In this post-BEPS age more and more countries are implementing Transfer Pricing documentation regulations.
This substantially increases the compliance burden for both small and large MNEs. Full-on compliance with all local regulations is quite costly and leads to substantial annual update work as well. To manage this compliance burden as well as mitigate risks, we suggest considering the following 4 steps in this process, which is an analysis we often perform with our clients.
1. Determine your general tax risk strategy
The level of compliance that suits you will largely depend on your tax risk strategy. The board may want to avoid tax risks at any cost. On the other hand, they may be more focused on cost reduction and are willing to run some risks in the process.
Your risk appetite could be different if you are reporting well-defendable routine level of results or when you have a loss-making entity with fluctuating results.
2. Determine the level of compliance you wish to obtain: distinguish between formal compliance and material compliance
Full-on compliance with all local regulations may not be feasible. Therefore, it is important to determine your optimal level of compliance as a company.
Here a distinction between formal and material compliance can be made. With formal compliance you meet all the documentation requirements and prevent risks like penalties and the shift of the burden of proof. Material compliance focuses on the transfer pricing (“TP”) design to ascertain that this is in line with the economic reality and well-defendable.
- Company Y and X have the same fact pattern and group result.
- Company X has fulfilled all legal documentation requirements but has not looked at its TP design.
- Company Y has only paid attention to its TP design and made sure that all results are at arm’s length.
- The tax auditor visits both companies.
- Results visit Company X:
- The tax auditor can easily argue that results are not at arm’s length. Although the burden of proof lies with the tax auditor, he has pretty convincing evidence, resulting in a lengthy (and costly) audit procedure.
- In addition, various group entities have suffered losses for which the carry-forward term has passed.
- Results visit Company Y:
- The tax auditor concludes that the results are at arm’s length and only urges the company to work on its TP documentation. It may of course be the case that penalties are imposed or that TP documentation is requested by an auditor.
- In addition, the company has a transfer pricing system that:
- costs less administrative time with fewer invoices to process;
- supports the business; and
- is more tax efficient.
Obviously, this example is a bit black and white, but the message stands: it is very important to determine where your resources and budget add the most value.
3. Determine what type of documentation process suits your company
There are various ways in which documentation can be prepared. Which documentation process suits you depends amongst others on:
- the size of your company and the relative importance of transfer pricing;
- the internal resources available;
- your tax risk strategy; and
- the level of compliance you wish to obtain.
Items in the documentation process to consider are, amongst others:
- To localise or centralise.
- To localise or centralise is relevant both in terms of internal responsibility and for the way the documentation is prepared.
- The annual update process.
- In general, the more you localise your documentation process, the more time the MNE will have to spend on the annual update process.
- It may be considered to write part of the documentation in a manner that it can be used for multiple entities on an annual basis.
- Outsourcing versus insourcing.
- To outsource or/and insource drafting of the TP documentation.
- The use of a documentation tool and its purpose. If you only wish to make your writing process more efficient you will not need an extensive tool that has functionalities that you will pay for but will not use. Choose your tool carefully. Quantera Global offers Transfer Pricing software in which it is possible to start with the documentation module and upon preference take a next step towards an overview and insight module as well as a monitoring module.
4. Create a priority list and obtain buy-in from stakeholders
- Once you have determined which activities you wish to undertake, set up a priority list and a timeline that includes deadlines and budget required.
- In determining the role you wish to play consider the amount of time that role will absorb, as it may restrain the number of activities you can take on.
- Clearly communicate the approach and restrain with stakeholders, for example the CFO, and obtain buy-in from these stakeholders.
If you would like us to support you in determining a well-considered TP documentation and/or compliance approach, we are always happy to assist you.
Also, if you are interested to learn more about our Compliance Menus in which you can opt for the optimal format of support to you, please let us know. Of course, we are also pleased to provide a free demo of the TP software if desired.
We suggest however to start with a conversation to determine which solutions are best suited to your needs.
Please feel free to contact us.