This article answers the question: what is transfer pricing documentation?
First, we explain why tp documentation exists. After that, we look at the goals of the current documentation requirements. Finally, we explain the three different reports that together form a full set of transfer pricing docs.
Why Do You Need Transfer Pricing Documentation?
Transfer pricing has been a relatively new focus-area for tax authorities. Only as recent as 1995, the OECD wrote a first recommendation with regards to transfer pricing documentation.
This first recommendation was very general. It aimed on finding a balance between the interest of the tax payer and the tax authorities. It did not presented a specific frame work for transfer pricing documentation.
The result of this approach was that there were large differences in approach in countries around the world. At the same time, international corporate structures and flows of value become more complex. This led to uncertainty on both ends of the spectrum. More over, the tax authorities reported that the documentation provided was not good enough for their tax enforcement and risk assessment needs.
What was needed, was a set of standardized documents. In addition to that, standardization on the documentation process, the administration of penalties and the burden of proof.
In the recent BEPS initiative, this became one of the Action Points (Action 13). And on 16 Sep 2014, the OECD issued the “Guidance on Transfer Pricing Documentation and Country-by-Country Reporting” (source) to tackle this issue.
According to the OECD, there are three main objectives of transfer pricing documentation:
Objective 1: “to ensure that taxpayers give appropriate consideration to transfer pricing requirements in establishing prices and other conditions for transactions between associated enterprises and in reporting the income derived from such transactions in their tax returns.”
Documentation requirements create awareness and a culture of compliance. Tax-payers are forced to take in a position, with regards to transfer pricing rules.
Objective 2: “to provide tax administrations with the information necessary to conduct an informed transfer pricing risk assessment.”
The documentation provides tax-authorities with a clear overview of the activities of a multinational enterprise. It tells them where there are risks.
Objective 3: “to provide tax administrations with useful information to employ in conducting an appropriately thorough audit of the transfer pricing practices of entities subject to tax in their jurisdiction, although it may be necessary to supplement the documentation with additional information as the audit progresses.”
If tax-authorities think that there is a risk, the documentation provides them with a good indication of where else to look.
In order to reach the objectives mentioned above, there are three types of documentation that tax payers need to provide. We introduce them briefly here, but if you want to know more about the methods you can click on the links provided:
1. The Master File:
The master file is intended to provide a high-level overview. It explains the dealings of a Multinational Enterprise on a global scale. With this information, governments have a high-level overview of the economic, legal, financial and tax arrangements of the MNE. This gives them a good idea if any risks exist.
Read more in our article on the Master File.
2. The Local File:
The local file is where you go into detail. Here, you look at specific inter-company transactions that are relevant for the tax authority involved. The local file contains relevant financial data, like the transfer prices used and the transfer pricing method chosen to calculate them. Where the Master File provides the general overview, the Local File explains how the inter-company transactions happen at “Arm’s Length.”
Read more in our article on the Local File.
3. The Country-by-Country Report
The Country-by-Country Report is an additional high-level report required from large Multinational Enterprises with a turnover of 750 Million USD or more per year. It requires details of the global allocation of income, taxes paid, and the location of economic activity among the jurisdictions in which the MNE group operates.
In addition, a list of the legal entities that together form the group has to be added, as well as information about their jurisdiction or incorporation and residence status.
Read more in our article on Country-by-Country Reporting.
Time-Frame For Preparing Transfer Pricing Documentation
Unfortunately, the time frame for preparing the documentation differ among countries. Some countries require information to be ready at the time a tax return is filed. Other countries want to see it ready at the time of audit.
However, the entire logic of the transfer pricing regulation is to actively apply the the Arm’s Length principle. You do this, by calculating the correct transfer price before the actual transactions take place. What this means is that you build transfer pricing documentation during the year when doing the business. Not at the end of the year, like .
Recent developments have created a renewed focus on transfer pricing practices. To combat (assumed) aggressive tax practices, there are now standard documentation requirements in place.
The objectives of these requirements are first of all to create awareness of transfer pricing regulation and a culture of compliance. Next to that, the documentation provides governments with an overview of potential risks. Finally, it makes a potential audit much easier.
There are three reports that need to be provided. The Master File, the Local File and the Country-by-Country report. The Country-by-Country report is only for large Multi National Enterprises with a turnover of 750 Million USD or more.
Finally, it should be noted that the creation of transfer pricing documentation is and ongoing process. And not something you do at the end of the year like .
If after reading this article, you think you need guidance on the paperwork your firm needs to create, please contact us and we can help you further.
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