Transfer pricing rules – how they can work to increase enterprise value

CapitalQuarter - Spring 2023

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Listed multinationals looking to navigate tax obligations and capitalise on market opportunity should proactively develop a transfer pricing strategy.

In an increasingly complex and challenging global economic landscape, listed multinationals encounter transfer pricing across many tax-related business processes and commercial activity. Annual statutory audit and tax reporting may be impacted if the business cannot demonstrate compliance with transfer pricing rules. Investors will expect tax transparency on capital funding, business disposal, and regulators too for public listing.

Transfer pricing issues resulting in erosion of enterprise and shareholder value may take different forms, such as a delay to IPO readiness, challenges in investment funding rounds, price chip on business disposal, or the additional cost of tax indemnity insurance. If a multinational’s overall tax liabilities deviate significantly from its peers or industry benchmarks, investors may ask why. All of these can be mitigated or avoided with proper planning.

What transfer pricing rules do

Transfer pricing rules govern the pricing of goods, services, intellectual property, and loans between entities in a multinational group. The group sets the prices of these internal transactions, known as the ‘transfer price’. But it must do so within the rules which determine how much profit is reported as taxable (or loss is allowable).

Listed multinationals are expected to price their related party transactions based on similar transactions between third parties (the so-called arm’s length principle). International transfer pricing guidelines issued by the OECD and the UN provide a framework for these exchanges. However, individual countries can interpret them differently, and introduce their own rules based on domestic economic and tax policy objectives.

Tax authorities apply transfer pricing rules to prevent multinationals from eroding the national tax base. They typically challenge the pricing of intercompany payments which appear to shift income and profits to group entities in low(er) tax jurisdictions with insufficient economic activity.

Any mispricing of related party transactions, which results in the under-reporting of tax by a group entity, may prompt a tax authority enquiry and potential tax adjustments with interest and penalties.

UK and international transfer pricing rules

The ever-growing complexity of transfer pricing rules may seem like a daunting maze for listed multinationals to navigate with unnecessary costs for the unwary and accumulating benefits for those proactively managing tax obligations with a transfer pricing strategy.

The transfer pricing landscape is constantly evolving. In recent years, the OECD has orchestrated one of the most far-reaching reform packages to modernise transfer pricing and international tax rules, known as the Base Erosion and Profit Shifting (“BEPS”) project. The introduction of a global minimum tax rate is targeted for 2024.

In the UK, large multinationals must comply with transfer pricing legislation. New rules mean greater transparency by these multinationals through the preparation of Master File and UK Local File documentation to the standard prescribed by the OECD.

Listed multinational SMEs often rely on a partial exemption from transfer pricing legislation in the UK. However, this does not benefit an overseas group entity which is the counterparty transacting with a UK entity. In this way, some UK multinationals may be inadvertently pushing potential transfer pricing issues into their overseas subsidiaries which are less well placed to address them properly, especially if they impact the group reporting and global tax strategy.

Listed multinationals need to ensure that their transfer pricing policies are contemporaneous and do not become outdated or develop gaps, especially when laws and regulations change or business developments overtake prior tax positions.

Developing a transfer pricing strategy

A proactively developed transfer pricing strategy based on enterprise goals, international rules and local country insights, not only supports tax compliance by listed multinationals – it can facilitate business growth and market opportunity.

The transfer pricing strategy should pay attention to international guidance and local country rules which can impact a group entity, such as creating a minimum expected profit level, mandatory documentation, and transaction reporting forms.

To be effective and robust, the transfer pricing policy should be closely aligned with the business operating model, facilitate commercial activity and manage overall tax risk.

Transfer pricing relies on the allocation of profits (and losses) based on profit drivers and control of risks across a group’s value chain, having regard to the location of key personnel and intellectual property across individual entities and jurisdictions.

When undertaking intra-group transactions as part of a transfer pricing policy, the importance of VAT and customs duties on supplies of certain goods and services, or withholding taxes on IP royalty and loan interest payments, should not be overlooked. These may require careful consideration to assess entitlement to potential reliefs provided by double tax treaties and domestic incentive regimes.

Listed multinationals should take steps to develop, implement, document and defend, if necessary, appropriate transfer pricing arrangements in the UK and globally. The key matters to address and achieve will include:

  • Reviewing the current transfer pricing arrangements for gaps in local compliance and potential misalignments with the business operating model and commercial activity
  • Evaluating whether the transfer pricing policy aligns (or deviates) significantly from industry benchmarks and the overall tax strategy
  • Assessing the proper implementation of transfer pricing policies across tax and tax-related business processes in other corporate functions such as finance, IT, HR and trade and customs
  • Maintaining contemporaneous transfer pricing documentation and intercompany agreements, and testing the financial returns of each operating entity and its related party transactions accordingly
  • Identifying the impacts on other direct and indirect taxes such as withholding taxes, VAT and customs duties.

Each listed multinational and country will have different and unique transfer pricing considerations, and consulting with experienced transfer pricing specialists will help navigate to appropriate solutions.

If you would like further guidance, please contact Farhan Azeem, Transfer Pricing Director in our Tax team. He collaborates with local experts across PKF Global.