How to Avoid (or at least minimize) the “Year-End” Blues?
Nowadays, transfer pricing compliance efforts pretty much cover the whole financial year: You start at the close of the previous financial year and gather all necessary information to prepare the annual master file and respective local files. For many countries you may have to prepare appendices or forms that summarize transfer pricing positions as part of the annual corporate income tax return filings. And for some, you’ll have to contend with the actual filing of the local file with the tax authorities.
Throughout the process, every now and then you may find that the actual margins on inter-company flow may not be what was expected based on the company’s internal transfer pricing policy, or that the margin realized—perhaps calculated based on an existing (old?) benchmarking analysis—doesn’t sit within the arm’s length range. The problem is often that by the time that this crystallizes, the financial year has already closed, and in many countries, you are not allowed to make any post-year adjustments. This increases the risk of challenges by tax authorities. It may also warrant potential internal discussions on whether the tax function is “in control” of managing the company’s transfer pricing. So, is there anything you can do to mitigate this risk and avoid (or at least minimize) these— let’s call them—year-end blues?
It’s important to realize that the annual transfer pricing compliance cycle actually starts before the close of the financial year. Since the majority of companies have a financial year-end equal to the calendar year-end, November/December is the right moment to prepare for the transfer pricing compliance cycle for 2022. First, it’s recommended to analyze the company’s Q3 or Month 11 inter-company transactional data and review whether the actual cost base and/or allocation for each of the respective inter-company transactions have been applied accurately and that the actual margins realized on the inter-company transactions are aligned with the company’s internal transfer pricing policy. If not, consider making the necessary true-ups in Month 12 so that the full 12-month intercompany financials are aligned with the company’s internal transfer pricing policy.
It may also prove beneficial to update the economic analysis of the companies that are used as benchmarks and check whether the margin realized (based on the Q3 or Month 11 data) are still within the arm’s length range. You may even do a fresh benchmark analysis. Given more and more countries prefer local benchmarks in relation to a TNMM-based analysis, especially if the tested party is resident in such a country and considering that not all countries apply the same rules on how to perform an economic analysis, you may need multiple updates. If based on such updated analysis it turns out that the margin realized may be at risk of falling outside the arm’s length range, then before the year-end you may want to update the internal transfer policy and the margin and post true-ups to reflect any modification.
These year-end action points help companies to remain compliant with their transfer pricing compliance efforts, manage tax risks, and demonstrate they are in control of managing this part of the tax function—and from a transfer pricing compliance perspective, avoid those year-end blues.