Multinational groups will often transfer goods and services between their member companies in different countries. Given that every country has its own corporate tax rates there is an obvious incentive for profits to be shifted to the country with the lowest tax rates. To prevent this, most global tax jurisdictions apply the concept of Transfer Pricing so that related parties deal with each other on an arms’ length basis. This is a complex area of international tax law, but broadly this means to deal with rated parties on the same terms that you would deal with an external party, in order to avoid artificial shifting of profits across borders.
We have set out the three common approaches to transfer pricing that we see in international businesses operating in Australia:
1. Transfer at cost
Using this method the cost to the importing company is the cost of production of the good or delivery of the service to the exporting company. This is the lowest possible cost that you can assign to the goods – and often the simplest transfer pricing methodology to adopt. However it is an approach fraught with risk – if you were dealing with an unrelated company, would you be willing to sell at cost with no profit markup? This arrangement can be suggestive of an approach where profits are being artificially shifted.
2. Comparable Uncontrolled Price (“CUP”)
This is the “holy grail” of transfer pricing methodology, preferred by the OECD throughout its Base Erosion Profit Shifting (BEPS) project aimed at aligning the transfer pricing regimes in the world’s major economies.
In CUP the price charged to a related party is the same price charged in a comparable transaction to an unrelated party. While it sounds simple in theory, finding those comparable transactions can be extremely difficult. Prices between unrelated parties are rarely publicly disclosed, although there are large private databases of these prices maintained for the exact purpose of transfer pricing. It may well be that there simply are no comparable transactions, and the nature of the good or service in question and the market power of the parties involved may make this exercise impossible, or at least require complex adjustments and weightings.
3. Transfer at cost-plus
Where CUP has proven too difficult, cost-plus is a common method that imposes a price of the cost of the good or service plus a reasonable profit margin for the selling party. The obvious question is then what constitutes reasonable margin – a question with a complicated answer. A reasonable profit margin is on that produces a return to the exporting company that would satisfy that company if they were operating as an independent company – which is reflective of where the real economic risk of the transaction lies, the economies of scale of production, whether the transaction is core business for either party and any number other relevant factors.
Transfer pricing is important to get right, as national tax authorities have the power to make “transfer pricing adjustments” to claim a greater share of global profits if they can show that artificial profit shifting has taken place. There is more and more transnational cooperation and data sharing to make enforcement easier, with measures such as Country by Country Reporting coming into force in recent years. By engaging experts such as Azure Group to implement and document compliant transfer pricing companies can reduce the imposition of fines and penalties, and be confident that adjustments will not be imposed.
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"One common problem that INTERNATIONAL ENTREPRENEURS encounter is that they don't have all of the resources supporting them in a foreign country. Finding the right support could be critical for GLOBAL SUCCESS."
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