Turning transfer pricing (TP) policies into actual business transactions and improving the way intercompany transactions are executed has assumed even greater significance. Inconsistent data, inaccurate processes, insufficient insight and inadequate controls on transfer pricing can cripple a company’s tax and corporate strategy.
Core problem statement
Traditionally, we view transfer pricing as a tax compliance obligation and a post-facto exercise to demonstrate that inter-company transactions reflect the arm’s length principle. This approach is deficient because it does not answer how a company’s transfer pricing policy is:
- Translated into actual transaction flows
- Integrated into financial reporting (both management and statutory) and Enterprise Resource Planning (ERP) systems
- Governed for price setting, monitoring, adjustment and documentation purposes
- Implemented within protocols that go beyond the individual
- Enabled to swiftly identify potential risks and implement remedial measures
A TP policy may state that a service provider within the group should earn 10 percent mark-up on operating costs. In reality, however, there may be operational transfer pricing issues involving how common costs related to the relevant segment are identified, how different costs (i.e. foreign exchange, restructuring etc.) are treated, under or over-invoicing resulting in year-end adjustments and impact regulatory filings, financial statement reporting, implementation of advance pricing agreements etc.
Organizations continue to manage their operational transfer pricing activities by largely relying on manual entries, spreadsheets and ad-hoc measures. There is extensive human effort of tax, finance, treasury, IT and business teams to bring together process and data to reach reliable financial outcomes, often resulting in gaps.
An integrated operational transfer pricing approach, therefore, becomes critical. It can be explained as efficient integration and management of data, process and controls to align transfer pricing policy and its implementation with strategic business goals. It drives consistency, reduces complexity, delivers strategic insights, enables sharper governance and fosters better decision making. Technology can significantly automate and enhance operational transfer pricing.
How to rise to this challenge
Setting and building an operational transfer pricing framework cannot be managed in a silo. It requires inputs and alignment across stakeholders in an organization. Companies can adopt a milestone-based approach and start by mapping existing processes for key intercompany transactions, collecting information about common challenges and defining pain points. It can be followed by selecting key jurisdictions, business areas, sales channels and identifying potential leakages, such as double taxation, impact on goods and services tax, custom duties, inventory levels and foreign exchange. Some key operational transfer pricing challenges and root causes may be hidden in the ERP core such as:
- Undefined and complex, entity, product structures and hierarchies
- Missing requisite flags and data fields in ERP master data
- Invoice details and amounts not providing sufficient operational transfer pricing related information required for compliance, or aligning with policies and jurisdictional requirements
- Disintegrated data feeds from multiple data sources
Depending upon the level of interdependencies in the operating model across the processes of price-setting, monitoring, reporting and preparedness for controversy and litigation, a structured, scalable and effective operational transfer pricing, framework can be designed for better control and efficiency, and to help mitigate tax risks.
In practice, companies have successfully leveraged new age, off-the-shelf or customized technologies to automate and resolve organization specific operational transfer pricing areas like:
- Preparation of segmental profitability reports with different dimensions (product, geography)
- Data consolidation and reporting for economic analysis purposes e.g.: data for applying Comparable Uncontrolled Price (CUP) method and its analysis
- Reconciliation and matching of financial data from various sources (MIS, financials, SEZ filings) with transfer pricing outcomes
- Mapping of tax and transfer pricing related cost centers to accurate legal entities and business segments
- Cost pooling from different hubs providing intragroup services and allocation of pooled cost to legal entities
- Automating evidence and benefits documentation collation for audit support, reducing human dependencies for prior period information