Recently, I was asked to join a discussion about investors and transfer pricing, and the focus centered around whether or not companies should have to disclose information to investors about their intercompany transactions. Generally, most investors look at a company’s financials, and to be candid, nowhere within those reports is transfer pricing discussed. The closest thing an investor may see concerning transfer pricing is a reference within the tax footnote about some possible issue concerning intercompany transactions and an ongoing audit.
The art of crafting a tax footnote is an adventure unto itself. The author needs to balance the requirement to be accurate in what information is presented and concurrently not bog down the reader down with rhetoric that renders the note indecipherable. The fable of the four blind people describing an elephant each from their own perspective comes readily to mind.
Without going into the intricacies of transfer pricing methods for achieving arm’s length pricing, and all of the economic analysis behind the calculation, an investor is given a highly distilled description of the transfer pricing situation and perhaps a notion of what a real-world impact will be in the form of a very oversimplified state, “They claim we did not include X amount of income in their tax return, and consequently owe Y amount of additional income tax plus penalty and interest.
This may be a precise description of the dollar amounts at stake, but it adds nothing to what the investor understands about both the transfer pricing issue and the relevant arguments on either side of the controversy. So, is the disclosure relevant at all?
From a reporting perspective, the answer is a resounding YES—any investor would think it’s necessary to evaluate the amount of risk the company is willing to assume as it may not be the same level with which the investor is comfortable. However, from a layperson perspective, the disclosure may not be worthwhile as the full details are not laid bare. That said, additional information would not increase the understanding of the transfer pricing issue to the average investor. They’re not involved in the minutia of the company’s cost accounting or the tax department’s transfer pricing compliance processes, and so they lack the necessary analytical framework to parse the information appropriately. But what the retail investor may be interested in is the amount and nature of risk the company is willing to assume as part of its business practices. For a very risk-averse investor, this could be quite significant.
Going forward, investors should take note of any tax issues disclosed in the annual report of the company and seek out more detailed information to better understand the general nature of the issue and the threat it poses. Hopefully, that will allow them to accurately assess the economic reality of the situation and place faith in the company management accordingly.
