I know a lot of heads of tax have lost sleep over the operational side of transfer pricing (TP). Do any of these scenarios sound familiar?
“The tax department’s transfer pricing policies aren’t being followed by the finance.”
“Our transfer pricing model can’t be implemented because our finance system can’t accommodate it.”
“Incorrectly set transfer prices have at times left the group unable to ship products due to systems issues, or customs/vat valuations.”
Typically, in such situations, finance blames tax and tax blames finance. But the truth is usually somewhere in the middle.
Most OTP problems stem from the two functions not working together, as well as the loss of focus on the statutory accounts of individual entities. As a result, there’s no shared understanding of what each team is trying to achieve or why, the policies to be followed when carrying out intercompany transactions; or of the systems and processes in place to implement them.
This inevitably leads to confusion and mistakes. In one case, the tax function stipulated charging a mark-up on costs: so, the finance team just charged the mark-up, not the cost element. The adjustments or risk during audit this necessitated didn’t bear thinking about.
Transfer pricing pitfalls
As you know all too well as a tax leader, the more adjustments you make to your internal transactions, the greater your organisation’s exposure to multiple risks. These include:
- a higher effective tax rate (ETR) and/or potential double taxation
- having to make significant cash movements between countries – which could be troublesome from a currency control perspective as well as the year-end scramble to book everything correctly
- the need to re-file import VAT returns and/or customs declarations – and the possibility of inspections
- being identified in a tax audit – and getting an unfavourable outcome as well as the penalties that maybe be received
Where tax audits are concerned, tax authorities are increasingly looking beyond companies’ TP policies, to the processes and controls that underpin them. They want to see evidence of robust governance and ensure that transfer pricing policies are being implemented correctly across the business.
To get a sense of how exposed to these risks your company is, it’s worth asking yourself the following questions:
• Are your TP processes well defined and closely followed?
Due to a lack of cross-functional communication and cooperation, the tax team lack control and sometimes knowledge over how this policy is implemented at an intercompany transaction level.
• Are the roles and responsibilities of those implementing your internal transactions clear and understood?
Many tax departments don’t know how their transfer pricing policies are being implemented at the transaction level, who is responsible or where the errors might be occurring.
• Are you having to calculate significant volumes of TP adjustments?
More adjustments mean more risk. Making large numbers of adjustments should act as a warning that your processes need reviewing and potentially aligning more closely with the finance and forecasting processes.
• Are spreadsheets your main tool for calculating transfer prices and the associated tax outcomes?
Running thousands of transactions in spreadsheets is prone to human error, and lacks checks and balances; it could cost your business millions of pounds in tax for minor errors that accumulate over years of calculations.
• Would your TP governance withstand audit scrutiny?
Tax authorities are looking to the tax risk framework and the governance processes that support this - without clearly defined and documented processes, tax authorities are unlikely to rate governance as sufficient.
• Does your ETR depend substantially on your TP calculations?
TP underpins the calculation of the ETR for many groups and inadequate policies and controls can result in profits trapped in the wrong location, which can lead to tax leakage and/or double taxation.
Transfer Pricing fit for the future
An effective way to ensure good governance of your internal transactions is to establish an Operational Transfer Pricing (OTP) programme.
OTP combines the structured management of TP data, processes and controls; and the use of technology to make these more efficient where possible.
An OTP framework embeds your TP policies into the intercompany transactions – or the process of moving profits or cash from one entity to another. It does this by mapping the individual elements that make up your internal transactions end to end – including:
- your data and systems
- how data flows through the systems
- the TP calculation process
- the roles and responsibilities of those involved
As it’s focused on process, not results, OTP clarifies your transfer pricing policies and how to put them into action. It sets out who does what, how, and what’s expected of which functions.
It provides a granular view of transfer pricing, demystifying the practice, and helping to bridge the gap between tax and finance. It also shows you where automation technology can be deployed to accelerate your processes, increase accuracy and drive cost efficiencies.
A phased approach to Operational Transfer Pricing
We have a range of OTP solutions we can tailor to your specific circumstances and requirements. For example, we have developed a structured method for building an OTP framework, consisting of three distinct stages:
1. Current state assessment
- Identify high-risk internal transactions
- Map data flows, systems, and roles and responsibilities
- Evaluate the interaction between the tax and finance teams
2. Process design and improvement
- Formulate an OTP strategy, defining objectives for the tax and finance functions
- Design your TP processes and controls, and define the roles and responsibilities of those involved
- Identify where technology can support your new processes and controls
3. Implementation roadmap
- Align tax and finance with your implementation plan
- Set out best practice to be followed
- Document your TP processes and controls
Not all intercompany transactions are equal, and some are more important than others. Being able to identify them up front and mapping them end to end helps identify risks, issues and potential implementation and governance failures. This is the first step to designing a better process. And partnering with Finance to simplify, structure, document and automate the process can help you achieve better results and help you sleep better at night, at least for the OTP risks.
Get in touch if you’d like to find out more about OTP or discuss how we can help you develop a framework for effective transfer pricing management.