Common Challenges to Consider in Transfer Pricing

In this article, we will outline the main challenges that occur with transfer pricing, particularly for companies wanting to expand abroad.

What is transfer pricing?

Transfer pricing involves assigning a market price to inter-company transactions, including the cross-border selling of goods and services.

Without local tax rules, transfer pricing could be used as an artificial tax-reducing method. HMRC’s regulations on transfer pricing adhere to the internationally recognised ‘arm’s length principle’. The legislation defines an arm’s length price as the price which might have been expected if the parties to the transaction had been independent persons dealing at arm’s length, based on OECD (the Organisation for Economic Co-operation and Development) guidelines.

The UK transfer pricing rules require an adjustment of profits where a transaction between connected parties is not undertaken at arm’s length and has created a potential UK tax advantage. Application of an arm’s length principle under the OECD guidelines is based on a comparison of transactions between associated parties in a multinational enterprise (MNE) with the transactions which would have taken place between independent parties under the same circumstances; this is known as a ‘comparability analysis’.

This legislation ensures that UK companies that are part of an international group are not selling goods or services for a lower amount than the market price to other group companies for tax purposes or incurring expenses at a higher than market price.

Transfer Pricing Challenges

• External Market Conditions

One of the challenges of transfer pricing is to adapt to any fluctuating market conditions. The arm’s length principle requires the related parties to transact at market- prices for tax purposes, but changing market conditions can affect this. Various external factors can affect the price, such as economic disruptions caused by the political landscape, supply and demand, material costs, margins, and more. Companies should be prepared to adjust prices to reflect the external market conditions. There are various transfer pricing strategies and methods to support this and to help companies avoid mispricing their inter-company transactions for tax purposes.

• Global Regulatory and Tax Compliance

Navigating complex global networks is a huge challenge that multinational groups of companies face. The evolving maze of tax laws and regulations of different countries can make transfer pricing difficult. Countries have their own rules and regulations on transfer pricing and different tax authorities might challenge the validity of transfer prices. Misinterpretations can lead to double taxation or expensive disputes with tax authorities. It’s important to have a robust transfer pricing policy that aligns with the relevant tax rules. This is equally crucial for companies looking to expand overseas. 

• Meeting Documentation Requirements

To combat tax evasion, tax authorities often require extensive documentation and evidence to support transfer pricing policies. Companies may be required to prepare a detailed report that must explicitly explain the rationale behind the price of inter-company transactions. The report must reflect what economic analysis (“benchmarking”) has taken place to evidence the pricing is at arm’s length.

In addition to current international groups, companies expanding overseas should closely evaluate the relevant country’s transfer pricing documentation requirements and ensure every box is ticked. This is a complex, time-consuming, and crucial step. It is best to consult an industry expert.

How Finerva Can Help

Transfer pricing can be a minefield to navigate, especially for companies expanding overseas. With various compliance regulations, documentation, and requirements, you might seek out support in setting up a policy. For actionable advice, guidance, and compliance support, get in touch with the tax experts at Finerva.