Businesses that operate globally continue to face complex tax
issues, and transfer pricing – the practice of establishing
arm's-length prices for related-party cross-border transactions
– has become more important than ever.
When it comes to transfer pricing, I consider the Organization
for Economic Co-operation and Development (OECD) Guidelines for
Multinational Enterprises my bible. This is where organizations
working internationally find everything they need to know about the
rules and regulations that govern the complex art of transfer
Transfer pricing relates to inter-company transactions. When you
are moving goods, inventory, people and services around, they have
to be priced based on fair market value to determine the profits to
report within each country.
Large multinationals devote considerable time and energy to
managing transfer pricing. But it affects any business working
internationally. The issues are the same, but mid-market companies
don't have the sophistication and resources to handle all of
this. If they don't do it right, they can end up spending tens
of thousands of dollars in penalties.
By way of example, an equipment manufacturing company in Canada
selling products to U.S. customers may transfer ownership of the
equipment to a U.S. subsidiary at an "appropriate" cost.
If the transfer price (the price charged to the subsidiary) is too
high, too much of the profit is shifted to Canada to be taxed in
that jurisdiction. If it's too low, too much profit will shift
to the U.S.
Determining fair market value is not an exact science. It's
a very vague, very grey area and has to be done to a reasonable
extent so both countries are happy. But it is legitimate, as long
as you are complying with transfer pricing rules and regulations
for each country.
There are two major drivers affecting change in transfer pricing
practices. The volume of global transactions crossing borders has
grown exponentially over the last decade. At the same time, taxing
authorities are looking more and more to transfer pricing as a way
to get at greater tax revenues.
The most important thing companies need to do is ensure transfer
pricing policies are set up properly from the outset. I have had
clients come after they've set up the business and have the tax
authorities knocking. You have to be proactive by planning out and
setting yourself up correctly. That means figuring out what will
work operationally for you and following a transfer pricing policy
that is efficient and works.
Risk mitigation also comes into play, depending on the countries
you are working in. You need to know about the differences and what
risks you might face. There are more than 80 OECD countries that
have transfer pricing documentation requirements. If you are being
audited by the Canada Revenue Agency, for example, that
documentation is the first thing they want to see. If you don't
have it, they will do an audit and come up with an adjustment,
which could lead to substantial cash penalties, regardless of
whether you owe taxes or not.
Documentation should be generated annually and must explain
clearly how you run your operations, your transfer pricing policy
and why it makes sense.
Transfer pricing can also open up areas of opportunity. Savvy
advisers can help you use transfer pricing to manage global
liability. It's never about doing something illegal. It's
about optimizing your global tax rate.
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