Why does nobody like transfer pricing adjustments?

The typical financial and tax reporting process

You are a Finance Manager, Controller, or Tax Manager with some basic knowledge about transfer pricing (TP). You are fine with Corporate Tax and VAT understanding, but TP is flying a bit under the radar.   

Your financial year is over and your financial statements are done and signed off by your auditors. The results are fine, you are worried about your bottom line, but you did your very best to make sure all numbers are matching and you had your fair share of headaches going back and forth with your accountants and reconciliations. The management is happy. There will be bonuses. 

You start preparing your corporate tax returns, you do your deductibles, your tax provisions, and tax depreciation. All things considered, your corporate tax payable is only slightly higher than your provisions (if not done beforehand), but the difference is not material and everything looks fine. 

TP Adjustments take one

However, your TP advisor comes in, reviews your financial statements, does the usual functional analysis (or its update), the benchmarking, and writes the annoying and lengthy TP report (who in the World has the time to read that Anna Karenina?) and comes back to you with the bad news. 

You haven’t calculated the interest rate on your related party loan properly. Your profitability on the provision of services is non-existent or lower than needed. Your return on sales should be much higher. You haven’t rewarded your IP-generating function properly. 

You need to perform a TP adjustment – adjust (increase) your corporate tax base and pay more corporate tax. 

Now that would make your bosses unhappy. The numbers are suddenly not looking so great!

Another headache!

What do we pay these advisors for? The fees are quite high for them to only come back with such an outcome! They have one job and they are not able to do it right! 

The advisors scared not to lose the client, go back to the engine room. They try their best to adjust their benchmarking, or try to change the TP method, or play with the numbers and the cost base a little bit. Come up with a good argument to justify your position being at “arm’s length”. 

Suddenly, your TP report looks shiny, and everything checks out. You are happy, your bosses are happy, and your advisors are happy. Problem solved? 

Next year, you do the same. And the one after that. And another few. 

Or maybe you just joined the company and you decide to follow the advice of your colleagues to “do things exactly the same as the last year”.

No questions asked, no headache. The advisors keep reducing their fees year after year. 

Well, they should! It’s too expensive anyway, and besides, we told them how to do their job!

TP Adjustments take two

A few years down the road, a tax inspector knocks on the door. He starts questioning your brilliant TP masterpiece. 

He finds out that your benchmarking should include a few more comparables. Your cost base is not really that rock solid. Your financing arrangements should include a bit of a higher interest rate. Your service fees charged by related entities are not fully deductible. 

If you are lucky, by that time you already left the company for another, more exciting and rewarding job. 

If not, here they come again – the transfer pricing adjustments! 

But this time – accumulated, and much higher than in the first year. Maybe, with some additional penalties attached. Maybe, a court case comes out of that. Maybe, you make the headlines. Maybe, there is no bonus that year. Maybe, you have just another, bigger headache. 

By that time, your advisor, more likely than not, left his company for another, more exciting, and rewarding job. 

And your boss is definitely not so happy about transfer pricing adjustments. 

Nobody likes transfer pricing adjustments! 

How to deal with the TP adjustments

So how do you tackle this problem, and sleep tight?

One solution is to claim that the advisor was wrong, and did a very poor job for all that money he was paid. TP is not your expertise anyway and the advisors with the big brand name on your TP report and famous for their expertise should take the hit. 

Easy, right? Slam dunk.

Another one is to find the right moment for the “Big Bang”, set up your TP policies and procedures right, and make sure you do not have to worry (so much) about it. 

The occasion could be – the introduction of the TP rules in your country/region (such as the UAE introducing its corporate tax law, OECD coming up with another grand tax plan for the World, etc.). Another chance is perhaps when you take on the new role and start changing things around, or if there is a TP audit of an industry competitor which you can highlight to your company management to gain support. 

Or you read this blog post and decide it is better to get your TP under control! 

So how do you get your TP policies and procedures tight and as rock solid as possible? 

The first step is to perform a functional / value chain analysis and map your key functions, risks, assets, and your related party transactions. 

After such an assessment you can (together with your advisor or a TP in-house person) decide on the best methods and pricing policies you can apply to your related party transactions – or even restructure your transactions a little bit to align them with your functions/value chain. 

As a result of such decisions, you can draft your TP Policy, and you can do some initial benchmarking. You can implement the selected pricing mechanism in your day-to-day price calculations, accounting, and invoicing. 

You can decide on your internal timings for the TP adjustments before the books are closed and the financial statements done and dusted. For example, you can do your TP adjustments quarterly, or at the year-end. 

Suddenly, your TP adjustments are not so painful and you use them to your benefit. 

You are making sure that there are minimal exposures to post-closing pushbacks from your advisors and limited scope of tax authorities’ challenges. 

TP report is a much easier exercise and you can even think about TP process automation, using cheaper service providers, TP software solutions, and creating similar efficiencies. 

In my book, that is called – being Smart about your Transfer Pricing! 

Hope you will appreciate a bit of irony and sarcasm in this blog post. 

Do reach out to me if you need any support with your transfer pricing. 

I would be happy to have a chat, discuss how to solve your TP complexities, and hopefully help you have a bit less stressful life. 

Feel free to reach out to me at: milos@smarttransferpricing.com