TP automation is an ally to face controversy
Mónica Piedrahita of EY Colombia explains how companies can prepare in advance of a transfer pricing audit.
It is no secret to anyone how the transfer pricing (TP) litigation resulting from the measures proposed by the OECD and by the governments individually, as well as the collection pressure that has been generated to the tax authorities because of COVID-19 are detonating countless audits worldwide.
Colombia has been no stranger to this trend and taxpayers have seen a significant increase in TP audits. Tax authorities have gone from imposing sanctions for purely formal issues, which are among the largest in the region, and may lead, for example, to the imposition of sanctions of up to $185,000 for the late filing of the local file, to the review of substantive issues.
Today, the Colombian Tax Authority is questioning the application of methods at the gross level, challenging the functional profile of the taxpayer and his ability to take risks. Likewise, it is reviewing the selected comparable, questioning whether the risks assumed by the companies selected as comparable to those faced by the taxpayer, leading it to raise the need to review in detail the financial information of the comparable used and the need or not to make comparability adjustments.
Many questions are being raised in relation to the use of financial information of more than one period either for the tested party or the comparable, under the argument that economic circumstances affect taxpayers and comparable equally, concluding that a multi-year analysis does not add value to the definition on whether a transaction complies with the arm´s-length principle, just to mention a few.
All the above leads to the conclusion that taxpayers must undoubtedly take action to manage the risk arising from TP disputes.
There has been a significant increase in the appetite for conflict resolution in advance by requesting advance pricing agreements (APAs) to the Colombian Tax Authority, which is a step in the search for certainty and tax security by taxpayers.
However, companies will need to be more proactive in managing their controversy. To do so, they must act earlier in the controversy cycle and not only improve the documentation available to the tax authorities, for whom the policies or contracts signed between the parties are not being sufficient, but providing evidence of the effective performance of activities, the ability to assume risks and the benefits obtained by participating in an intercompany transaction. Companies should think about simplifying, streamlining, and automating processes, so that they are more prepared to respond to questions from the authorities.
Automation, despite sounding sophisticated to some, implies that control mechanisms are generated, and topics as simple as how costs are being parameterised, how TP policies are being implemented or how adjustments are being accrued, are being properly and timely addressed.
Many of these processes are being carried out manually generating significant risks and a high probability of error and inaccuracy. Without proper control and management, there is a tremendous weakness when facing controversy, and ultimately, a high likelihood of not meeting what organisations have design for their TP setting; therefore, the review of internal processes is urgent. This review needs to be accompanied not only by the TP or tax team but by the entire organisation, since working in relative silos is part of what is triggering these risks.
Executives need to get involved as early and as deeply as possible in this process and promote a mindset within their organisations of incorporating requirements around data, automation, and reporting.
It seems, then, that the work that companies must do must begin by introspecting and determining what processes can be improved, simplified and controlled. Organisations must work on rethinking how to redesign their transactions, stop operating automatically and do it in a smart way that allows them to address the problems of the audit in advance, if the risk is to be managed.
Associate partner, EY