Various countries—including Spain, Finland, Argentina, Mexico, and Germany—are revisiting their tax laws as the pandemic and its economic impact continue. Fearing that multinational companies operating within their borders could be looking to avoid tax obligations, many national governments are focusing their lenses on the issue of transfer pricing.
Companies with global operations use transfer pricing to report profits in the jurisdictions where they do business. Central to transfer pricing is the “arm’s-length” principle, which states that the price tag in a transaction between two related parties—or two subsidiaries of the same parent company—must be the same as it would be between two unrelated parties on the open market.
Countries shoring up their transfer pricing rules means that, for a U.S. company with overseas subsidiaries, something that is already complex is getting further complicated.
And changes to transfer pricing rules could add another layer of complexity to U.S. companies looking to hire and build teams across international borders, which has been ramping up as the worker shortage in the U.S. threatens economic recovery.
Though it might seem daunting, it is more important than ever for companies to have audit-proof tax and transfer pricing policies in place. Failing to structure transfer pricing properly can mean paying far too much in taxes or falling out of compliance in one or more jurisdictions and paying hefty fines.
Here are three steps any multinational company can take to shore up its transfer pricing strategies to avoid making costly errors:
Turn to the Experts
Instead of trying to take on this complex matter alone, consult with tax advisors about changes to transfer pricing and tax regimes in other countries. Take your time in crafting the right strategy.
Additionally, professional employer organizations (PEOs) can be helpful in matters of international taxation. Creating a successful global payroll strategy can become far less complex with the addition of the right PEO. These providers help companies eliminate the burden of recruiting, local tax and compliance, payroll processing, benefits management, salary requirements, and work permits. PEOs can take administrative responsibilities—such as wages, taxes, and benefits—off of the HR department’s plate.
Companies with multiple subsidiaries often find that consolidating financial vendors through a PEO eliminates management stress and frees up time to focus on growth initiatives. PEOs can assume much of the risk, helping companies successfully navigate the complexities of global payroll and eliminating the need for a transfer pricing strategy, especially if you do not have facilities in foreign locations.
Understand the Nexus, and Craft Your Strategy
Businesses do not open overseas offices without a plan in mind. Is the expansion all about penetrating a new market, or is it about conducting research and development for a lower price? Is the subsidiary meant to stay small, or scale up to become a major player in its local market? Will it challenge local incumbents or work closely with them?
These are questions that companies already know the answers to before they hire overseas or open a subsidiary or a branch. Answering them definitively is known as determining your company’s nexus. If you have real estate or personnel in another country, then you have a nexus in that country.
Knowing exactly why your company opened a new office in a new location—the exact nature of that nexus—is critical in navigating transfer pricing. The transfer pricing rate for a research and development center will be different from a sales center.
The government of another country will apply tax regulations to your nexus in the way that they see fit. So, knowing exactly what is happening in every nexus—where revenue is earned, where losses are incurred—is critical in making sure your business is being taxed appropriately.
In transfer pricing, knowledge is power.
Working with established experts and understanding your company’s nexus is a good start but remember: You will need to show everything in meticulous detail to tax authorities in other countries.
Whether you have been operating overseas subsidiaries for years or are about to expand internationally for the first time, you need to get used to documenting every aspect of your business in a painstaking fashion.
The authorities who impose taxes on your business know less about your business than you do. In order to be treated fairly, you need to do more than know the business. You have to show it.
Some countries require prior approval of your transfer pricing strategy before you finalize it. Others will ask later to see the documentation. Tax attorneys can help with these matters, and you can help the attorney by knowing the exact nature of your business in every jurisdiction.
It is also a good idea to proactively stay in contact with tax officials in other countries. Documenting your business should be an ongoing process and sharing your documentation as you go along will make the transfer pricing process smoother overall.
Controlled transactions, uncontrolled transactions, royalty agreements, and the arm’s-length principle: Transfer pricing is complicated even in normal times. But with the pandemic still on, and national economies responding and recovering differently, we said goodbye to normal times in early 2020.
Transfer pricing may seem like a dry topic that is the purview of tax attorneys (and no one else), but global events over the past year have put a spotlight on this issue. It’s risen to the top in terms of importance for companies with operations in multiple jurisdictions.
Countries are reexamining and, in some cases, tightening their transfer pricing policies, so companies must do the same. Without a methodical approach, the help of experts, and relentless documentation, businesses face taxes that are higher than they should be or penalties that threaten the bottom line.
This column does not necessarily reflect the opinion of The Bureau of National Affairs, Inc. or its owners.
Ragu Bhargava is CEO of Global Upside.
Bloomberg Tax Insights articles are written by experienced practitioners, academics, and policy experts discussing developments and current issues in taxation. To contribute, please contact us at TaxInsights@bloombergindustry.com.