Tax authorities aren’t exactly secretive about their efforts to eliminate base erosion and profit shifting, and they’re certainly not covert about plans to increase transfer pricing scrutiny to do it.
Countries such as the Czech Republic are open about examining transfer pricing transactions that take place with tax havens, and Poland makes no pretense about its willingness to investigate companies presenting losses.
India is openly dubious about royalty management fees, and there are no mixed messages from Belgium, which over the last few years has doubled the number of inspectors in its transfer pricing audit unit.
When tax authorities do you the favor of blatantly announcing that intercompany transactions will be under the microscope, it’s easy to plan accordingly. But there are plenty of less obvious indicators that hawkish behavior lies ahead.
Reading between the lines allows you to be proactive and minimize risk, but only if you’re paying attention. Here are discreet signs that promise an uptick in transfer pricing scrutiny, and how to navigate it.
Routine Audits
Some countries make transfer pricing reviews part of their income tax audits; others look at transfer pricing separately. However, when a country announces combining the two as part of a new transfer pricing audit program, a larger pool of taxpayers undoubtedly will be subject to examinations.
Example. In 2020, when Japan announced that its National Tax Agency would conduct transfer pricing audits as part of routine corporate income tax audits, it wasn’t just a way to streamline responsibilities—it was a way to conduct more transfer pricing reviews. Transfer pricing examinations increased by 14% between 2021 and 2022.
To minimize risk, prepare contemporaneous documentation—if the NTA requests your local file, for example, you’ll have just 45 to 60 days to submit it. That’s hardly enough time to pull reports together from scratch. Put extra effort into the functional analysis; the NTA pays close attention to who owns functions, assets, and risks.
Tax Break Promises
When personal tax breaks are central to a party’s running platform, a government typically plans to make up lost revenue elsewhere—and transfer pricing is an easy mark. Disputes (even settlements) can mean huge payouts for tax authorities. So, expect a close-up of the documentation.
Example. When the Australian Labor Party came to power in 2022, tax breaks for citizens were accompanied by a proposal for more corporate transparency—including public country-by-country reporting and mandatory disclosures for business in tax havens. There would also be more funding for the Tax Avoidance Taskforce, which helped the Australian Taxation Office collect AU$22.9 billion in tax liabilities as of June 2021.
To minimize risk, embrace tax software. Technology that automatically updates regulations can help you comply and strategize for change.
Landmark Wins
Different jurisdictions weigh transfer pricing with varying levels of importance. Some, such as Canada and India, are aggressive; others, such as Ireland and Singapore, not so much. But when a country wins a landmark transfer pricing case—and a significant payout—you can safely assume tax authorities recognize they’re on to something.
Example. Historically, the IRS has seemed laid back about transfer pricing compliance, but that may change thanks to 2020’s game-changing $3.3 billion Coca-Cola Co. victory over the transfer pricing of intangibles. This victory, the first legal transfer pricing win in years, gives the IRS the confidence and case law to pursue other cases.
To minimize risk, document diligently. Use reliable data to select comps, such as the comparable uncontrolled price method. Assign value based on robust development, enhancement, maintenance, protection, and exploitation function analyses.
OECD Guidance
OECD guidance is merely a recommendation until it’s adopted into local legislation. However, when new guidance is incorporated, tax authorities won’t take long to use it.
Example. In 2020, the Organization for Economic Cooperation and Development released Transfer Pricing Guidance on Financial Transactions, which offered recommendations on how to price intercompany loans, guarantees, and cash pools.
Two years later, the report became Chapter X of the transfer pricing guidelines. Now that tax authorities understand how to analyze the arm’s length pricing of transactions, expect an uptick in financial transaction examinations when tax authorities review documentation for fiscal 2022 and after.
Chapter X reveals how tax authorities will examine the arm’s length veracity of financial transactions. To minimize risk, use that intel proactively and construct financial arrangements accordingly.
Jurisdiction Rule Adoption
When a jurisdiction goes through the years-long process of proposing, negotiating, and passing unique transfer pricing laws, it’s a sure sign tax authorities will review more documentation to ensure taxpayers adhere to it.
Example. His Majesty’s Revenue and Customs in the UK, one of the most aggressive tax authorities when it comes to multinational companies engaging in profit shifting, required only a country-by-country report in terms of transfer pricing compliance. But since April 2023, new regulations mandate the preparation of the master file, local file, and an audit summary questionnaire, along with that CBCR.
While the new requirements offer more tax certainty, clearly that isn’t the only goal. Between tax years of fiscal 2015-2016 and fiscal 2019-2020, HMRC generated over £6 billion ($7.3 billion) in additional tax revenue from transfer pricing compliance.
Fiscal 2020-2021 alone yielded a record £2.1 billion. New transfer pricing requirements will be used to ensure that profits that belong in the UK stay in the UK, and to hold multinational companies accountable if they aren’t.
The UK isn’t the only jurisdiction to legalize new transfer pricing requirements. Malaysia, Malta, Montenegro, and Paraguay are just a few countries that have also recently added transfer pricing legislation.
To minimize risk, prepare contemporaneous documentation as though you’ll have to submit it. Use local comparables and produce consistent reports that reflect business reality, and your documentation will stand up under any amount of scrutiny.
This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Mimi Song is chief economist at Exactera. She manages client relationships and helps implement transfer pricing solutions.
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