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 revenue and geographic footprint will provide opportunities to collaborate with an advisor about a strategic transfer pricing policy. A well-designed transfer pricing policy can identify transactional flows that align with both the business operations and management’s objectives of managing effective tax rates, creating cash repatriation valves, and mitigating tax compliance risk.
A middle-market business that’s starting or expanding operations in new countries should approach transfer pricing with a risk-based evaluation of the anticipated level of intercompany transactions, the local regulatory environment, including legislative requirements and tax authority engagement, and the company’s resources to administer the ongoing maintenance of the intercompany policy. A formal policy plus documentation may be prohibitively expensive at this stage in the business, but a customized approach that assesses likely jurisdictional concerns and transactional characteristics can help support a reasonable approach employed by the business when faced with scrutiny from tax authorities. Even without external consulting services, taxpayers should develop and maintain documents that outline and support the transfer price they’ve developed.
Jurisdictional considerations when customizing a transfer pricing method
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 peculiarities. To customize a transfer pricing method for operations in each country, a business should 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 more than a new in-country subsidiary of a multinational that operates at a loss, particularly over an extended period of time. In addition, an entity bearing initial losses, and therefore, risk, may have the unintended consequence of having a claim to future intangible profits as a result. Tax authorities tend to be quick to assess this claim for future profits. Almost any business starting operations in a new country may struggle to turn a profit — the question is, who bears that risk? A thoughtfully designed transfer pricing policy will be critical when asked to support and justify the accuracy and appropriateness of low financial results to the taxing authority.
- Local exemptions: Some countries may exempt small or new businesses from documentation requirements based on certain criteria, such as volume of sales in the jurisdiction. Others may accept less than the full-blown OECD documentation required for businesses in early stages of operations within their borders. It’s important to know and take advantage of these exemptions or limited requirements to mitigate risk.
- Likelihood of audit & worst-case projection: When it comes to planning a transfer pricing policy process for operations in a new country, a business should 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 shouldn’t be overlooked, but engagements should be designed based on the company’s potential risk in the jurisdiction.
- Industry focus: Some countries have taxes or campaigns targeted at specific industries, such as technology. Businesses subject to these initiatives should consider them in their transfer pricing documentation.
Intercompany transaction values
Regardless of jurisdiction, the value of the intercompany cross-border transactions will play a significant part in the discussion when it comes to transfer pricing. To customize a transfer pricing policy for intercompany transactions, a business should consider factors like:
- The dollar value of transactions: Similar to the worst-case projection, the cost of 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 its transfer pricing efforts justifying $25,000 of markup, the business may have missed important factors in the cost base itself.
- Norms & safe harbors: This aspect 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 intercompany cross-border transactions, a business should account for that within its transfer pricing strategy.
Leveraging transfer pricing documentation when managing multiple business risks
A business planning its transfer pricing strategy and weighing the risk of its investment should also 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 support tariff calculations and provide a record for customs authorities.
- Justification for other U.S. taxes on multinationals: If a business plans ahead when designing a transfer pricing policy, the output can support calculations relative to U.S. taxes on multinationals, such as GILTI, BEAT, FDII, and foreign tax credits.
- M&A due diligence: 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.
Planning your transfer pricing strategy
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. Use these considerations to start your plan today and position your company for future success.
