Insight into Operational Transfer Pricing and Pillar Two Compliance in 2024’s Financial Management Landscape
As we enter 2024, the adherence to the new Organisation for Economic Co-operation and Development’s (OECD) Base Erosion and Profit Shifting (BEPS) Pillar Two regulations seems ever closer.
The Pillar Two regulations have introduced additional challenges for multinational enterprises (MNEs) when it comes to managing and pricing their intercompany transactions. 84% of respondents to an EP survey of this year say they face a moderate or significant risk of double taxation related to the OECD Inclusive Framework on Base Erosion and Profit Shifting (BEPS) project, which introduces various new tax regimes under Pillar Two, including a new global minimum tax of at least 15% for multinational enterprises.
The aim of the new regulations? To address global tax challenges by ensuring that MNEs pay a minimum level of tax on their income.
But, to avoid complex calculations and potential double taxation, it is crucial for MNEs to upgrade and enhance their operational transfer pricing processes to adapt to the new expectations.
This blog digs into the world of operational transfer pricing - its opportunities, challenges and complexities, what you need to know about Pillar Two in the coming months - and how the support of enterprise performance management consultants can support your compliance.
Transfer Pricing 101
Transfer pricing is a critical concept in financial management, particularly for multinational enterprises engaged in cross-border transactions. It involves setting prices for goods, services, or intellectual property transferred between related entities within the same organisation.
While essential for accurate cost allocation and performance evaluation, transfer pricing also presents challenges and regulatory considerations that companies must address effectively.
Why Does Transfer Pricing Matter in Financial Management?
Transfer pricing is crucial for assessing the profitability of individual business units within MNEs. According to a report by Deloitte, 71% of global companies consider transfer pricing to be a key priority for their tax departments. By establishing transfer prices for intercompany transactions, companies can allocate costs and revenues accurately, enabling management to make informed decisions regarding resource allocation and pricing strategies.
Key Approaches to Transfer Pricing
Several principles guide the establishment of transfer prices to ensure fairness, transparency, and compliance with regulatory requirements.
Arm's Length Principle
The arm's length principle stipulates that transfer prices should reflect the prices that unrelated parties would agree to in an open market transaction. This principle aims to prevent related parties from engaging in artificial pricing practices to manipulate profits or tax liabilities. A 2019 survey by PwC suggested that 90% of tax executives consider compliance with the arm's length principle to be a significant challenge.
Comparable Uncontrolled Price (CUP) Method
According to the OECD, the CUP method is the most commonly used transfer pricing method among member countries and involves comparing the price of the controlled transaction with prices charged for similar transactions between unrelated parties. This approach ensures that transfer prices are consistent with prevailing market conditions.
Cost-Plus Method
Under the cost-plus method, a markup is added to the production cost incurred by the selling entity to determine the transfer price and, according to Ernst & Young, 62% of companies use the cost-plus method for establishing transfer prices. The benefits of this method are that it allows companies to ensure a reasonable profit margin on intercompany transactions.
Resale Price Method
According to the Tax Foundation, the resale price method is commonly used in industries such as retail and distribution. The resale price method involves applying a predetermined profit margin to the resale price charged by the buying entity and helps companies maintain consistent pricing across different distribution channels.
Transactional Net Margin Method (TNMM)
The TNMM compares the net profit margin earned from a controlled transaction with the profit margins observed in comparable transactions between unrelated parties. A 2020 study by KPMG showed that 47% of companies prefer the TNMM for establishing transfer prices. (The method allows companies to assess profitability relative to external benchmarks.)
Transfer Pricing: Challenges and Compliance
While transfer pricing is essential for multinational corporations, it also presents challenges and regulatory risks. Here’s why…
- Complexity
Determining appropriate transfer prices requires a thorough understanding of economics, market dynamics, and regulatory requirements. According to a survey by Bloomberg Tax & Accounting, 78% of tax professionals cite complexity as a significant challenge in managing transfer pricing. Factors such as product differentiation and geographic markets contribute to the complexity of transfer pricing arrangements.
- Documentation Requirements
Many jurisdictions impose documentation requirements to substantiate transfer pricing arrangements. Thomson Reuters states that 82% of tax professionals cite documentation requirements as a significant compliance challenge in satisfying regulatory scrutiny.
- Compliance Risks
Non-compliance with transfer pricing regulations can lead to disputes with tax authorities and potential penalties. One study (EY) states that 63% of companies have experienced transfer pricing-related disputes with tax authorities.
The new OECD's Base Erosion and Profit Shifting (BEPS) Pillar Two regulations have significant implications for operational transfer pricing specifically for in-scope MNE's and large domestic groups i.e. those with consolidated group revenues of €750m or more in at least two of the four preceding fiscal years
They present a new set of challenges for these organisations in terms of compliance when it comes to managing and pricing their intercompany transactions, risk management, and tax planning… that must be adhered to by 2026.
This includes the introduction of new compliance and reporting requirements, amongst which is the filing of a GloBE Information Return (GIR), to be submitted within a specified timeframe after the end of the accounting period.
How to ensure compliance and avoid double taxations within the new OECD Pillar Two regulations?
Concerns about the predictability of Pillar Two calculations amongst executives and TP professionals are centred around data, in particular standard transfer pricing data - leading to EP’s 2024 survey to state in no uncertain terms that the operational needs and data processes must compel corporations to attempt to standardise their internal data to manage the groundswell of tax authority controversy-related requests and Pillar Two calculations.
Specifically, they clarify: “Standardised data will help businesses address workload demands and effectively manage current and anticipated tax controversy. More control over their data will also help businesses manage increasing demands for public transparency about their tax payments globally.”
Tax departments should focus on driving transfer pricing certainty through standard data and changing processes to facilitate dispute resolution - and this is where an enterprise financial management consultancy can support this vital work, and facilitate deep organisational change.
Transfer pricing is a critical aspect of financial management for multinational corporations enabling companies to optimise tax outcomes and enhance overall performance. However, navigating the complexities of transfer pricing requires careful consideration of regulatory requirements and market dynamics - which are changing this year.
As organisations move to improve their transfer pricing processes, against the backdrop and implications of the new Pillar Two regulations, as a performance management consultancy, Insight Models can advise on and build solutions to enable you to run the reports your business needs to be compliant, avoid discrepancies and reduce risk.
Contact us for a no obligation discussion about your current situation. info@insightmodels.co.uk