Navigating Transfer Pricing Methods: Key Insights for Global Expansion

Crucial to managing your financial reporting and international tax obligations, transfer pricing demands meticulous attention and should be part of your wider global expansion strategy.

Understanding transfer pricing

Transfer pricing refers to the pricing of transactions between related entities within the same global enterprise. These transactions can include the transfer of tangible goods, services, intellectual property, loans, and other financial instruments. The goal of transfer pricing is to ensure that each entity, and therefore each country, is getting a fair return for what that entity actually does.

For that purpose, transactions between related entities must be conducted at arm’s length—that is, at prices and terms comparable to those that unrelated companies would employ in their transactions under similar circumstances.

The arm’s length principle was adopted by the Organisation for Economic Co-operation and Development (OECD) as an objective guideline for multinational companies and tax authorities in international taxation. Its goal is to avoid the erosion of the tax base or the allocation of profits to low tax jurisdictions. While each country’s rules may be different, the majority follow the internationally accepted OECD arm’s length principle and its transfer pricing guidelines.

Importance of transfer pricing in global expansion

A well thought out transfer pricing strategy will enable your global company to remain compliant with international tax regulations across borders, while optimising taxes and mitigating risks.

Tax compliance and avoidance of double taxation

Proper transfer pricing ensures compliance with tax regulations in various jurisdictions and helps prevent double taxation, where the same income is taxed by two countries. The burden of proof is usually on the company to demonstrate that fair transfer prices have been applied. By establishing arm’s length pricing, companies can minimize the risk of tax disputes and penalties.

Optimisation of tax liabilities

Effective transfer pricing strategies allow companies to optimise their global tax liabilities by allocating profits to jurisdictions with favourable tax rates while adhering to international tax regulations and transfer pricing guidelines.

Risk mitigation

Inaccurate transfer pricing can attract scrutiny from tax authorities, leading to audits, penalties, and reputational damage. By implementing robust and fair transfer pricing policies, companies can mitigate the risk of tax-related disputes and protect their corporate reputation.

Analysis consideration for fair transfer pricing

To establish appropriate transfer pricing policies and rates/percentages, it is important for a business to consider both internal (functional analysis) and external (local market analysis) factors.

Market analysis

Understanding local market dynamics such as demand, competition, and pricing trends is crucial for setting fair transfer pricing arrangements that reflect market conditions accurately.

Functional analysis

A thorough functional analysis helps to align the allocation of profits (and losses) with the value contribution of each entity, ensuring transparency and fairness. It consists of identifying the key functions performed (e.g. R&D, marketing, procurement, etc.), the crucial assets deployed (tangible, intangible), and the level of risks undertaken by each entity.

The depth of analysis should match the scale and complexity of the intercompany transactions. For a business venturing into international markets for the first time, an extensive transfer pricing study might be unnecessary, but it may be warranted in other scenarios.

Common transfer pricing methods

Multinational enterprises and tax administrations commonly use one of five transfer pricing methods recommended by the OECD to determine arm’s length prices between related entities.

Comparable uncontrolled price method

Compares prices and conditions of controlled transactions (between related entities) with those of uncontrolled transactions (between unrelated entities), utilising comparable data from commercial databases.

Resale price method

Analyses resale prices and margins to determine an arm’s length price for the original transaction between related entities.

Cost plus method

Adds supplier costs and a mark-up for appropriate profit to determine the arm’s length price for transactions, commonly used for semi-finished goods or long-term buy-and-supply arrangements.

Transactional net margin method

Assesses net profit against an appropriate base resulting from controlled transactions, comparing with net margins of unrelated enterprises.

Transactional profit split method

Divides profits or losses from controlled transactions based on how they would have been divided between unrelated enterprises in comparable transactions, using contribution or residual analysis.

The method selected depends on each company situation and should align with the operating model of your cross-border business. Selection factors usually include the availability of comparable data, the comparability of transactions, and the nature of the intercompany transactions which can be determined through a functional analysis in the case of complex organisations. Access to reliable market data and documentation of comparable transactions (benchmarking) can be critical for demonstrating compliance with transfer pricing regulations. Seeking expert advice to select the right method for your particular business is wise.

Other considerations for transfer pricing in global expansion

Documentation and compliance

Maintain detailed documentation of your transfer pricing analysis, and intercompany agreements. Documentation is critical to support compliance with local transfer pricing regulations and prevent tax disputes. Some jurisdictions even require the submission of transfer pricing agreements and analyses with the company’s corporation tax return, and so it is important that this documentation is in place and in good time.

Advance pricing agreements (APAs)

Consider seeking advance pricing agreements with tax authorities to obtain certainty on transfer pricing arrangements and minimize the risk of disputes. APAs provide a mechanism for negotiating and agreeing on transfer pricing methodologies in advance, reducing compliance uncertainty.

Transfer pricing adjustments

Monitor and adjust transfer pricing policies periodically to reflect changes in business operations, market conditions, and regulatory requirements. Regular review and adjustment of transfer pricing arrangements ensure ongoing compliance and alignment with business objectives.

Transfer pricing considerations play a crucial role in the success of enterprises expanding abroad. By adopting a proactive approach to transfer pricing, your company can optimise tax efficiencies, mitigate risks, and ensure compliance with international tax regulations.

How ZEDRA can help

At ZEDRA, we can help analyse your business situation and provide suitable professional advice to establish appropriate transfer pricing policies and documentation that support your global expansion objectives while minimising tax-related risks and maximising value creation.

We can also help you select the transfer pricing method best suited to your business model and industry, and draft the related intercompany contract.

Whilst no-one can guarantee that you won’t have a transfer pricing enquiry from a revenue authority, we can put you in a favourable position, should an enquiry arise.

Get in touch to find out more about how we can help you with Transfer Pricing.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.