Transfer pricing under the spotlight for tax authorities

Jonathan Russell

Jonathan Russell

International Tax Senior Manager

For businesses operating internationally, transfer pricing is a crucial aspect of tax planning. Without efficient transfer pricing policies in place, the business could suffer from double taxation, whereby it is taxed on the same income in two countries. However, businesses must ensure that their policies are robust enough to stand up to increased scrutiny from tax authorities.

In simple terms, transfer pricing (TP) relates to the rules for pricing transactions between related parties, such as companies within the same group. The “at arm’s length” principle aims to ensure that such transactions are carried out at the same price as they would be between two independent companies under the same circumstances.

Although most countries have TP regimes in place, the specific requirements of these will differ from jurisdiction to jurisdiction. Since the 2008 economic crash, Governments and tax authorities have become increasingly concerned about tax “base erosion and profit shifting” (BEPS); businesses exploiting these differences in tax systems to avoid paying tax. 

The Organisation for Economic Co-operation and Development (OECD) undertook a BEPS project to combat this practice, and a large part of this was focused on transfer pricing. This resulted in an update to the guidelines in 2017, including the introduction of a new minimum standard for Transfer Pricing Documentation and the automatically exchanged Country by Country report (CbCr).

The first automatic exchange CbCr took place in June 2018. The report is designed to increase transparency and applies to multinational enterprises with a consolidated turnover of €750m or more. Through the CbCr, tax authorities across the world have full visibility of employees, assets and profits reported in each territory in which the group carries on business. This provides a powerful new risk assessment tool that tax authorities are now taking advantage of.

As the BEPS measures bed in and tax authorities intensify their focus on profit shifting (as an example, HMRC stats show that between 2016/2017 and 2017/2018 they increased the number of staff dedicated to this area by 283FTE) it is highly likely that cross border disputes will continue to increase. OECD figures released in October 2018 show that new TP cases are up by 25% on the previous year. Resolving double taxation resulting from TP disputes is far from straightforward, with resolution taking an average of 30 months and double taxation fully eliminated in only 65% of cases.

Often, TP disputes do not just involve those groups with aggressive pricing policies that don’t reflect the commercial realities, but, due to the complexity and changing environment, also draw in those whose goal is to comply fully and fairly with the law in each territory they have a presence in. It is therefore imperative for businesses to be aware of the fast-moving international landscape and keep up to date with evolving guidelines.

Tax returns in the UK require businesses to self-assess their taxable profits. For TP this means confirming that transactions within the accounts are in accordance with the arm’s length principle, or, if not, that an appropriate TP adjustment has been made or an exemption from the rules applies.

How we can help

The world of transfer pricing is ever evolving as the OECD now looks to BEPS 2.0 for developments affecting transfer pricing, especially around the digital economy.

If penalties are found to be due in TP disputes, these can be significant. Our specialist International Tax team can support you in reviewing your intra-group pricing policies to ensure you are compliant in all jurisdictions, and producing the correct documentation to demonstrate that your TP model reflects the reality of your operations. For more information, get in touch with me or your usual Johnston Carmichael adviser.