How Executives Can Increase Their Bottom Line and Reduce Risk through Strategic Transfer Pricing

Tax authorities worldwide see aggressive transfer pricing as a potential threat to their tax base. With its impact on a company’s global tax liability, tax authorities are focusing on stopping multinationals from using transfer pricing to shift profits artificially and avoid taxes. With this increased scrutiny, executives must understand the risks as well as the opportunities available from a transfer pricing perspective.

Transfer pricing determines arm’s length pricing for goods, services, funding or intangible assets between related parties across multiple countries. Though a highly technical area of international tax, executives need a basic understanding of transfer pricing to leverage it strategically. To do this, executives should:

• Develop strategic and sound transfer pricing policies
• Understand the resources their tax and accounting department needs to add value through a proactive transfer pricing strategy
• Plan and prepare before transactions to avoid common transfer pricing mistakes and pitfalls

Develop Strategic and Sound Transfer Pricing Policies

Even without an in-depth understanding of tax or transfer pricing, executives can lead their organization to develop optimal and defensible transfer pricing policies. Executives can involve their tax and accounting departments in understanding three key areas: intangible asset development, global cash management and acquisitions.

• Intangible asset development: Transfer pricing involving intangible assets has become both the greatest area of opportunity for optimization and the greatest area of risk for tax controversy globally. Executives need to recognize the risks and opportunities in managing intangible assets as tax authorities focus on the development, enhancement, maintenance, protection and exploitation (DEMPE) process. To deliver enhanced returns for their shareholders while mitigating risk, executives must understand the tax and transfer pricing complexities in the intangible asset development life cycle. It’s important to ensure that decision makers manage the location of key development activities, including strategic, tactical and functional contributions. This involves aligning key business value drivers with the location or movement of personnel, strategic authority and capacity to invest and bear risk in the marketplace, as well as the creation and use of key assets.
• Global cash management: Executives often overlook the risks and opportunities that transfer pricing offers for tax efficient corporate cash management. They need to understand how intercompany loans or cash pooling could leverage a company’s global cash more efficiently. Executives must ensure that cash management strategies include compensation for intercompany services, remuneration for intangible asset ownership and alignment of global supply chains.
• Acquisitions: Executives should involve transfer pricing in acquisition due diligence to identify exposures that could open opportunities to negotiate better terms or pricing. It could also identify opportunities to capture post acquisition tax efficiencies by improving the alignment of transfer pricing policies with global business objectives.

Empower Accounting and Tax Teams to Add Value

Transfer pricing bridges cross-border business models and taxation, placing tax and accounting in a critical role. Executives can help tax, and accounting departments add value to the organization by considering several business priorities. They should ensure that accounting and tax personnel are involved early in strategic business planning and in acquisition due diligence and integration planning. To do this, executives must ensure that accounting and tax personnel have the skills or external support to go beyond basic compliance.

Plan and Prepare to Avoid Mistakes and Pitfalls

Executives need to be aware of common transfer pricing mistakes and pitfalls that arise from insufficient planning and preparation. Transfer pricing mistakes arise from insufficient planning, leading to costly tax challenges and penalties or missed opportunities in acquisitions. To mitigate risks and maximize tax savings, executives can prioritize:

• Controlling the narrative that supports accurate delineation of intercompany transactions through timely preparation of intercompany agreements and documentation that align key terms and conditions with the substance of the business
• Developing a deliberate strategy to optimize opportunities and to minimize risks involved with global development and exploitation of intangible assets
• Involving tax and accounting departments proactively in global expansion, business restructuring, due diligence and post acquisition integration

Establish pre-transaction intercompany agreements: Companies that align intercompany agreements with their global plans optimize their tax rate and defend transactions before tax authorities effectively. Executives should ensure that the company executes such intercompany agreements before the transaction occurs. This will create a strong defense against hypothetical alternatives that tax authorities might propose. Setting transfer pricing policies and intercompany agreements before transactions validates them and defends against the presumption that the company is using transfer pricing for tax avoidance. However, this requires proactively involving the tax and accounting departments during the strategic planning phase of cross border business decisions.

Address intangible assets, restructurings and acquisitions: The management of investments in self-developed or acquired intangible assets, business restructurings and acquisition integrations create the most significant strategic transfer pricing opportunities for tax savings and the most significant risks of challenge from tax authorities. Executives must address these challenges during planning, not post transaction. This requires understanding how tax authorities measure a company’s contributions to value-creating activities within their country. For example, some countries view the cost of labor savings, basic market penetration and local market product customizations as taxable local contributions to an organization’s global profits.

Develop a post acquisition strategy: Executives should ensure that proactive planning around a post acquisition strategy for the target company’s intangible property is the top transfer pricing priority for the tax and accounting leadership team. Challenges from tax authorities can subject a company to prolonged and tedious scrutiny, as well as remediation between multiple tax authorities. These challenges often show missed opportunities for risk mitigation due to poor planning.

Key Takeaways for Executives

Transfer pricing is not just a tax compliance issue. It’s a strategic opportunity to lower cash taxes and optimize the global effective tax rate. Executives need a working understanding of transfer pricing to guide their organizations in mitigating risks and seizing opportunities in global business. Executives can effectively navigate transfer pricing risks by developing strong transfer pricing policies, ensuring their accounting and tax teams add value and plan ahead to avoid common transfer pricing mistakes and pitfalls. In doing so, executives can prioritize the following key considerations:

• Executives have the greatest impact by strategically and holistically planning the development, exploitation and integration of intangible assets. These assets drive any above-average or “residual” profits. Taxation of these profits creates the highest risk of controversy with tax authorities and the greatest opportunity for optimizing transfer pricing.
• Strategic and operational decisions around investments in intangible asset development and exploitation, supply chain management, acquisition diligence and integration are key to optimizing transfer pricing and mitigating risk.
• Increased global scrutiny of transfer pricing is raising reporting and compliance complexities. To leverage transfer pricing strategically, an organization needs early and consistent involvement from its tax department.

Many executives struggle with the challenges of transfer pricing, especially with growing global oversight and changing tax rules. Weaver’s experienced tax professionals can help you develop strategic transfer pricing policies that optimize your global tax position and mitigate risk. Contact us. Our tax professionals are here to help.

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