Numerous countries, negatively impacted by the pandemic, are revamping their tax laws. The issue of transfer pricing is a top focus as governments look to ensure multinational companies aren’t evading their tax responsibilities by reallocating profits to lower-tax jurisdictions.
Transfer pricing refers to the guidelines and practices regulating pricing transactions between businesses under common ownership. An effective transfer pricing strategy can help companies maximize profitability while minimizing costs, taxes and liabilities.
To maintain tax compliance, a company’s transfer pricing needs to happen at arm’s length. Simply put, this means the price paid to purchase goods or services from a related company must be the same as if the two companies were unrelated.
For U.S.-based companies with legal entities in one of the many countries looking to shore up transfer pricing rules, the already complex tax laws may become increasingly more complicated. This could hinder efforts to grow and expand teams across borders while a country is challenged with economic recovery efforts during worker shortages.
Now, more than ever, it’s important for companies to take steps to ensure their tax and transfer pricing policies are audit-proof. Failing to do so can result in double taxation or crippling fines when failing to meet compliance.
Here are three tips to help multinational companies avoid costly tax errors and secure transfer pricing policies:
Develop your strategy
Naturally, a business would never consider opening a foreign office without having a solid plan in place. The reality is many get started without a clear strategy. Will the office provide low-cost research and development, or has it been set up to test a new market for sales? Is the plan to remain small or grow into a dominant market power?
These answers should already be defined before setting up a branch or hiring employees overseas. These definitive answers are also helpful in determining a company’s nexus. Generally, a company has a nexus in a country if it has real estate or a certain category of personnel there.
Understanding every aspect — gains and losses — for nexus is crucial to determining if the business is being taxed appropriately.
Keep meticulous documentation
Probably the most critical step in the process is keeping meticulous records for the tax authorities in each country of operation. The government will need proof that you not only understand the company’s nexus but that you’re maintaining compliance and contemporaneous documentation.
Whether a company is just taking the first steps in expanding its business or has been operating in foreign markets for quite some time, it is never too late to improve its documentation methods. There may come a point when they must show tax authorities details about their business to ensure fair taxation. Maintaining proper documentation is the way to do that.
While some countries will ask for documentation of a transfer pricing strategy after the fact, others will require approval prior to the company’s finalization of it. Working closely with a tax advisor or attorney will help companies understand the requirements for their business. It is far better to draft the strategy correctly the first time than to possibly get hit with fines after the fact.
Transfer pricing has become a major issue, with countries looking to recover lost taxable resources during the pandemic. For companies with operations in multiple territories, this has put transfer pricing policies at the top of the priority list.
As countries are reexamining and tightening up their transfer pricing policies, companies must follow suit to avoid paying inflated taxes or exorbitant noncompliance penalties that eat into their profit margin. Whether they’re just opening their first office overseas or have operations in numerous countries, planning, documentation and expert advice will help lead the way.