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How to implement your transfer pricing study

Putting your study to work is vital for effective transfer pricing

INSIGHT ARTICLE  | 

Here's a common transfer pricing pitfall. A company pays for a transfer pricing study to provide the economic analysis necessary to support its transfer pricing decisions in case it is challenged by the IRS or tax authorities in another jurisdiction. But these studies don't come with instructions for implementation. As a result, companies sometimes just put the study on a shelf, thinking that the study alone is enough. Then, when a company's transfer pricing decisions are challenged, it finds it hasn't actually aligned its policies and systems to reflect its own transfer pricing study. In fact, its own study provides evidence against the company.

Once a company has a solid transfer pricing study, how does it effectively implement the policies and procedures that translate the findings in its study into its operational and financial statements?

Where to start?

Start by considering implementation at the very beginning of the process. The company's ability to implement the results of a transfer pricing study has to be considered during the study itself. But the real work of implementation begins after the study is delivered.

Companies have to understand that transfer pricing implementation does not just involve the tax function. Effective implementation will require considerable coordination among operations, finance and tax. A key first step is to define exactly what will be needed from each function and to assign responsibilities accordingly. Focus on risk to help drive these efforts. Which transactions have the largest impact on your overall transfer pricing position?

Next, you have to be sure to collect documentary support for transfer pricing decisions, such as intercompany agreements and communications, policy memos and invoices. Then, all material intercompany transactions should be reconciled against this documentation.    

Finally, consolidate all of this activity into a comprehensive transfer pricing manual for the controllership function. This manual provides the road map for reflecting the entire transfer pricing process in the general ledger.

Common implementation issues

As you implement your transfer pricing process, watch for some common issues that can lead to inconsistencies that can result in unwelcome year-end transfer pricing adjustments. A common problem is for a company to treat transfer pricing as a parallel process that occurs outside of its accounting system. Even if this doesn't lead to inconsistencies in results, it is still a labor-intensive and inefficient approach. Transfer pricing activities should be integrated into your accounting systems.

Other issues that can lead to inconsistencies include:

  • Mismatches in accounting policies among operations in varying tax jurisdictions
  • Interunit transfers and the profit inflation that can result from them
  • Alignment with business unit compensation

Getting implementation right is increasingly important. The IRS and tax authorities around the world are taking a close look at transfer pricing and cracking down on companies that make unsupportable transfer pricing decisions in order to shift profits and avoid taxes. Keep in mind that transfer pricing is always a double-edged sword. Decisions that make one jurisdiction happy may cause another to take a harder look. Your transfer pricing study should provide the background you need to ensure your results are falling within appropriate ranges. Operating profit margins are often a vital metric. Know the range of results for companies in your industry and where your results fall. The more in line you are with your peers, the more likely your results will be viewed as arm's length.

Understand too that there is some room for strategic considerations. In which jurisdiction do you most need cash? Inappropriate profit shifting to meet your cash needs is not an option, but shifting within an acceptable range of results and backing this up with a solid transfer pricing study and effective transfer pricing implementation can help you meet your strategic goals.

The bottom line? A transfer pricing study alone is not enough. You need to effectively implement transfer pricing across your organization to deliver well-documented, supportable results that will withstand the increasingly strict attention that taxing authorities around the world are paying to this key area.

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