Transfer pricing operational excellence model

PHASE 1: PLAN
The plan phase in the transfer pricing operational excellence model is comprised of three sub-phases: the governance strategy, the global operational strategy and the pricing policy strategy.

Governance strategy 

Global operational strategy 

Pricing policy strategy

In many multinationals, transfer pricing is best structured as a standalone functional area, but one that is highly-integrated with tax, accounting, finance, treasury and even operational groups. Where materiality and risk do notrise to a level that warrants formal departmental delineation, the transfer pricing function should still contain its own set of strategies, processes, controls and procedures.

Elements of a best-in-class core governance strategy include:

Treating transfer pricing as a global exercise, rather than a local one, has become necessary. The complexities of compliance obligations and the variability in how jurisdictions administer these obligations make it critical for organizations to adopt a globally consistent strategy and approach. Failure to do so could lead to missed filings, contradictory transfer pricing positions and inefficient operational outcomes. 

Elements of an effective global operational strategy include:

Robust and globally-consistent intra-group pricing policies are critical. Transfer pricing requires complex analyses and it is important to deliberately set and continually update intra-group pricing, particularly for highly material transactions. A best practice would include the implementation of global pricing policies to which every subsidiary is subject. Global policies should exist for all cross-border transaction types, and exceptions should be well documented.

Transaction types include:
  • Procedures for resourcing and budgeting the transfer pricing functional area.

  • A departmental/functional organization strategy.

  • A staffing and training/staff development strategy.

  • Quality and review/sign-off protocols and standards.

  • A departmental performance measurement framework.

  • A transfer pricing technology strategy.

  • An integrated effective tax rate (ETR) management strategy.

  • A transfer pricing risk measurement framework.

  • An intellectual property (IP) holding strategy.

At minimum, regardless of the size of your organization, procedures should exist for establishing a framework for transfer pricing risk identification/measurement and a formal transfer pricing functional area of responsibility.
  • A comprehensive transfer pricing compliance requirements map.

  • A transfer pricing filing/compliance deadlines calendar.

  • Integration with permanent establishment (PE) monitoringand compliance.

  • Integration with customs and trade/tariff compliance.

  • Integration with VAT/indirecttax compliance.

  • Integration with the personnel foreign travel monitoring and compliance.

  • Specific global financing and treasury protocols.

  • Cross-functional and cross-border communication/information flow protocols (e.g., between transfer pricing and other departments, and between HQ and foreign affiliates).

At minimum, regardless of the size of your organization, procedures should exist for identifying transfer pricing requirements on a jurisdiction-by jurisdiction basis and establishing a transfer pricing filing/ compliance deadlines calendar.
  • Service fees (e.g., management, administrative, technical, operational and other services).
  • Tangible goods sales.

  • Capital asset transfers or leases.

  • IP licenses (e.g., royalties or license fees) or IP sales.

  • Cost sharing arrangements.

  • Intra-group reimbursements and shared expenses.

  • Financial transactions (e.g., intra-group lending, guarantees, insurance, etc.).

At minimum, regardless of the size of your organization, procedures should exist for establishing minimum standards for setting pricing policies and identifying regional non-compliance/policy inconsistencies.
PHASE 2: IMPLEMENTATION
Transfer pricing implementation procedures can be broken into three time horizons: the budgeting period (prior to the start of the financial year), the interim monitoring/maintenance period (during the year) and the year-end period (prior to the closing of the books for the financial year).

Budgeting (pre-financial year)

Interim monitoring/maintenance (during financial year)

Year-end (prior to financial close)

Pre-financial year procedures can help minimize interim or year-end transfer pricing complications. This period involves the technical work relating to establishing transfer pricing policies prospectively, as well as the set-up of the implementation and maintenance procedures to be undertaken in the remainder of the compliance cycle. Most organizations don’t sufficiently invest in this period and consequently find themselves scrambling to book appropriate entries, document transactions after-the-fact or, in the worst case, discovering fundamental weaknesses in pricing policy during a statutory or tax authority audit.

During the year, the transfer pricing group should be in constant communication with the business to identify new transactions/material business changes, as well as with the accounting/finance teams to provide support and instructions, as needed. More complex supply chains may require interim transfer pricing testing, variance analyses, monthly or quarterly service fee calculations and other processes.

The year-end/pre-close of books period represents the cut-off to when transfer pricing entries and adjustments may be made for accounting purposes. Although some jurisdictions allow the true-up of transfer pricing for tax purposes post-close, it’s not a best practice to carry significant book-to-tax differences due to transfer pricing. Robust year-end testing and transfer pricing adjustment mechanisms should therefore exist ahead of close, so that book and tax are as closely aligned as possible.

Before the start of the year, it can be important to adopt and execute procedures for:

  • Establishing price lists, mark-up factors, royalty rates, service fees, and interest rates to use for the year.
  • Integrating transfer prices into group budgeting and financial planning and analysis (FP&A).
  • Preparing new intra-group agreements or agreement updates.
  • Preparing instructions to regions re: invoicing, accounting entry, withholding and intercompany settlement.
  • Analyzing and resolving indirect tax and trade/customs implications.

At minimum, regardless of the size of your organization, procedures should exist for establishing transfer prices for the year and preparing new intra-group agreements or agreement updates.

 

Throughout the year, it is important to execute procedures for:

  • Identifying new transactions/material changes to facts.
  • Performing interim transfer pricing outcome testing.
  • Implementing periodic retroactive price adjustments, where necessary.
  • Updating transfer prices for the remainder of the year.
  • Resolving implications for budgeting and FP&A.
  • Updating instructions to regions, where needed.
  • Updating indirect tax and trade/customs compliance processes, where needed.

At minimum, regardless of the size of your organization, procedures should exist for identifying new transactions/material changes to facts and implementing (or updating) pricing policies for new transactions/changes.

In the fourth quarter of your financial year, look to implement procedures for:

  • Identifying material changes to facts/transactions in that year.

  • Validating policy assumptions.

  • Performing year-end transfer pricing outcome testing.
  • Performing budget vs. actual analysis.
  • Implementing retroactive year-end price adjustments, where necessary.
  • Calculating year-end management/support fees, where necessary.
  • Integrating transfer pricing with tax provision/statutory audit processes.

At minimum, regardless of the size of your organization, procedures should exist for identifying material changes to facts/transactions in that year and performing yearend transfer pricing testing and computing adjustments.
PHASE 3: DOCUMENTATION
Documentation procedures relate to required annual transfer pricing submissions/forms filings, as well as preparation of transfer pricing documentation and other supporting documents, as needed.

Transfer pricing submissions/forms/filings 

Preparation of transfer pricing documentation

The period following the closing of books, but preceding the tax return filing deadlines, is also critical. In this period, a robust compliance strategy should exist that results in the identification and fulfillment of transfer pricing-specific reporting requirements.

In most jurisdictions, there are no annual transfer pricing documentation submission requirements. Rather, tax examiners must specifically request that documentation be provided, which generally gives taxpayers some time to assemble the documents. Further, in most jurisdictions, transfer pricing documentation acts as a penalty protection mechanism—its contemporaneous preparation may relieve transfer pricing penalties—but penalties are often relevant only in cases where tax authorities assess highly-material pricing adjustments. Transfer pricing documentation resources should consequently be invested strategically, focusing on high-risk transactions and jurisdictions.

After books are closed, you may need procedures for:

  • Identifying all transfer pricing reporting requirements, materiality thresholds and deadlines.

  • Preparing and submitting accurate transfer pricing disclosures/forms.
  • Addressing notification requirements for country by-country reporting (if applicable).
  •  Preparing and submitting country-by-country reporting (if applicable).

At minimum, regardless of the size of your organization, procedures should exist for identifying all filing and disclosure requirements, by jurisdiction, and submitting all requisite filings by the stipulated deadlines.

What transactions to document, and to what extent, is often not clear. To implement an effective transfer pricing documentation strategy, organizations should:

  • Identify all material cross-border intra-group transactions that occurred during the year.
  • Assess the tax authority audit environment on a jurisdiction-by-jurisdiction basis.
  • Determine transfer pricing penalty regimes on a jurisdiction-by-jurisdiction basis.
  • Apply a risk-based documentation framework to determine what transactions to document, to what extent and pursuant to what testing framework/legal regime.
  • Develop a documentation preparation/update plan, inclusive of what to prepare in-house versus what to outsource to transfer pricing advisors.

  • Adopt procedures for cross-affiliate information sharing and reviews, particularly if multiple advisors and multiple affiliate jurisdictions are involved in the documentation preparation.
  • Prepare and leverage global master file reports (if applicable).

At minimum, regardless of the size of your organization, procedures should exist for identifying material crossborder intra-group transactions that occurred during the year and assessing benefits of transfer pricing documentation versus risks.
PHASE 4: DEFEND
Defense procedures relate to managing transfer pricing audits and reassessments, as well as proactively defending transfer pricing positions using mechanisms such as the Advance Pricing Arrangement/Agreement (APA).

Post-filing defense

Finally, after the tax return is filed, there will exist a multi-year period in which transfer pricing positions may be examined and challenged by a tax authority. Transfer pricing audit timing statutes vary across the world but generally allow tax examiners to reassess multiple prior taxation periods. Many jurisdictions have extended reassessment periods for transfer pricing, as transfer pricing audits tend to be complex and time-consuming.

To manage your transfer pricing defense and the risk of tax authority reviews, it’s important to:

  • Implement clear tax authority examination management guidelines, including communication/information flow/review protocols, to stay informed about regional audits and avoid inadvertent misrepresentations by regional affiliate teams.
  • Develop a transfer pricing audit strategy unique to the jurisdiction whenever an audit of transfer pricing issues starts.
  • Establish a continuous monitoring plan for active transfer pricing audits, particularly with flags for when to update the audit strategy, and involve external transfer pricing experts or legal counsel.
  • Assess risk inherent in historical pricing positions, particularly if policy/pricing changes were recently implemented.
  • Determine whether voluntary disclosure mechanisms for self-initiated reassessments should be pursued.
  • Assess robustness of historical transfer pricing documentation and determine if it may warrant revision.
  • Consider whether APAs may be appropriate in the circumstances.

At minimum, regardless of the size of your organization, procedures should exist to identify the commencement of any transfer pricing audits and develop a high-level risk assessment and audit plan, to inform how to manage the audit.