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Transfer pricing poses risk to multinationals

Sunday, 16 December 2007

Eighty-seven percent of multinational enterprises (MNEs) believe that transfer pricing is a risk when managing their financial statements.

Compliance requirements have increased due to developments in financial reporting, according to Ernst & Young’s biennial "Global Transfer Pricing Survey" of 850 MNEs.

John Hobster, Ernst & Young’s Global Accounts Leader, Transfer Pricing, says that risk mitigation is a key priority for MNEs, and transfer pricing has increasingly moved into board rooms and audit committees.

"As convergence of customs and tax authorities continues, tax authorities collaborate more and more across borders, and new regulations come into place, MNEs want to ensure that transfer pricing is compliant with tax laws,” Hobster adds.

Inherent complexity

The degree of perceived transfer pricing-related financial-statement risk varies significantly by industry, reflecting the inherent complexity of the underlying transfer pricing issues of those industries.

In particular, 53 per cent of parent company respondents in telecommunications, 48 per cent in pharmaceuticals, and 45 per cent in the biotechnology industry reported that transfer pricing posed the largest financial risk they face.

Hobster says that companies need to manage their financial risks with greater precision, as enhanced transfer pricing documentation requirements have intensified the responsibilities of MNEs to actively report and justify the impact of their tax position.

He believes that this is particularly tough at a time when there is a greater chance that transfer pricing policies and practices will be audited.

Convergence of customs and tax authorities

Over half of the survey respondents (53 per cent) said that their transfer pricing compliance costs have increased. This is a significant increase on the 2005 survey results where only 29 per cent of parent companies mentioned a rise in costs as a result of financial reporting and regulatory developments.

Convergence of customs and tax authorities in many countries has increased the complexity of transfer pricing compliance.

The survey shows, however, that only half of the MNEs coordinate their internal customs and transfer pricing systems post transaction.

“This is surprising, as a third of the respondents from parent MNEs say that during a transfer pricing audit they have been aware of exchange of information between tax and customs authorities,” says Hobster.

Increased supranational dialogue

The lack of MNEs’ internal customs and tax coordination has increased since Ernst & Young's 2005 survey. Hobster thinks that this is concerning and probably a result of general lack of appreciation of how customs and tax offices work together, domestically and internationally. He would therefore welcome increased supranational dialogue and discussion about this difficult area.

The survey shows that 19 per cent of parent respondents have had their customs valuations challenged where they have been based on their transfer prices for the same goods, or vice versa.

In 44 per cent of these cases, increased customs valuations (and costs) have not resulted in corresponding adjustments (and credits) to corporate income taxes.

Industry focus

Transfer pricing is the single most important issue for 76 per cent of parent respondents in the pharmaceutical sector, which is an increase of 19 per cent on the 2005 survey.

Pharmaceutical companies are nearly twice as likely as companies in any other industry to experience an adjustment of transfer prices, and parent respondents in the pharmaceutical sector said that 56 per cent of transfer pricing examinations since 2003 resulted in adjustments.

Other sectors where transfer pricing is important include: automotive, biotechnology, consumer products and telecommunications.

Forty per cent of all respondents identified transfer pricing as the most important tax issue, whilst 65 per cent of respondents from parent MNEs believed transfer pricing documentation is more important today than two years ago.

Advance pricing agreements

Only one-third of MNEs, however, prepare their transfer pricing documentation on a concurrent, globally coordinated basis.

Over half (52 per cent) of all respondents have undergone a transfer pricing examination since 2003, with 27 per cent resulting in adjustments by tax authorities. Seventy-two per cent of respondents believe the level of transfer pricing expertise within tax authorities is ‘good’ to ‘very good’ based on their audit experiences.

Only 21 per cent of parent respondents use advance pricing agreements (APAs) as controversy management tools, however, 86 per cent of those who have used APAs would do so again.

Almost 40 countries have now effective documentation rules, and China, Ireland and Russia are expected to launch their rules soon.

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