Tax & Accounting Blog

Operational Transfer Pricing – Going from the Tax Provision to New Documentation Requirements

Blog, Global Tax Compliance, ONESOURCE, ONESOURCE Transfer Pricing, Tax Provision, Transfer Pricing March 13, 2014

As your CFO worked with your company’s financial auditors to prepare for the filing of your 10-K, you may have been tasked with the tax provision under ASC 740-10 (formerly FIN 48).  As a multinational corporation, your financial auditors are likely asking a lot of questions as to whether your intercompany pricing policies are arm’s length and how these policies tie to the financial accounts of your key legal entities across the globe.  Hopefully, you have some efficient means for performing operational transfer pricing in order to assist the CFO and your financial auditors.

Since many of you have completed the financial audit, you will have to turn to transfer pricing documentation for each of the major jurisdictions that your company operates in.  You will likely wonder where this OECD Action Plan on Base Erosion and Profit Shifting is heading as well as what the OECD intends in terms of its White Paper on Transfer Pricing Documentation.  A lot of your effects during the ASC 740-10 tax provision process may be useful especially when you consider the following from the OECD Draft Handbook on Transfer Pricing Risk Assessment:

  • Some taxpayers may seek to shift income into jurisdictions where it will be lightly taxed. They may not provide tax administrations with a full picture of their related party transactions. They may engage in transactions that are designed to erode, or have the effect of eroding, the local country tax base. They may not prepare documentation that accurately describes all material intercompany transactions and may not be fully transparent in applying appropriate transfer pricing methods to confirm the arm’s length nature of their related party pricing … The challenge for tax administrations is to be able to distinguish taxpayers and transactions that involve a high degree of transfer pricing risk from those which do not, and to make such assessments accurately, with confidence, and with a limited expenditure of scarce resources …It is often very helpful to understand an MNE’s overall income attribution among its group companies in order to assess its overall tax policy and hence the level of transfer pricing risk existing in connection with the MNE. Where data on income allocation among countries is available, a large allocation to lower tax jurisdictions where few economic activities take place would be among the strongest indicators of transfer pricing risk. As noted above, gaining access to the data required for such an evaluation may be particularly difficult.

Many multinational enterprises fall under one of two categories.  Multinationals that do not source profits in tax havens are likely most concerned with avoiding double taxation.  Multinationals that source profits in low tax jurisdictions will likely argue that their transfer pricing and resulting modest effective tax rate is consistent with arm’s length pricing.  In either case, the questions posed by your financial auditors during the tax provision are very likely the types of issues needed to address the “big picture” aspect in the OECD’s White Paper on Transfer Pricing Documentation.

This White Paper also recommends that the various national tax authorities insist on receiving from the multinational their consolidating financial accounts which would enable the tax authorities to understand the multinational’s “overall income attribution”.  Many taxpayers have historically only provide the local legal entity financials needed to support profits based analyzes under the headings of the Comparable Profits Method or its OECD counterpart – the Transactional Net Margin Method.  The White Paper is suggesting that a fuller big picture accounting may be necessary in order to comply with documentation requirements in the near future.  While this extra layer of financial reporting may be seen as a new burden in one’s transfer pricing documentation, multinationals that have efficient operational transfer pricing procedures for purposes of their tax provision under ASC 740-10 may find what they did for their financial auditors may prove useful in their upcoming transfer pricing documentation.