The way we deal with transfer pricing adjustments has undergone many interesting developments. A little over a decade ago, most finance professionals could not be bothered dealing with this subject, as corporate tax matters are preferably solved in the realm of tax. In recent times, transfer pricing adjustments were manually calculated, posted once a year (usually after year-end) and often booked without a review of how this would impact VAT and custom duties. However, in the current age of transparency, transfer pricing adjustments are part of our business routine, and ideally are as small and contemporaneous as possible. The EU Joint Transfer Pricing Forum suggest that: “Taxpayers should make reasonable efforts to comply with the arm’s length principle before or at the time the intercompany transactions are undertaken.”
The use of suboptimal processes, to deal with transfer pricing adjustments, is where the shoe pinches. As unclear processes or insufficient cooperation and coordination - between your finance and tax department – will make work more inefficient, labour intensive and tedious. In addition, late changes to your transfer pricing adjustments could distort reports, and suboptimal processes which can give rise to the exposure of corporate income tax, VAT, or customs duties – where transfer pricing adjustments have been improperly included in your Intrastat filings, European Sales Listings, or SAF-T filings.
Most of all, the reality is that we are required to do more transfer pricing adjustments, due to the increasing financial transparency and number of reporting units in companies, with the same number of tax professionals.
Recognize any of this?
Yes, well, that is not uncommon. Transfer pricing adjustments are often not a straight forward exercise, it may perhaps involve a complex web of adjustments over several transactions and multiple jurisdictions.
- Firstly, you need to decide where best to apply the adjustment. Should the adjustment be towards product prices, the payment or receipt of services fee, royalties, management fees or the introduction of subsidies?
- Secondly, you need to decide on when the adjustment should be made. This could be during the year, before year-end, before closing of the books and filing the tax return, in the tax return only, or after the tax return. The fact of the matter is, the earlier you make the adjustment the less likely you’ll face complex implications; especially given the diverse treatment of transfer pricing adjustments by different tax authorities.
Prospective and retrospective approach
Principally two basic approaches to adjusting transfer prices can be recognized, these are the prospective approach and the retrospective approach.
A prospective approach ensures that the product price is adjusted going forwardfor the remaining reporting period, preventing the need for large adjustments towards the end of the year. Additionally, how you change the uplift is determined by whether you have chosen for a standard cost price plus uplift or resale minus approach within your ERP system. In a standard cost price plus (mark-up percentage approach), a targeted operating margin is calculated during the budgeting cycle; the mark-up percentage requires regular upkeep – during the reporting period – where the actual operating margin is reviewed against the targeted operating margin.
A retrospective approach involves adjustments that correct differences in the actual financial data. The so-called year-end adjustments are considered retrospective price adjustments that occur once the final invoices or credit notes are sent to countries. These adjustments go to the accounts of the relevant groups companies and are made just before or after year-end – at times subsequent to the accounts closure. It’s important to be aware that large year-end adjustments may trigger the attention of the tax authorities or that some countries may not accept year-end adjustments; for example, a deductible item becoming double taxed.
Tytho transfer pricing
Based on the above, you may conclude that there is something at stake here. Well, you would be right. Incorrect transfer pricing adjustments could be cause for tax authorities to challenge requirements: corporate income tax, VAT or customs, and related compliance. As a result, this could create uncertain tax positions regarding financial reporting.
But, there is a way out of this maze of transfer pricing adjustments! If you work to minimize risks, in relation to incorrect or incomplete handling of transfer pricing adjustments, the following – among others - is recommended:
- A transfer pricing governance process that ensures the central and local (tax and finance teams) are interconnected and able to work together to achieve the targeted operating margin for the relevant year. The process should guarantee timely, correct and efficient adjustments, and clear handovers – between the different players and teams involved.
- Management and statutory accounting, which can be set up in such way that setting and evaluating intercompany prices becomes easy.
- A periodic monitoring approach: have your tax team track and compare actual results against budgets on an ongoing basis and agree policies on incidental costs, forex exchange and financing costs.
- Make adjustments promptly and regularly (on a quarterly or monthly basis), taking VAT and customs requirements into consideration.
- Include, in the intercompany agreements, terms describing the compensation and calculation method, as well as the potentially adjustments made periodically to reflect the arm’s length compensation. Note that intercompany agreements are still used as a starting point by tax administrations to check whether the remuneration is at arm’s length.
- Have contemporaneous transfer pricing documentation and analysis prepared to substantiate and support the adjustments.
Would you like to discuss possible improvements to your transfer pricing adjustments’ processes or are you considering ways to improve the automation of this aspect of the financial process? If so, get in touch via phone or email. We would be pleased to meet up and discuss this with you over a cup of coffee.