By Hansen, Fay
Business Finance , Vol. 12, No. 4
In an increasingly global economy and complex regulatory environment, transfer pricing strategies form the core of tax planning.
AN EVER-LARGER SHARE OF WORLD TRADE CONSISTS OF THE TRANSFER of goods, intangibles and services within multinational enterprises, so determining the tax liability in each jurisdiction hinges on the pricing for each product or service. Since the new surge in global direct investment and sourcing began two years ago, transfer pricing has claimed a central role in tax planning and minimization strategies for companies in every region. Forty-three percent of European companies and 49 percent of Asian companies named transfer pricing as the most important tax issue they face in Ernst & Young's 2005 survey of 348 parent companies and 128 subsidiaries in 22 countries. Seventy percent of U.S. companies ranked tax planning as their first or second tax priority, and 59 percent named transfer pricing as their first or second. By industry, transfer pricing ranked first for 57 percent of the pharmaceutical companies and 46 percent of the retail companies. The new focus on transfer pricing is unlikely to dissipate in the near future. More than three-fourths of the surveyed companies believe that transfer-pricing issues will be "absolutely critical" or "very important" over the next two years.
The Most Powerful Tool
"Transfer pricing is a primary driver in determining where the income generated by an affiliated cross-border transaction will be taxed," says Gary Stone, a partner at PricewaterhouseCoopers global tax services group based in Chicago. Companies must price goods, services and intellectual property moving between affiliated companies using the "arm's-length standard" as if the affiliated companies were engaged in uncontrolled negotiations.
"Relatively small changes in an intercompany price often result in realigning millions of dollars worth of income," Stone says. "Therefore, tax planning using the arm's-length principle must be done in conjunction with - and complement - operational and supply-chain strategies to be optimized and sustainable."
Transfer pricing now sits at the center of global tax planning strategies. "Transfer pricing has long ceased to be simply a compliance issue," says Bill Dodge, director of the global transfer pricing team and codirector of the U.S. transfer pricing team, with Deloitte Tax LLP in Washington, D.C. "It is no surprise that more and more companies are recognizing that transfer pricing is the single most powerful tax planning tool available.
"A small change in the gross profit margin or a royalty rate for intercompany transactions can have a material impact on the effective tax rate, even before multiplying the effect over a number of taxable years," Dodge explains. "And with complex supply chains stretching globally, the opportunities for planning - or unpleasant surprise - are ever-increasing."
Sean Foley, national leader, U.S. transfer pricing practice, at KPMG LLP in Washington, D.C., has another view. "Tax authorities and tax planners are focused on the substance in corporate tax planning methodologies," he says. "Today, tax planning with substance often depends in large measure on transfer pricing. By identifying and then locating or relocating functions and risks as part of a transfer pricing program, many tax planners find they can balance the need to manage both their effective rate and potential challenges that might be mounted by a tax authority."
Documentation and Audit Triggers
Beyond the substantial opportunities for tax minimization that derive from strategic transfer pricing, the regulatory environment has forced corporations to focus on pricing practices and documentation more than they did even a few years ago. Almost two-thirds of the companies surveyed by Ernst & Young reported that they have undergone a transfer pricing audit in the past three years; more than 40 percent of these resulted in adjustments by the tax authorities. …