Entrepreneur with International Operations? Know your Key Transfer Pricing Rules

Due to globalization and increasing technology advancements, more and more companies extend their operations internationally. These situations open the discussions of a new taxation sphere that entrepreneurs facing this context must be aware of and comply to: transfer pricing.

ATIPIC Solutions prepared a short checklist for entrepreneurs seeking for clarifications on what transfer pricing is and how it should be applied, as to serve and protect the company’s interest.

The arm’s length principle

The principle forms the basis of the transfer pricing sphere of regulations. It merely emphasizes the importance of combating the illicit shift of profits from higher income tax rate jurisdictions to lower income tax rate jurisdictions.

The principle states that two companies, part of the same group of companies, must trade their goods, services or capital as if they were unrelated of each other – utilizing the same transfer pricing as two independent companies would.

Value creation vs. tax planning

Although transfer pricing is used as a method to effectively reduce the global tax bill, this is clearly not the purpose here. Having in mind that transfer pricing has been established as a method to ensure profits are not shifted to jurisdictions where profit is not due, the structure of the company should follow the operations, not the lower taxation jurisdictions.

In this sense, entrepreneurs should perform an analysis as to where value is created or how to improve the value creation process for this sole benefit – not to use transfer pricing for tax planning purposes.

Focus on presence, not territory

If you only have presence in your country of residence, but your local operations are divided between different, stand-alone entities, transfer pricing should still be on your agenda.

Transfer pricing applies to all intra-group transactions, namely all transactions happening between all entities of the same group of companies, even if your presence is only local. Each jurisdiction has individual rules as to decide what percent of ownership defines a relation between entities resulting a group.

Documentation requirements – not just compliance

All countries recognizing the transfer pricing mechanism have implemented in national legislation documentation requirements, as to analyze, to test and to scrutinize the validity of the taxpayers’ transactions.

The transfer pricing documentation includes information on the intra-group transactions and on the entities involved, including the functions and risks undertaken by them, as well as justification of the transfer prices applied in these transactions by these entities.

Entrepreneurs should not perceive the transfer pricing documentation just as compliance, as the drafting up of the document frequently uncovers market trends or improvement areas.

Penalties

Severe penalties will apply if entrepreneurs choose not to comply with the transfer pricing principle and documentation requirements. Frequent tax audits are happening all around the globe as transfer pricing becomes a focus for most tax authorities.

Advance pricing agreements

If you are looking for solutions to completely avoid penalties and hassles with the tax authorities resulted from transfer pricing issues, the advance pricing agreement (APAs) is the instrument for you. In order to ensure no future transfer pricing audits will challenge the respective transactions, the tax authorities are informed in advance of the transfer pricing methodology proposed by the company and if all is agreed, will issue an APA.

Find out more

Transfer pricing reporting requirements may also apply to you. Since most jurisdictions place the burden of proof on the company, the tax authorities may impose penalties, if upon check, the transactions were not undertook according to the arm’s length principle. Read more on all the transfer pricing topics on the ATIPIC Solutions website.

Adam Hansen