Tax officials are reportedly scrutinizing audits of multinational companies more closely.
Following increased stringent examination by tax authorities during audits, tax leaders have advised corporations to concentrate more on the explanation of their transfer pricing technique.
Tax authorities are increasingly specializing on TP issues throughout their investigations, according to Ralf Paustian, TP partner at EY in Hamburg, who claims that TP is becoming a more significant problem in audits and that this has altered the way tax audits are handled.
According to Paustian, "The issue of having proper transfer pricing justification and taking care of issues such as company benchmarking standards has become more important."
The increased emphasis on TP has a knock-on effect that increases the likelihood that authorities may notice differences in benchmarking operations.
"Tax directors need to prioritise transfer pricing and the justification for those prices because they will be picked up sooner rather than later," he continues.
Businesses use similar business data for benchmarking exercises, but Marta Pankiv, head of group tax and TP at software firm Tricentis in Vienna, claims that the data is not necessarily the same as the choices made by tax authorities.
For taxpayers, this creates further uncertainty. According to Pankiv, TP experts must be vigilant and continually stay current with legislative changes, especially OECD policy advancements.
She argues that because to the nature of the arm's-length principle, organizations must constantly study the market, update their benchmarking studies, check their TP paperwork, and make sure their inter-company agreements are in place.
According to Pankiv, "It’s not like you prepare your benchmark and then you sleep well for the next five years, it’s just not the case."
To prevent disagreements with tax authorities or having difficulties brought up during investigations, businesses must also make sure that they have reliable processes in place for developing their benchmark policies.
While certain tax administrations may offer guidelines and mandate that businesses update their TP practices on a regular basis, tax experts advise that the timing of such revisions may be crucial.
"You’ll usually have a requirement from the revenue authorities to update it [benchmarking] regularly and to be up to date with what is happening in the [business] environment," according to Pankiv.
Businesses should strive to avoid doing comparability adjustments concurrently with audits, according to Ben Henton, worldwide head of TP at the UK-based banking institution Computershare.
"What you don’t want to be doing is dealing with a tax inquiry or challenge from an auditor, and then trying to use a comparability adjustment with the benefit of hindsight. This can undermine the credibility of such an adjustment," according to Henton.
He emphasizes how important it is for businesses to make sure that they exclude instances of extreme economic hardship or other unusual conditions from their third-party comparability studies. For a more accurate financial result, taxpayers should look to their own company outcomes.
Henton emphasizes that you should aim to stay out of long-term legal battles with the tax office about benchmarking.
There are instances where a single corporation or a small number of companies control a market. The OECD standards provide TP teams a technique to do an analysis based on the similarity of the risks associated in various situations.
"If you’re not really capturing the risk that you’re looking to transfer price, then you’re not really achieving anything with your comparability analysis," he continues.
Businesses have a variety of alternatives to take into account when choosing the best TP benchmarking procedure.
Businesses in Europe frequently use Bureau van Dijk's Amadeus database system.
Approximately 21 million enterprises in Europe are fully profiled in the Amadeus database. Anyone, including revenue services, consultants, and global corporations, can utilize this subscription-based system, but it costs money.
Most organizations hire consulting companies to handle the benchmarking process because of the amount of labor needed to run these systems.
Regarding the various benchmarking solutions, Paustian says, "basically, we all look at the same databases, but for multinationals it’s about deciding whether they should do it themselves and pay for the service or to outsource it to the tax advisers."
Companies have access to RoyaltyRange, Thomson Reuters OneSource, and Orbis, among other databases.
A variety of information systems, including KtMINE, RoyaltySource, Bloomberg, and S&P Global Market Intelligence, are also available to corporations for rates of compensation and interest.
Henton claims that whereas European businesses have a harder time accessing comparable data, businesses in the US are spoiled with options.
"When it gets outside of the US and European debt markets, then you are really struggling [for information]," he says.
For the majority of businesses, benchmarking efforts are undoubtedly challenging. They frequently incorporate both subjective market judgments and in-depth financial analyses of the organization.
Additionally, tax experts must do challenging tasks including choosing a sample of businesses that are purportedly comparable to the one being studied.
According to Paustian, benchmark studies are simply one method for defending transfer pricing.
This means that, in cases when benchmarking is employed, the TP technique chosen must be consistent with the reasoning process. A taxpayer may have problems as a result of a lack of alignment.
For normal transactions with a one-sided TP process, like the transactional net margin approach, benchmark studies are typically utilized. This method of comparing net profit margins compares an arm's-length transaction to similar transactions between similar parties.
Companies frequently conduct benchmark studies to determine the range of prices at which external parties would set their prices for identical services. Based on the outcomes of that exercise, this is then utilized to calculate a business's transfer pricing.
On the other side, businesses frequently dispute with tax authorities as a result of this same activity and the range they select.
Paustian refers to the stance occasionally adopted by revenue services during audits: "We may not disagree with you using a benchmark study – in fact we accept that – but we think the entities chosen are not comparable to your business."
These disputes frequently stem from divergent interpretations of the comparable entity's commercial operations by taxpayers and authorities. This contains important information like the market's size and the company's market share.
As a result, multinational groups discover that their sample of comparable companies has shrunk from 10 to perhaps only a few companies.
On conversations with tax officials regarding benchmark studies, Paustian states that "these can become very intense."
Taxpayers and their advisors can take a variety of steps to lessen the likelihood of lengthy disagreements with tax authorities.
These can include lowering the spread by 25% on each end to reduce the inter-quartile range.
"You need to also look at the outliers," advises Henton, "if it [benchmark study] is throwing up some very broad range results which don’t give you much comfort in terms of the margin you can support."
In order to do this, he claims, the inter-quartile range would need to be cleaned up of outliers, and then the profit and loss of the selected comparable data would need to be examined further to weed out any exceptions that would distort the results.
"If your numbers don’t make sense then you probably need to probe the underlying data set more," he continues.
Making a mistake runs the danger of the tax authority determining that a business has not properly recorded its transactions. This can lead to an estimation of tax liabilities that is erroneous.
This may entail working with the authorities to reach consensus and identify common ground on any variations in the benchmark study range.
Henton advises that if a disagreement arises, "make sure you agree that fact pattern because quite often the tax authority and taxpayer are essentially not benchmarking the same type of transaction."
However, firms must make sure they take the necessary measures to reduce conflicts well in advance of audits.
This can entail paying more attention to the comparables in question to ensure that TP teams are accurate when using databases and benchmark studies. For higher accuracy, it can additionally entail running a corroborative analysis in addition to the benchmark analysis.
In order to prevent disagreements with revenue services during audits, multinational businesses must have reliable benchmarking studies in place. However, it appears that such research on comparable firms may not be sufficient on their own.
The combination of benchmark studies and corroborative analysis used by firms to support their TP in front of stricter tax authorities may be the solution.
By fLEXI tEAM