For businesses operating internationally, transfer pricing (TP) requires proactive decision-making to reduce the tax risk inherent in operating in multiple tax jurisdictions. Without efficient transfer pricing policies in place, the businesses can suffer from double taxation, whereby the same income is taxed in two countries.

Businesses are increasingly focussed on ensuring that their policies are robust enough to stand up to increased scrutiny from tax authorities around the world.

In simple terms, transfer pricing relates to the rules for pricing transactions between related parties, such as companies within the same group. The “arm’s length” principle aims to ensure that such transactions are carried out on the same terms as those between independent companies under the same circumstances.

Although most countries have TP regimes in place, the specific requirements of these can differ from jurisdiction to jurisdiction. Governments and tax authorities have become increasingly concerned about tax “base erosion and profit shifting” (BEPS); international businesses exploiting differences in national 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.

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 CbCR report is designed to increase transparency and applies to multinational enterprises with a consolidated turnover of €750m or more. Through CbCR, tax authorities across the world now have 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.

While the current turnover threshold provides an exemption for most businesses, the trend is towards increasing transparency in tax matters and greater cross-border co-operation between tax-authorities.

As the BEPS measures bed in and tax authorities intensify their focus on profit shifting (as an example, HMRC stats show rapid expansion in staff members focussed on international taxation, currently approaching 500 FTEs) it is highly likely that cross border disputes will remain a significant area of concern for multinational groups.

OECD figures released in November 2021 show that the number of new TP cases has now stabilised, however, resolving double taxation resulting from TP disputes remains far from straightforward. On average, resolution takes 35 months and double taxation is fully eliminated in only 51% 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. 

We can help guide you and your business through the process of establishing and reviewing TP methods that align with the value creation in your organisation to help mitigate the double taxation risk arising from non-compliant TP. The functions performed, assets employed, and risks assumed should be taken into account so that the prices applied within your organisation reflect commercial realities and are internationally defensible. 

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 present Johnston Carmichael adviser