TP Documentation: 4 steps to manage the compliance burden efficiently and mitigate risks

In this blog we would like to explain the 4 steps you can take to manage your transfer pricing compliance burden efficiently and mitigate risks.

Why is this relevant? There is a great deal of media attention that suggests that MNEs avoid paying their fair share of taxes. In addition, also due the Covid crisis, there is a need to fill the Treasury. This combination is likely to put political pressure on tax authorities to audit MNEs.

On the other hand, full-on compliance with all local regulations is quite costly. To manage this compliance burden as well as mitigate risks, we recommend that you consider the following 4 steps in this process.

1. Determine your general tax risk strategy

• The level of compliance that suits you will largely depend on your tax risk strategy. The board may want to avoid tax risks at any cost. On the other hand, they may be more focused on cost reduction and may be willing to take some risks in the process.
• Your risk appetite may differ if you report a well-defendable routine level of results or if you have a loss-making entity with fluctuating results.

2. Determine the level of compliance you wish to obtain: distinguish between formal compliance and material compliance

Full-on compliance with all local regulations may not be feasible. Therefore, it is important to determine your optimal level of compliance as a company.

A distinction can be made here between formal and material compliance. With formal compliance you meet all the documentation requirements and prevent risks like penalties and the shift of the burden of proof. Material compliance focuses on the transfer pricing (“TP”) design and operational transfer pricing to ascertain that the TP system matches with the business rationale and financial results.

An example:

• Company Y and X have the same fact pattern and group result.
• Company X has fulfilled all legal documentation requirements but has not looked at its TP design.
• Company Y has only paid attention to its TP design and made sure that all results are at arm’s length.
• The tax auditor visits both companies.
• Results visit Company X:
• The tax auditor can easily argue that results are not at arm’s length. Although the burden of proof lies with the tax auditor, he has pretty convincing evidence, resulting in a lengthy (and costly) audit procedure.
• In addition, various group entities have suffered losses for which the carry-forward term has passed.
• Results visit Company Y:
• The tax auditor concludes that the results are at arm’s length and only urges the company to work on its TP documentation. Of course, penalties or TP documentation may be requested by an auditor.
• In addition, the company has a transfer pricing system that:
• costs less administrative time with fewer invoices to process;
• supports the business; and
• is more tax efficient.

• This example may be a bit black and white, but the message remains: it is very important to determine where your resources and budget add the most value.

3. Determine what type of documentation process suits your company

There are various ways in which documentation can be prepared. Which documentation process is right for you depends on, among other things:

• the size of your company and the relative importance of transfer pricing;
• the internal resources available;
• your (tax) risk strategy; and
• the level of compliance you wish to obtain.

Items in the documentation process to consider are, among other things:

• To localise or centralise.
• Which parts of the process to localise or centralise is relevant both in terms of internal responsibility and for the way the documentation is prepared.
• Outsourcing versus insourcing.
• Which parts of the process to outsource or/and insource.
• Tooling
• The use of a (documentation) tool and its purpose. If you only wish to make your writing process more efficient you will not need a comprehensive tool that has functionalities you pay for but will not use. Choose your tool carefully. We offer Transfer Pricing software in which it is possible to start with the documentation module and, if desired, take the next step to additional modules.
• The annual update process.
• This should be considered and thought through in all the above items to make it effective and efficient.

4. Create a priority list and obtain buy-in from stakeholders

• Once you have determined which activities you wish to undertake, set up a priority list and a timeline that includes deadlines and budget required.
• When determining the role you wish to play, consider the amount of time that role will take, as this can limit the number of activities you can undertake.

• Clearly communicate the approach and restrain with stakeholders, for example the CFO, and obtain buy-in from these stakeholders.

If you are considering dealing with your compliance burden, we are happy to offer a non-committal, free-of-charge consultation to determine which process best suits your needs. We are looking forward to hearing from you!