One of the hallmarks of a successful middle-market business is growth in a wide variety of categories. For many businesses at this level, the combination of growth in revenues and in their geographic footprint will necessitate a discussion with an advisor about transfer pricing documentation. Unfortunately, that discussion is often cut off too quickly because the participants fail to understand how to create a scalable transfer pricing documentation policy that evaluates the rules and risks in each relevant country and maps out an effective proportional response.
For many businesses at this level, the combination of growth in revenues and in their geographic footprint will necessitate a discussion with an advisor about transfer pricing documentation.
A middle-market business that’s starting or expanding operations in new countries needs to approach transfer pricing with an initial focus on building and documenting a policy that anticipates the types of challenges it’s likely to get from each relevant country and the information needed to answer those questions. A full-blown study and documentation engagement may be prohibitively expensive at this stage in the business, but a customized approach that assesses likely jurisdictional concerns and transactional characteristics can help a business stay prepared for potential questions from tax authorities. Even without counsel from the outside, taxpayers should develop and maintain documents that outline and support the transfer price they’ve developed.
Most countries follow guidelines set forth by the Organization for Economic Co-operation and Development (OECD), but every country has its own variations on the rules and local idiosyncrasies. To customize a transfer pricing method for operations in a country, a business needs to consider variables such as:
- Red flags & audit triggers: Some circumstances will raise concerns anywhere a business operates. Few things draw the attention of a taxing authority than a new in-country subsidiary of a multinational that operates at a loss, particularly over a period of time. In addition, an entity bearing losses may have the unintended consequence of having a claim to future intangible profits as a result of bearing the initial upfront risk. At the same time, almost any business starting operations in a new country struggles to turn a profit there — the question is who bears that risk. The business’s transfer pricing method will be exhibit A when asked to document and justify the accuracy and appropriateness of the financial results to the taxing authority.
- Local exemptions: Some countries may exempt small and/or new businesses from documentation requirements based on criteria like volume of sales in the jurisdiction. Others may have a policy of accepting less than the full-blown OECD documentation required for businesses in early stages of operations within their borders.
- Likelihood of audit & worst-case projection: When it comes to planning a documentation process for operations in a new country, a business needs to understand how much money is at stake in the event of a worst-case audit result. This is of particular importance to middle-market companies. Some transfer pricing services can cost significantly more than a business earns in a particular jurisdiction. Transfer pricing should never be overlooked, but engagements should always be designed proportional to the level of transactions a business has at risk in the jurisdiction.
- Industry focus: Some countries have taxes targeted at specific industries, like technology. Businesses that are subject to these focused taxes need to plan for them in their transfer pricing documentation.
Regardless of jurisdiction, the value of the intercompany cross-border transactions will always play a significant part in the discussion when it comes to transfer pricing. To customize a transfer pricing method for a certain level of intercompany transactions, a business should consider factors like:
- The dollar value of transactions: Similar to the worst-case projection, the cost of any transfer pricing services should be considered in light of the value of the transactions involved.
- Documentation of cost pool vs. markup: In some cases, companies focus so much on documenting their markup percentages that they fail to track the component costs of the transaction. If a business focuses all of its transfer pricing documentation efforts and dollars justifying $25,000 of markup, they may have missed important factors in the cost base itself.
- Norms & safe harbors: This aspect also cross-references back to jurisdictional considerations noted above, but it bears repeating here. If there’s a local exemption or safe harbor based on the value of intracompany cross-border transactions, a business needs to account for that within its transfer pricing strategy.
Leveraging transfer pricing documentation as support for managing multiple business risks
A business planning its transfer pricing documentation and weighing the risk of its investment also needs to consider other purposes that the information can serve, including:
- Financial statement support: Financial statement auditors may look to transfer pricing calculations to support different assertions and account balances.
- Customs & tariffs: Some of the effort that goes into transfer pricing documentation can also support tariff calculations and provide a record for customs authorities as well.
- Justification for other U.S. taxes on multinationals: If a business plans ahead when designing a transfer pricing method, the output can also support calculations relative to U.S. taxes on multinationals such as GILTI, BEAT, and FDII.
- M&A due diligence: Lastly, another hallmark of the middle market is that companies always need to be ready to respond to a potential merger or acquisition. A business operating across borders that doesn’t have any documentation for its transfer pricing process will likely see potential suitors either reduce their offers or, in the extreme, walk away from a deal if they find an unacceptable level of risk.
The sooner a business starts planning for transfer pricing documentation, the easier and more cost-effective it is to build a scalable policy.
Talk with an advisor
The sooner a business starts planning for transfer pricing documentation, the easier and more cost-effective it is to build a scalable policy that can address current needs and grow with the company. For more information, please contact your Plante Moran advisor.