Spotlight on Transfer Pricing - Identifying complexity and areas of risk

The Survey results speak for themselves. Our goal in this article is to provide Multi-National Corporations (“MNC”s, commonly referred to by the OECD as Multi-National Enterprises) with insights, based on the Survey results, to further guide them in the decision-making process as it pertains to tax planning, compliance, record keeping, documentation and controversy management.

BDO engaged its network, which is active in 169 countries, to respond to the survey based on their knowledge of their clients tax needs, their markets, and their experience assisting clients in responding to tax authority inquiries.

The Survey is important for BDO and its international clients, as it highlights the tax areas considered most complex. It also highlights the tax risks which need to be considered when doing business aross the globe.

The Survey aims to:

• Assess tax complexity levels across countries and regions;
• Evaluate and determine the drivers of tax complexity; and,
• Analyze how tax complexity changes over time.

Transfer Pricing as Most Complex Tax Issue

The Survey confirms, as it did in both 2016 and 2018, that transfer pricing is one of the most important tax issues and is considered the most complex tax issue of the day. Transfer pricing was ranked as the most complex area of tax legislation / regulation by 69 of 110 countries (63% of all responding countries).

Table 1, below, presents the respondents’ ranking of the tax issues surveyed, on a scale where 0.00 indicates a tax issue that is not complex while 1.00 indicates one that is extremely complex. As the table shows, transfer pricing is at the top of the complexity scale with its ranking of 0.60, and is the only issue ranked above 0.50.

Table 2, above, shows five factors or drivers contributing to the complexity of transfer pricing. These factors include, for example, record-keeping, computation, and required detail, among others. The table presents the survey respondents’ ranking of these complexity drivers for transfer pricing versus the average of the other tax issues listed above in Table 1. The table shows that transfer pricing scored higher on all five complexity drivers as compared to the average for all tax issues.

These results are not surprising in view of the fact that transfer pricing is at the centre of many of the OECD’s Action Plans aimed at dealing with global concerns over Base Erosion and Profit Shifting (“BEPS”). Examples of added complexity that MNCs must now address include the OECD’s guidance on:

1. Analyzing in great detail where the Development, Enhancement, Maintenance, Protection and Exploitation (“DEMPE”) functions and risks are performed with respect to the MNC’s Intellectual Property (“IP”). This determination is critical in establishing which entity or entities are entitled to the residual income attributable to the MNC’s IP. Legal ownership of the IP is not, in and of itself, sufficient to support that entitlement to the group’s residual income.
2. Performing a detailed analysis to clearly delineate the risks within a MNC in terms of which entities are bearing the risks, which entities actually control those risks, and which entities are financially capable of absorbing the risk. The clear delineation of risks has a significant impact on the determination of arm’s length pricing for all intercompany transactions, not only those transactions relating to IP.
3. Determining an appropriate arm’s length return to the owner of Hard-to-Value intangibles, with that being factored into the MNC’s transfer pricing planning.
4. Analyzing and documenting high-risk transactions in order to ensure that the resulting transfer pricing is aligned with the value creation.
5. Performing the requisite analyses required for three levels of documentation: Country-by-Country Reporting, Master File, and Local File.
6. Performing and documenting the analyses required for financial transactions in order to meet the arm’s length standard.

It is clear that MNCs must devote a great deal of time and resources to transfer pricing planning and transfer pricing compliance in order to avoid dedicating more time and resources to transfer pricing controversy matters.

If we are to look forward to the survey results to come two years from now, we anticipate transfer pricing will still be at the top of the list of most complex tax issues. In fact, we would not be surprised if transfer pricing’s ranking ends up being even higher than it currently is, as MNCs grapple with the pending introduction of a new taxing right for digital presence. Under the auspices of the OECD, an “Inclusive Framework” of (now) 133 countries has signed on to a new tax and transfer pricing approach through which certain MNCs would be taxed not only where they have a traditional tax presence, but also where they earn income from digital activity. This proposal is known as “Pillar One” of a two-pillar approach, with Pillar One addressing the taxation of the digital economy and Pillar Two addressing the international tax rate competition referred to as the “race to the bottom.” Pillar One in particular may have a significant impact on the transfer pricing models used by many MNCs. See more from BDO at Taxation of the Digital Economy.

Other Insights from the Survey

Increasing Tax Complexity

According to 58 of 110 countries (53% of all responding countries), tax complexity has increased over the past two years. Likewise, respondents from the OECD member countries reported a substantial increase in tax complexity except for the following three areas:

• Transfer Pricing – while still the most complex tax issue facing MNCs, transfer pricing was ranked as being less complex than the ranking in 2018;
• Tax Authority Experience and Skill – ranked as being less of a problem in 2020 versus the ranking in  2018; and,
• Communication of Topics during Tax Audits - ranked as being less of a problem in 2020 versus the ranking in 2018, possibly due to increased transparency and improvements in open communication.

Insufficient Quality in Drafting Tax Legislation / Regulations

The Survey confirms that 85 of 100 countries (77% of all responding countries) believe that there is a lack of quality evident in the drafting of various tax laws.

Time Duration for Appeals

The long duration of proceedings in the case of an MNC appeal against a tax authority’s proposed transfer pricing adjustment is another issue of great importance. The overall time commitment for an appeal helps in determining whether a MNC should try to negotiate an agreement during  a tax audit (or before, through an Advance Pricing Agreement) or whether it is better to appeal against an assessment made by the tax authorities. A majority of the responding countries indicated that this was a significant factor leading to increased tax complexity. One change from 2018 to 2020 was within the OECD countries which believed that some aspects of tax audits were becoming less complex due to two main factors:

• Tax auditors are becoming more experienced; and,
• There is clearer communication around topics and issues.

Please follow this link to learn more from the 2020 Global MNC Tax Complexity Survey.

BDO’s Global Tax Outlook 2020

In February 2020, BDO Global launched its new international research program for Tax. In an interview BDO’s Global Head of Tax, Robert Aziz offered insights into what BDO’s Global Tax Outlook 2020 research tells us about the challenges tax and finance leaders face beyond today.

BDO’s Global Tax Outlook 2020 identifies some of the same tax complexity factors discussed in the Survey. For example, Robert Aziz shared the following with respect to tax compliance:

“From a tax perspective our research tells us that there are two or three really big issues which are here today and they will be here in the future. The first is just the task of being compliant - the biggest issue on companies’ minds throughout the world, large or small, is ‘can I report correctly? Can I report on time, do I make my payments correctly and on time?’ The biggest issue is just to be compliant, and that sounds easy to some people, but if you operate in many jurisdictions, it's a huge exercise.”

“The second thing is to be able to respond effectively to a multitude of tax changes. Governments will have to deal with the deficits that have arisen, and tax reform will be a part of that thinking.”

“Our research tells us that over 40% of businesses around the world have actively changed their tax governance procedures - how they decide questions on tax, and how they approach taxation matters.”

On the subject of tax and its importance in the cash flows of MNCs, Robert Aziz commented that:

“Tax has been one of the most important mechanisms that governments have used to support businesses and people throughout the crisis. The old adage about cash being king really comes to the fore. Businesses have realised just how much tax played an important role in that – understanding how much tax is involved in the cash flows of your business is a vital component of your decision-making, and that will put tax right in the heart of the boardroom.”

To listen to the full interview with Robert Aziz and to learn more from BDO’s Global Tax Outlook 2020, please follow Global Tax Outlook client research 2020.

How BDO Can Help

BDO has a global tax and transfer pricing team that is fully capable of helping your MNC address the challenging complexity of the tax landscape, working with you to:

• Develop effective and efficient tax structures and transfer pricing models to maximize your MNC’s cash flows, while ensuring you are paying the correct amount of tax in each country, in accordance with all relevant domestic and international tax and transfer pricing rules;
• Assist you in developing stronger, more robust tax governance policies and procedures in order to mitigate the potential tax risks facing your MNC;
• Work with you to defend your tax structures and transfer pricing models should one or more governments audit your MNC and challenge any aspect of your tax and /or transfer pricing;
• Perform the requisite analyses required for three levels of documentation: Country-by-Country Reporting, Master File, and Local File - to meet a variety of local territory obligations, which may have significant penalties attached for non-compliance; and,
• We help inform your decision-making on where to prioritise and which territories require greatest focus, using a combination of structured data for 100+ territories gathered using our global BDO network and proprietary technology, to present options and recommendations as to timing, coverage and overall approach for documentation.

Please contact your local BDO tax / transfer pricing advisor today, and let us help you to better navigate this complex and ever-changing tax landscape. Follow BDO Global Transfer Pricing