Transfer Pricing Study 2018
Transfer pricing in business practice
Transfer prices quantify payments for goods and services transferred within MNEs. To be accepted by the tax authorities around the globe, they must be determined in line with the principle of dealing at arm’s length. This means that transactions between related parties are priced as if the parties were unrelated and operating under the same or similar conditions.
To explore about how MNEs apply the arm’s length principle in practice, surveys were conducted among German companies in 2015 and 2018. New rules have come into force in numerous jurisdictions in the aftermath of the OECD/BEPS project. The increasing impact of digital transformation has also ushered in transfer pricing management challenges.
Key findings of the 2018 transfer pricing study 2018
Respondents to the survey identified legal certainty above all their other corporate goals, such as tax optimization, performance measurement and steering group units. The number of corporations with this intention has grown significantly since 2015, which may be due to stricter compliance requirements and greater legal uncertainties resulting from the OECD/G20 BEPS project.
Functional and risk analysis
The starting point for determining arm’s-length transfer prices is comparing the intercompany transaction with comparable free-market transactions, which in particular includes a functional and risk analysis. The study findings reflect the common business practice in which neither production nor sales predominate: More than half of the group entities with a production and R&D function are fully-fledged manufacturers or R&D, and half of the group entities with a sales function are fully-fledged distributors. Moreover, commission agents and sales agents rarely exist within MNEs for the sales function.
Choice of methods
A number of transfer pricing methods are recognized for tax purposes, with the cost-plus method being by far the most frequently used among the survey respondents. The comparable uncontrolled price method (CUP) and the profit-oriented methods are less common in practice (see fig. 1).
Price comparison methods are of particular importance for the licensing of intangibles such as patents. In contrast, the cost-plus method is predominant (80%) in the development of intangibles.
The variety of transfer pricing methods applied for the various types of transactions reflects the challenge facing businesses: They must find a method appropriate not only for taxes, but also for managerial accounting and IT purposes
Disputes in tax audits
The way in which transfer prices are determined is scrutinized closely in tax audits, and has become a predominant issue in tax disputes for MNEs. The survey findings paint a clear picture in this area. About two-fifths of survey respondents reported that their transactions with distributors had been reviewed in a tax audit, which constitutes no major change to 2015.
Other transactions are now being scrutinized more closely than ever, though: Importantly, 48% of survey respondents had been scrutinized in terms of intercompany services (up from 37% in 2015). Also, a significant share of the companies surveyed (41%, up from 34% in 2015) reported they had been exposed to income adjustments in their most recent tax audit in connection with the licensing of intangibles. A total of 35% reported that they had faced financing-related income adjustments in their most recent tax audit (up from 31% in 2015). – see fig. 2 below
The study also confirms the increasing significance of the taxation of group restructurings: In 2015, only 23% of the respondents had been confronted with this then relatively new issue in a tax audit; in 2018, the figure had risen to 35%.
Only one-third of the survey respondents had been involved in at least one mutual agreement procedure (MAP) and arbitration procedure at a taxpayer’s request to prevent international double taxation.
Special valuation models – and not commonly known transfer pricing methods – are found for digital business models (56%) and digital value-added activities (69%), but these are the exception rather than the rule. If applied at all, the cost-plus method is used (digital business models: 22%; digital value chain: 19%).
The situation is different for internal digital services, where 56% of respondents now use the cost-plus method in particular. Looking at the impact of tax audits on transactions, only around one-sixth of respondents report disputed cases, mostly related to transfer prices for digital services.
Another question is to what extent transfer pricing management itself will be ‘digital’. Ac-cording to the survey respondents, IT support for transfer pricing is not yet what it could be. However, the survey respondents reported a clear desire to increase IT support for transfer pricing processes (see fig. 3).