Are all transfer pricing distribution activities interchangeable? I mean how much different can it be? You’re moving stuff from one place to another, right? Someone needs to load merchandise on a truck at the manufacturer and send it to a store, so what’s the big deal?
If only it were that simple. Distribution comes in a variety of forms, and depending on the items being transported, a wide variety of considerations and concerns affect the process. While 2x4s and lettuce are agricultural products, there are very real differences in how they are handled and transported. Lumber doesn’t need to be refrigerated, and the truck it moves on is very different from the refrigerated-box truck lettuce travels in. That translates to your transfer pricing documentation, too.
Which Type of Distributor Are You?
Differences in the types of transportation and the various product requirements should be noted within the functional analysis. You must properly convey the differences in storage and transport of the products. No one is going to keep lettuce in an open-air yard, nor will we keep 2x4x8 in a refrigerated cooling box. But the entity responsible for each of these situations might earn more profit because it’s assuming more risk. What happens if the refrigerated box breaks, and the warm temperatures spoil your lettuce inventory? Who is taking the hit for that loss? The entity assuming that risk might be warrant more compensation than a distributor assuming limited risk.
When we talk about distributors in terms of transfer pricing, we need to keep in mind what we are moving, and the various aspects that can impact the analysis. Everything from the selection of origin and destination locations to the types of transportation can have a dramatic impact on pricing. Changes occurring in technology can upend an analysis—think in terms of the energy for the vehicles moving the products from traditional diesel fuel to propane or electric or hydrogen fuel cell. And who knows what will be available tomorrow?
The nature of the goods also impacts the distribution process and ultimately your arm’s length pricing. Just as lettuce and lumber require different modes of transport, products like pharmaceuticals, jewelry, and other goods can have different security concerns and methods of transport. When looking at what is special about certain goods, the obvious differences are self-evident, but they need to be elaborated on in the functional analysis. While pharmaceuticals and jewelry can be small packages with high value, the security surrounding each does differ, and the differences tend to increase the costs of the process for inventorying and transportation. No one is putting 2×4’s in a locked vault nor are they keeping gold bars out in the open behind a fence,
Document Your Distribution Activities
Tax authorities, however, don’t know the nuances of your business, so it’s imperative that you make them aware of any unique circumstances. A robust functional analysis and a well-constructed narrative go a long way in terms of proactive transfer pricing. In the changing world we occupy, the variety of challenges seems to grow exponentially. To meet these challenges and changing circumstances, your transfer pricing must be kept current to capture your changing environment.
The not-so-secret benefit of doing a comprehensive transfer pricing review is the knowledge you gain about your organization and what is happening where and why. An additional consideration is that once understood, potential improvements to the process may become obvious.
