Transferring goods, services and intangible assets between companies in a multinational group is a popular approach for achieving tax savings, but mistakes can be expensive.
According to the Tax Justice Network, over a third of international trade takes place within corporations, rather than between different companies. The main reason behind that is the drive to minimize tax liability. Corporations sell goods or services to a company in their group that’s based in a jurisdiction where less tax will be applied to the profit they make from selling them on. Setting the price for these internal transactions is what’s known as transfer pricing.
While tax evasion is a criminal offense, tax optimization techniques like this are mainstream practice. It’s simply about avoiding paying more tax than necessary – a key part of ensuring that a business operates efficiently.
However, while intra-company sales are perfectly above board in principle, there can be pitfalls to getting transfer pricing wrong.
Transfer Pricing Pitfalls
Problems can arise if the transfer price appears to have been set unreasonably low, sometimes referred to as transfer mispricing, or if there is evidence of transfer pricing manipulation or fraudulent transfer pricing. If the transfer is between countries which are both OECD members, the price must be set fairly, following the arm’s length principle – as if the two companies were unrelated.
Additionally, the transfer pricing methods of some organizations have occasionally been questioned in court, with Apple, Google and Amazon being recent notable examples. However, those organizations have typically won out due to demonstrating legitimate transfer pricing processes.
Still, this underlines the vital importance of getting your facts right before making decisions on issues like transfer pricing, and ensuring you keep on top of current legislation.
Choosing the Right Location
In some cases, the location to transfer to is obvious. For example, it is usually somewhere the business wants to make sales and where the corporate tax incurred would be lower than if sales were made directly from the parent company. In other cases, the choice is more strategic, based purely on the goal of optimizing tax outlay.
Either way, the price set for the transactions needs to strike the balance between legislative compliance and maximizing profit.
Ireland’s low rate of corporate tax (just 12.5% compared to 35% in the USA) combined with generous terms make it a popular place for US corporations to transfer to.
It’s worth noting here that there are 9,998 sales tax jurisdictions in the US alone. Also, in certain countries such as Brazil, different types of products are subject to different rates of tax.
The Role of Entity Management Software in Transfer Pricing
In order to decide on the best location to transfer to and the price to set for the transactions, corporations need access to certain key information. And, ideally, a variety of functions, including tax, legal, treasury and compliance, should be able to work together to agree on an approach and manage it appropriately.
It might even be that an element of restructuring will be needed to achieve maximum tax-efficiency within the bounds of the law. This makes it even more essential that everyone involved has access to the same detailed, accurate and current data on the structure of the business and the relevant compliance requirements.
Entity management software, such as Diligent Entities, can be invaluable here. It not only provides a central repository of information about the entire organization, including detailed organizational charts to visualize the entire corporate structure, but also full regulatory compliance document trails and reminders of when tasks are due.
Access to a single source of truth, such as that provided by entity management software, aids collaboration between functions which are often siloed. So instead of each subsidiary and department working separately with its own disparate set of records and spreadsheets, the relevant business units in all parts of the organization are able to work together from one data source. An entity management system also saves time for busy paralegals and company secretaries, by allowing the legal ops and tax teams quick and direct access to the information they need.
In an effective entity management system, all the key information will be accessible in a few clicks through the dashboard, avoiding the need to dig for it or email colleagues with inquiries. And administrators can quickly produce reports to provide executives with the information they need to make decisions.
So, while transfer pricing will never be straightforward, entity management software seamlessly helps the relevant functions work together to come up with a plan that’s both tax-efficient and legally compliant.