By Bart de Gouw, Melanie Meyer & John Alcantara
Most of the movements of goods and services in the world are governed by principles of transfer pricing. Essentially, transfer pricing refers to setting the prices for cross-border transactions between related parties. This can cover a wide variety of transactions including an arrangement that involves the supply or acquisition of goods, services, money and intangible property. Transfer pricing is a tool used to ensure the profits reported by a member of a multinational enterprise (MNE) is an actual reflection of the economic activity of that entity in the particular country.
The main principle that needs to be followed in setting the price for these related party transactions is that pricing should be on an “arm’s length basis.” Generally, the “arm’s length principle” is satisfied if a related party pays to the other member of the MNE group an equivalent price that would be charged to a third party in a similar economic circumstance.
The OECD provides guidelines on how MNEs are to price these transactions. The most recent iteration of the OECD guidelines contains 658 pages of explanation on the arm’s length principle, methods of transfer pricing, comparability analysis, and documentation requirements. The guidelines also contain granular rules on the pricing of intangibles, intra-group services, cost contribution arrangements, and business restructurings. These rules are aimed at preventing profit shifting, by ensuring that the taxable profits of MNE group members reflect their true economic circumstances.
A core principle of these rules is that MNE groups should consider, and document, the relevant facts and circumstances surrounding the pricing of transactions between related parties. The so-called “transfer pricing documentation” has three objectives (set out in the OECD Guidelines):
Further, the OECD guidelines advocate for a three-tier standardised approach to documentation:
Recently, the Inland Revenue has launched a campaign focusing on compliance with the transfer pricing rules by requesting taxpayers to submit their transfer pricing documentation. Taxpayers who are part of a MNE group should regularly review their transfer pricing documentation to ensure it is date and fulfils the objectives outlined above. Documentation that is not up to scratch leaves taxpayers vulnerable to increased audit activity by the Inland Revenue and should an adjustment result, be exposed to shortfall penalties and interest. If you have questions about your transfer pricing documentation please contact Bart or Melanie for further discussion.