Why transfer pricing is important
When independent parties transact with each other, the conditions of their commercial and financial relations are ordinarily determined by market forces. When associated parties transact with each other, their commercial and financial relations may not be directly affected by external market forces in the same way. Transfer pricing is an agreed framework of principles that seek to recreate the ‘arm’s length’ position between connected persons or associated parties that would have existed had they been independent. The tax authorities in many countries, including South Africa, accept transfer prices only if they are in line with the arm’s length principle.
The globalisation of business models and increasing tax authority focus has elevated transfer pricing to a mainstream priority for companies operating internationally.
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Tax authority focus
Many governments have experienced a reduction in tax revenue as economic growth has weakened. Additionally, transfer pricing is often seen by governments as an area of compliance weakness and of potential abuse. As a result, it has been increasingly under the spotlight as tax authorities focus on cross border transactions between associated parties as a means of securing and increasing tax revenue.
If a tax authority enquires into the cross-border transactions of a company, the tax authority will expect to see documentation that supports the arm’s length nature of the transactions. It is not just financial risk either. Defending a transfer pricing audit can be a long and resource intensive process. Getting it right up-front can be a significant cost saving.
The South Africa Revenue Service has implemented transfer pricing requirements in line with the OECD’s three-tiered approach which consists of, submission or notification of Country-by-Country Reporting, potential preparation and submission of a master file and local file, as well as potential retention of transfer pricing documentation.
The globalisation of business value chain models
In the competitive global economy, companies are always looking at commercial ways to improve the efficiency of their business. This may involve a restructure of the entire international value chain or it may be as simple as establishing a presence in a new country to be closer to suppliers or customers. In either case, differences in the business model adopted could drive very different tax outcomes and transfer pricing will be a critical consideration in both framing and measuring this.
Managing transfer pricing risk
These factors have made it of key importance for businesses to develop supportable transfer pricing policies, suitable documentation and to establish internal review processes to monitor the proper application of these policies. If a tax authority enquires into the cross border transactions of a company, they will expect to see documentation that supports the arm’s length nature of the transactions.
A robust transfer pricing policy that is implemented correctly as well as accurate and complete transfer pricing documentation will help minimise tax exposure and improve the chances of a successful defence on audit.
The financial risks of getting transfer pricing wrong can be significant. The number of local compliance obligations is increasing year on year and many tax authorities will take a multiple year approach to an audit. This means that any adjustment will be across a number of financial years, magnifying the potential effect with a corresponding increase in interest on unpaid tax and/or penalty provisions and the potential for double taxation.
It is not just financial risk either. Defending against a transfer pricing audit can be a long and resource intensive process. Getting it right up-front can be a significant cost saving.
In order to assist our clients with the above, we specialise in:
- Development of an efficient transfer pricing strategy in line with business requirements
- Preparation, maintenance or review of Country-by-Country reporting
- Preparation, maintenance or review of master files and local files
- Preparation, maintenance or review of transfer pricing policy setting documentation
- Preparation of supporting benchmarking studies
- Conducting transfer pricing risk reviews
- Resolving of transfer pricing disputes with tax authorities
- Review and maintenance of transfer pricing control adequacy
- Pricing and supporting of financial transactions such as debt or guarantees
- Overall international tax planning
- Assisting with Reserve Bank approvals