Our 2016 survey of 623 transfer pricing executives in 36 jurisdictions across 17 industries finds that respondents are encountering significantly more transfer pricing disputes.
Perhaps more significantly for the months and years to come, respondents expect to face more conflict across a broader range of geographies and issues.
Our survey also indicates that transfer pricing has entered an era of heightened tax risk and controversy, driven by an exponential increase in the demand for tax-related transparency.
In response to heightened calls from activists and collection agencies, tax rules are being designed and implemented in a more comprehensive manner the world over.
Companies now must share significantly more details on their operating data and tax strategies, both with the public and in materials available to tax authorities.
This further aligns with the Base Erosion and Profit Shifting (BEPS) project and messages from the United Nations, both of which intensify the spotlight on the local activities of multinational groups.
At the same time, the more companies have to disclose, the more they will find themselves examined, and possibly misunderstood, by both tax activists and tax collectors using deeper insight to demand more income.
The questions become:
- What changes are taking place in the tax risk landscape, and where are instances of controversy becoming more prominent?
- What rules are being written to alter the mix in transparency and compliance, and how are they being interpreted?
- What proactive operational steps are needed for companies to stay ahead of today’s transfer pricing realities?
The global tax avoidance debate
The fact that transfer pricing has become one of the most visible and controversial topics in the global tax avoidance debate has contributed to the new risk aversion.
In recent years, transfer pricing has attracted the attention of the news media, politicians and social justice groups that suspect multinational corporations use transfer pricing to pay less than a “fair share” of tax.
Largely as a product of this heightened visibility, tax authorities are under pressure to implement greater and unprecedented demands for transparency about multinationals’ operations, tax profiles and effective tax rates, and show tangible outcomes.
As of October 2016, 44 countries have implemented all or some of the BEPS recommendations, creating the potential for conflicting interpretations. In all, more than 80 countries are committed to implementation.
This compels more disclosure about a business’s transfer pricing activities in the aggregate and how they align with the operating model.
But it also necessitates a shift from a reactive stance to a proactive review of policies, procedures and operations so that any inevitable disclosures contain nothing untoward.
Companies today must increasingly demonstrate that they are following not only the letter but also the spirit of the tax and transfer pricing rules — as should any responsible corporate citizen.
The need to embrace openness
Unquestionably, companies will need to become comfortable with sharing more tax data with authorities far and wide.
More jurisdictions having unfettered access to more data will sharpen the focus on transfer pricing and heighten the risk of controversy.
In this era of increased transparency, reputational risk is also a concern.
Companies might even want to consider sharing more, not less, tax information.
To the extent an enterprise can do a more thorough job of educating the public and other stakeholders about the contributions made via tax, it may be able to turn a potential negative into a strong positive.
How businesses should respond
We believe transfer professionals should take concrete actions to adapt to this new, riskier post-BEPS world. Here are five immediate steps to consider.
- Refresh the assessment of your transfer pricing risk profile. As the changing transfer pricing environment unfolds, existing models may fall foul of new rules. Identifying where risk lies allows you to best understand and determine an approach to limit the risk of audit activity.
- Update your risk limitation and compliance activities. New strategies and actions are not optional — they’re required. This can range from enhancing your documentation package to modifying your transfer pricing model to supplementing the level of substance in relevant locations. To protect your intellectual property structure, steps such as these will best position you to substantiate your transfer pricing framework, given the likely lines of challenge that will arise.
- Develop a broad audit plan. The risk of audits is rising worldwide. Responding on an ad hoc, inconsistent basis will lead to inconsistent outcomes and may undermine your position in other jurisdictions. Having a plan in place will help you respond in a way that doesn’t undermine your overall model. Where tax risks are especially pronounced, executives should take another look at bilateral or even multilateral advance pricing agreements. Though these can take some time and effort to lock into place, they can reduce headaches further down the road.
- Revisit PEs. Do not overlook the emerging threat of permanent establishment (PE) challenges. If a PE is asserted under today’s tighter rules, it can significantly affect your tax profile. Remember that the thresholds have been tightened, and what was previously outside the scope may no longer be.
- Realign transfer pricing and IT systems. Evaluate the available tools to align your transfer pricing and IT or reporting systems. Relying on periodic, ad hoc manual adjustments carries a high risk of error, while post-period adjustment will produce financial statements that do not reflect the anticipated outcomes for a particular period. At a minimum, this will increase the level of inquiry into how the transfer pricing model has been applied, perhaps spilling over into a wider audit.
Read more: 2016 Transfer Pricing Survey Series