TaxMatters@EY - September 2013

Getting transfer pricing right is key to success in a globalized environment

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John Oatway, Toronto

As tax controversies continue to make news around the world, 76% of Canadian companies have identified risk management as their highest transfer pricing priority. This is according to EY’s 2013 Global Transfer Pricing Survey, appropriately titled Navigating the choppy waters of international tax.

That figure beats out the global trend, which shows 66% of companies across the board identified risk management as their highest transfer pricing priority, up 32% from 2010. In fact, 100% of Canadian respondents said they had their transfer pricing policy examined by tax authorities, compared to 82% globally.

Three key factors are behind this increased focus on risk management:

  • Enforcement — Tax authorities are stepping up their enforcement after voicing concern that transfer pricing rules give companies excessive latitude. According to our survey, examinations by revenue authorities have expanded in scope and complexity, while adjustments resulting in penalties are on the rise.

    Documentation requirements are also being strengthened, and there has been a significant increase in unresolved reviews and audits compared with previous years.
  • Compliance activities — Tax authorities in some rapid-growth markets have upped their compliance activities. Transfer pricing policies in markets like India and China that were never reviewed before are now under the microscope. Likely as a result of this scrutiny, our survey found over half of Canadian respondents (52%) are now monitoring financial results quarterly to ensure compliance with transfer pricing policies. While this figure is better than the global finding of 38%, companies here cannot stand still.

    The growing assertiveness by rapid-growth markets is giving rise to more occurrences of double taxation. In fact, 71% of our Canadian survey respondents reported they had experienced double taxation as a result of an adjustment.
  • Public scrutiny — Contributing to the rising importance of transfer pricing risk management is the amount of attention paid to transfer pricing by stakeholders who are not tax professionals. Transfer pricing has become a big topic in the media and among antipoverty and social justice organizations.

    Despite the fact that many of the protests and rhetoric display a lack of knowledge of how transfer pricing works, the coverage has created a new public perception, and companies that are now facing reputational risks have to reconcile legally compliant tax positions.

Considering how the public has come to perceive transfer pricing is only making complying with an increase in a global regulatory framework more complex. As a result, companies need to carefully reassess their transfer pricing priorities.

Understanding intercompany transactions, for example, goes beyond having a checklist of technical requirements. Companies need to understand these intercompany transactions so they can explain them to tax authorities. Meanwhile, they need to make sure they have the people and systems in place to undertake frequent reviews and adjustments to transfer prices to eliminate uncertainty of outcomes.

To better manage their transfer pricing risk, our survey results suggest companies will have to make a number of changes to the way they plan, implement, document and focus on controversy and resolve disputes. From making sure transfer pricing practices take into account indirect tax implications, to developing high standard documentation in a wide range of countries, to being prepared to rely on new channels of resolution such as advance pricing agreements and arbitration, companies are, in many ways, sailing in uncharted waters.

While it’s encouraging that Canadian companies are paying attention to transfer pricing risk management, transfer pricing rules are vast and always evolving. Proactively getting the right processes in place to monitor compliance is the only way to avoid costly double taxation and controversy that can take a company off course.

For more information, please visit Navigating the choppy waters of international tax and read our Tax Alert, 2013 Global Transfer Pricing Survey: the shift toward risk management.