resources to their transfer pricing processes and governance. But the extra attention can bring extra benefits, as a robust framework for transfer pricing operations can improve visibility, data quality, decision making and financial results.

Managing the transaction's journey from start to finish is more critical for financial services companies.

Historically, tax authorities have been interested in the end results of transactions, wanting to see that companies are paying tax on arm's-length returns based on the value created in various locations by their functions, assets and risks. This has led many transfer pricing teams to devote much of their time to the beginning and end of transfer pricing transactions.

  • When a transaction occurs, effort is spent developing the policy that will govern it.
  • After the year's end, when affiliates have settled their transactions, transfer pricing teams are again active, preparing transfer pricing documentation to show transactions are in line with the transfer pricing policies, and dealing with potential disputes.

While regulators are also interested in pricing and end results, they are also increasingly concerned about the stability and sustainability of large financial services companies. Consequently, they are also interested in the strength of the company's governance, risk management and controls, cash flows, and capital.

This puts more emphasis on the middle of the transaction's journey.

Regulators want to know not only that the company's transfer pricing policies are sound and in line with the market terms but also that controls are in place to ensure those policies are followed in the company's actual operations so that financial risk is mitigated. Tax authorities also are increasingly looking beyond individual transactions to broader risk assessments. They are also looking at the strength of a company's transfer pricing governance as an indicator of tax responsibility and lower risk of non-compliance.

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Different priorities lead to distinct differences in approach. For example, tax authorities looking to raise revenues are less interested in transactions below a certain materiality threshold, while regulators are less interested in materiality than they are in the processes around the transaction. In their view, if a transfer pricing control does not catch a million-dollar mistake, then it is just as likely to miss an error worth billions. Regulators therefore seek to understand the control framework from beginning to end.

Financial institutions are also caught between different notions of how transfer prices should be determined. Tax authorities tend to set clear rules for arm's-length pricing methods based on value creation and risk, with detailed guidance and examples. Regulators' guidance is more limited, and they tend to prefer prices in line with market terms. When these different economic perspectives are applied to the same transactions, financial institutions can find themselves caught in a clash between two regulatory environments.

With this focus on how transactions between financial services companies and their affiliates are controlled and managed, leading practices for financial institutions involve augmenting their governance structures and processes to ensure they provide effective, end-to-end oversight and control over the identification, set-up, pricing, and ongoing management of transactions with related parties, with clear delineation of first line, second line, and third line of defense.

In establishing the framework, it's important to step back and ask these broad questions:

  • Do you understand your company's process flow for intercompany transactions, including:
    • how transactions are initiated, identified, and recorded?
    • how transfer prices are set and how transaction costs are calculated?
    • how accounting (e.g. journal entries) and reporting (e.g. management, financial) are performed?
    • how compliance with policies and contracts is monitored?  
  • Does everyone involved in that process have the right skills and capacity, and clearly defined roles and responsibilities?
  • Does your governance and control structure establish formal process ownership, a robust risk assessment framework and appropriate controls embedded in business processes?
  • Is your company's transfer pricing aligned for tax and regulatory purposes? If there are differences, do you have workpapers in place to address the asks of both sets of stakeholders.
  • Do your company's IT systems provide the right data at the right time with the right quality to meet your transfer pricing obligations?
  • Does the transfer pricing team have a say in business investment decisions to help ensure new technology solutions facilitate regulatory and tax compliance?
  • Does your transfer pricing team have visibility and oversight over all functions involved in the end-to-end process, including business units, shared service centers and external service providers?

Your answers to these questions can help you define your desired end state, as well as the investments in people, processes and technology that you need to get there.

A strong governance and control framework can go a long way toward assuring financial services regulators and tax authorities that your company's transfer pricing policies are sound and well managed.

But the benefits don't stop there.

When transfer pricing processes are embedded across the company and touch a wide range of internal stakeholders -- whether from business units, finance, legal or treasury -- you gain visibility over transfer pricing data and company-wide engagement in related processes. And this visibility and engagement can combine to produce benefits in countless ways: to enhance decision making, spot efficiencies, reveal hidden threats and cultivate new strategic prospects.

In short, by focusing on transfer pricing transactions from start to finish, you can help your financial institution seize opportunities to add value every step of the way.