Transfer pricing has become the key focus area for tax authorities when assessing taxpayers. An explanation for this is that transfer pricing corrections are generally an easy way to drive tax proceeds. Within the industry it is observed that the number of transfer pricing “audits” increases when there is a large deficit in a government’s budget. This will of course be denied by tax authorities, but in practice, everyone knows about it.
If your firm is subject to Transfer Pricing Rules, there is a good chance that at some point you experience scrutiny on your policy. This may sound as a nightmare, and in some cases it is. However, the vast majority of transfer pricing audits do not end badly.
In this short article we provide information about transfer pricing audits, and suggestions on how you can handle these efficiently.
What is a Transfer Pricing Audit?
A Transfer Pricing Audit is an investigation by a tax authority to ascertain whether a company is compliant with applicable transfer pricing regulations. During the analysis, the tax authority assesses corporate information such as the accounts, ledgers, statutory records, documents, transfer pricing documentation, and agreements.
There are different types and levels of audits. In some cases, an audit is focused on a particular controlled transaction, and done by one single tax inspector. In other cases, transfer pricing can be part of a much bigger review, and involve a whole team of investigators.
What to do in case of a Transfer Pricing Audit?
Each transfer pricing audit is different and there are no standard rules that equally apply to each situation. However, below are some basic tips that you can follow:
- Ask the tax authorities about the nature and scope of the audit before handing over any information. If needed, ask them for time to liaise with your legal or tax advisor; they can give you useful advice on whether there is a legal requirement to cooperate and if yes, what information you can provide. It would be even better if they can attend the audit.
- Inform management and key stakeholders about the audit. An audit can expose the company to serious risks, and this is important information for management and key stakeholders. Don’t wait too long with this!
- Be methodical when preparing your records. You want to think carefully about what information to provide. It has to be relevant, factual, and presented in an orderly fashion. Include a table of contents or a cover letter exactly detailing where everything can be found. You don’t want to dump a pile of documents on the auditor’s desk, for two reasons:
- The easier you make it for them, the sooner the audit is over. Moreover, if you appear disorderly they might assume that your transfer pricing is also done carelessly.
- You want to have control of the information you hand over. It has to answers all the the questions, and nothing more. You don’t want to release information that raises new questions.
- Don’t panic. An audit is a regular control tool for tax authorities. It doesn’t necessarily mean that your firm is in trouble. If you have paid sufficient attention to analyze and document the transfer pricing position, the audit will end up just fine.
Can you avoid a Transfer Pricing Audit?
No, you can’t. Tax authorities decide who to audit and who not. What you can do is minimize the risks related to a transfer pricing audit. This comes down to doing your homework on transfer pricing:
- Solid documentation: Without substantiation of transfer prices, you open the door to a thorough investigation, and potentially a dispute. It allows tax authorities and other potential counterparts to force their own views on the situation, which are not necessarily beneficial. On the contrary, well-prepared and substantiated documentation enables you to defend your transfer pricing policies. It is then up to the counter-party to demonstrate that the transfer pricing is not in line with the rules, which is far more difficult.
- Be compliant: As a taxpayer, you don’t want to give tax authorities a stick to hit you with. Non-compliance or a non-timely compliance often results in a visit/audit from the authorities. During an audit, authorities often request a large amount of information to assess the tax position. This can be costly and time-consuming. Therefore, it is of paramount importance that you meet all local transfer pricing and tax compliance stipulations in time. Examples of such compliance requirements are the Local File, but also regular corporate tax returns.
- Non-aggressive positions: One of the explanations for the high level of disputes is that tax authorities perceive MNEs to use transfer pricing as an instrument to reduce their overall tax liability. Whether true or not, this is a fact that you must be aware of. In that light, aggressive transfer pricing positions do not help to avoid scrutiny. It is better to stay on middle ground. An example is not using the lower or upper quartile values in favor of the median value (unless you have a good explanation).
As you now understand, it is good to know what a transfer pricing audit means, what to do in case of one and how to reduce the risks related to it. In most case, if you have done your homework, there shouldn’t be much to be afraid of.
In case you want to learn more about getting your transfer pricing in order, we refer to our training material.