Transfer prices are the prices at
which services, tangible property and intangible property
are traded across international borders between related parties.
Transfer pricing is important because a change in the transfer
price would affect the profits of the business subject to
tax in a particular country. The tax authorities around
the globe can and do, adjust a businesses inter-company pricing
if they think that the transfer price would be different from
a price agreed between two unrelated (arms length) parties.
Such price adjustments can have an adverse tax effect on the
business entity, especially when combined with additional
interest and penalties.
In general, most tax authorities follow
the methodologies set out in the guidelines issued by the
Organization for Economic Co-operation and Development( OECD),
although there are some notable exceptions and interpretations
of how these methods should be applied is not consistent between
countries. Adoption of these methods provides better
certainty in the event of a transfer pricing audit and reduces
the tax risk profile of the taxpayer, by keeping adjustments
to a minimum.
You can find the details together
with examples on our 'Country Information’ page.
They briefly fall into the following categories:
1) Traditional transaction
methods.
The comparable uncontrolled
price (CUP) method.
Adopts as the transfer price the price used by an arms length
party in a similar transaction.
The resale price method.
Uses the arms length resale price of the product less an arms
length commission / expense to arrive at the transfer price.
The cost plus method.
Compares a selling price using a cost + overhead
+ profits method arrived at in dealing with an arms length
party to the actual cost + overhead to arrive at the
mark-up %. The mark-up so calculated plus total actual
transfer cost will result in the transfer price.
2) Transactional profit
methods.
The profit split method.
As it is apparent the total profit of the transaction made
between the non-arms length parties is allocated on a fair
basis to each of the parties. Profits are usually calculated
before taxes and interest and some cases gross profit is used.
The allocation will depend on such factors as functions performed,
assets used and risks assumed by each of them, in other words,
each of their contribution.
The transactional net margin
method.
Determines an arms length net profit margin and applies that
to the total cost of the transaction and calculates the notional
net profit. Adding this notional net profit to the total
cost gives the transfer price.
Why
should the method of calculating transfer pricing be documented? back to top It is essential to maintain contemporaneous documentation
in order to prove that the transfer prices that you use are
arms length. In many of the major trading nations this is now
a requirement that has been enacted in tax law. The lack
of contemporaneous documentation allows the tax authority to
construct the facts as they see they see fit and, needless to
say, this is not going to be in the taxpayers’ interests.
Where documentation requirements do exist, there can be severe
penalties on top of any transfer pricing adjustments, especially
where it cannot be demonstrated that a reasonable effort was
made to arrive at an arms length transfer price (a price unrelated
parties would have agreed to for same transaction).
Documentation requirements vary depending
upon the jurisdiction and, while there has been some attempt
recently to harmonise what is required by those tax authorities
which make up the Pacific Association of Tax Administrators,
it can generally be said that considerable variations still
exist around the world. However, as a rule of thumb,
the following should be seen as a minimum:
Description of the product and service
to which the transaction relates.
All terms and conditions of the transaction.
The identity of the parties to the transaction
and their relationship to each other at the time the transaction
was entered into.
The functions, assets and risks attributed
to each of the parties to this transaction.
The method used in determining the transfer
price.
Assumption, strategies and policies
that affect the calculation of the transfer price.
This again varies from country to country. However, regulations
exist in some of Europe’s principle countries that require
inter-company contracts to be in place before the transfer pricing
arrangements commence. Other countries are less stringent
and will not raise penalties if the documentation is in place
at the time that tax returns are filed.
The failure to have a robust Transfer Pricing policy in place
at the time of your next tax audit can seriously increase the
wealth of the Government who audits you first ! Cut your
Wealth Risks and contact pfTP for a discussion on how to minimise
the chances that you will be caught by the Act.
