Transfer pricing under pressure: recent developments and strategic options

Transfer pricing and the arm’s-length principle, as the main guardrails for an appropriate remuneration for intercompany cross-border exchanges of goods and services, are crucial for underpinning global supply chains and ensuring compliance with national and international tax regulations. The arm’s-length principle requires that intercompany transactions are priced as if they occurred with or between independent parties. However, recent tariff developments and evolving trade conflicts have introduced significant disruptions to established transfer pricing policies, creating challenges and opportunities for multinational enterprises (MNEs).

This article analyses how tariffs may disrupt transfer pricing policies, forcing MNEs to re-evaluate their supply chains and potentially adapt their transfer pricing arrangements. Such restructurings may increase compliance burdens but may also present opportunities for MNEs, both from a business and a financial/administrative perspective. A careful review and evaluation of adaptation potential is therefore key and at the top of the agenda for tax/transfer pricing leaders of MNEs.

Strategic supply chain restructuring, contract renegotiations, and leveraging free trade agreements can mitigate the negative impact of tariffs and enhance global competitiveness. The adoption of best practices, including customs valuation optimisation and robust documentation procedures, is crucial for complying with tax regulations and minimising disputes with tax authorities.

The evolving regulatory environment, including digitalisation and increased cooperation among tax authorities, further complicates the landscape. MNEs must proactively adapt their strategies and operations, and leverage data analytics and expert advice. This will enable them to navigate these challenges and capitalise on emerging opportunities. Finally, policymakers have a crucial role in providing clarity and stability in international trade to facilitate fair and efficient transfer pricing.

Tariffs – i.e., taxes imposed on imported goods – may have a significant effect on international trade and directly impact transfer pricing practices. This section analyses the multifaceted effects of tariffs, which may be of the following types (also see Boycewire’s Tariffs: Definition, Types & Example):

• Ad valorem tariffs – these are imposed as a percentage of the value of the imported goods. For example, a 10% ad valorem tariff on a good valued at €100 would result in a €10 tariff. These tariffs directly impact the customs value, which is a central parameter for calculating transfer prices in customs-optimised supply chains. This calculation method is mostly used.

• Specific tariffs – these are fixed amounts regardless of the value charged per unit of imported goods. For example, a €5 specific tariff on each imported good would add €5 to the cost, irrespective of the price. While not directly tied to value, specific tariffs still increase the overall cost and influence transfer pricing considerations.

• Compound tariffs – these combine ad valorem and specific tariffs. For instance, a compound tariff might consist of a 5% ad valorem tariff plus a €2 specific tariff per unit. These tariffs have a combined impact on cost and valuation.

Tariffs directly affect transfer prices by increasing the cost of imported goods. This increase in cost must be factored into the transfer price to ensure the related-party importer achieves an arm's-length profit. For example, if a related-party manufacturer sells a product to a related-party distributor in another country and a tariff is imposed on the import, the transfer price needs to be adjusted to reflect this increased cost. If not, this would lead to the distributor margin being lower than a potentially comparable arm’s-length profit, possibly attracting a tax audit.

This introduces specific challenges to the application of traditional transfer pricing methods.

The comparable uncontrolled price method, for instance, relies on finding comparable independent transactions. However, tariffs create price volatility, making it difficult to identify truly comparable transactions. In future, a more specific search and comparability focus must be put on geopolitical comparability.

Similarly, the transactional net margin method can be affected by tariffs. The reliability of the target profit range derived from comparable companies in tariff-free environments is diminished through potentially depressed profit margins. Similar to the above, benchmarking is facing new challenges and comes with increased double-taxation potential in case robust documentation, especially with respect to comparability criteria, cannot be presented during tax audits.

However, tariff impacts on MNEs cannot be solved by transfer pricing alone. The first step for MNEs should be to evaluate if, and to what extent, an additional customs burden can be passed through to customers. Price elasticity is therefore key with regard to the evaluation of market potential.

Only in a second step can transfer pricing help to accelerate business-driven decisions on how to operate in times of geopolitical uncertainty. As such, when tariffs can be passed through to the consumer, local distributor margins may increase, bringing additional pressure on transfer pricing to steer local target margins. However, in most cases the tariff cannot easily be passed through and consequently the receiving entity faces reduced margins. Absorbing the tariff costs affects its profitability, raising questions about the arm’s-length principle. If the importing business already operates at near-zero profitability, the added burden could send the receiving entity into a loss situation, leading to additional disadvantages in the market the entity is operating in.

As a first summary, the degree to which tariffs create the issues mentioned above depends heavily on the price elasticity of demand for the product. The demand being more elastic means that customers are highly price sensitive, making it increasingly difficult to pass through the tariffs without significantly impacting sales volume. In this case, the importing business is more likely to absorb the tariff, leading to the challenges outlined above.

The current tariff landscape presents a complex mix of challenges for businesses engaged in cross-border transactions.

While it complicates transfer pricing compliance – requiring careful adjustments to reflect tariff costs in complex supply chains and evolving regulations – it also incentivises strategic planning. Keeping up with constantly evolving regulations and ensuring consistent implementation across different jurisdictions adds to the compliance burden.

In particular, challenges may occur during advance pricing agreement (APA) processes. These are agreements between a taxpayer and one or more tax authorities that determine in advance the transfer pricing methodology for specific transactions, as well as the respective margins achieved by the entity involved. Securing transfer pricing models on specific transactions via an APA can provide certainty and reduce the risk of future disputes.

Considering the volatile impact tariffs may currently have, the suggested target margin being negotiated by the tax authorities during an APA process may no longer be an arm’s-length result for the respective entity. Multinationals may have to adjust the APA application, which potentially leads to re-applying under different conditions. If possible, it is recommended to include critical assumptions into a desired APA outcome or re-evaluate the case as such before applying for an APA. Nevertheless, with a volatile tariff environment, the overall uncertainty for MNEs in APA negotiations or currently applying transfer prices as agreed in an APA remains.

However, provided that sufficient business substance exists, tariffs can also catalyse supply chain optimisation, creating opportunities for domestic businesses to gain market share and enhance long-term competitiveness, thus achieving growth.

Companies can explore opportunities to restructure their operations and improve efficiency. This can lead to long-term cost savings and enhanced competitiveness, even beyond the immediate impact of trade regulations. However, any restructuring should be carefully analysed from a transfer pricing perspective to ensure compliance and avoid unintended tax consequences.

Strategic planning, including contract renegotiations and leveraging free trade agreements, can mitigate negative impacts and create value. Effective transfer pricing management in this context becomes a competitive advantage.

As a second summary, taxpayers must bridge the gap between long-term planning and highly volatile unpredictability. Adaptations to the transfer pricing policy and any securitisation mechanisms (e.g., APAs) need to be kept as flexible as possible to fulfil differing stakeholder interests.

Business model and value chain restructuring are certainly options to be considered by MNEs, but they usually come with significant impacts on business models, financial positions, and internal processes. While basically shifting production to a nearby country with a more favourable trade agreement (nearshoring) or even creating regional supply chains to serve specific markets and thereby minimising tariff exposure may seem to be the best solution to build a resilient supply chain with respect to fluctuating tariffs, one must consider potentially disrupting tax effects.

Usually, such supply chain restructurings can trigger high exit taxes in the jurisdiction from which assets are being relocated and may ultimately become more expensive than the effects of increased tariffs. In addition, these changes in supply chain structures demand adjustments to transfer pricing arrangements. New intercompany transactions may arise requiring new transfer pricing policies. Existing transfer pricing arrangements may become obsolete and require revisions. Moreover, reducing the effect of tariffs requires optimising customs valuations. This involves giving careful thought to the factors influencing the customs value, such as goods, insurance, and royalties.

Maintaining comprehensive and up-to-date transfer pricing documentation is essential. This should clearly explain the impact of tariffs on transfer pricing policies, especially the methodology used to determine adjustments and the supporting data. Regularly reviewing and updating this documentation is crucial to ensure accuracy.

The functional analysis should clearly state the functions performed, assets used, and risks assumed by each party involved in the transaction. Concerning the economic part, it should demonstrate how tariffs affect the profitability side, potentially also throughout an entire industry. This might involve analysing changes in costs, revenues, and profit margins.

By accurately documenting these elements, businesses can demonstrate to tax authorities that their transfer pricing principles align with the arm’s-length principle, even in a climate of fluctuating tariffs.

Technology and data analytics can play a vital role in managing transfer pricing in the context of tariffs. Automated tools can help to streamline data collection and reporting. Data analytics can provide insights into the impact of tariffs on profitability and identify opportunities for optimisation.

Advanced analytics can help to model future scenarios by analysing historical data and market trends. These models can assist businesses in anticipating potential challenges and proactively adjusting their strategies, therefore minimising the risk of non-compliance. Technology enables businesses to simulate different scenarios, determining key factors that drive transfer pricing outcomes. This ultimately leads to better-informed decisions by making simulations quickly available.

An additional advantage with respect to reporting is that the use of technology and data analytics allows transfer pricing professionals to present complex transfer pricing data in a concise manner, which is easier to understand for stakeholders and less time-consuming with respect to gathering the data.

By implementing these best practices and mitigation strategies, businesses can effectively address the challenges and capitalise on the opportunities presented by a volatile tariff landscape. A proactive and strategic approach to transfer pricing is essential for maintaining compliance, minimising costs, and achieving sustainable growth in a globalised economy.

The interplay between transfer pricing and tariffs is dynamic and constantly evolving, characterised by a high degree of volatility that makes predicting the future landscape particularly challenging. While forecasting with accuracy is difficult, recognising the volatile nature of global trade policies is the first step towards building resilience.

Geopolitical tensions and shifting alliances can significantly impact trade policies and tariff regimes. Businesses need to monitor these developments closely and be prepared to adjust their transfer pricing strategies accordingly. Planning different scenarios and stress testing can help to assess the potential impact of different trade policies.

The possibility of future trade wars and increased protectionist measures poses a significant risk to global trade. Businesses need to develop strategies to mitigate the potential impact of these disruptions, such as diversifying their sourcing and production locations.

Furthermore, businesses need to proactively monitor regulatory developments and adapt their transfer pricing strategies accordingly. This requires staying informed about changes in tax laws, trade policies, and international agreements.

Engaging in open and constructive dialogue with tax authorities can help to minimise disputes and build trust. This can involve seeking advanced rulings or participating in cooperative compliance programmes.

This proactive approach, coupled with an awareness of upcoming challenges, is essential for compliance, risk mitigation, and sustainable growth in an increasingly interconnected global economy.

This article has explored the significant disruptions caused by unexpected tariff changes to established transfer pricing practices. All forms of tariffs directly impact customs valuations and require adjustments to transfer prices to maintain arm’s-length compliance. Their indirect effects are equally profound, influencing supply chain restructuring or business model adaptations. The challenges presented are substantial, ranging from increased compliance burdens and further investigation from tax authorities to the need for more robust documentation and data analysis.

However, these challenges may also bring opportunities for MNEs. Tariffs can act as a catalyst for supply chain optimisation. By strategically restructuring operations, renegotiating contracts, and leveraging free trade agreements, businesses can mitigate the negative impacts, potentially enhancing their global competitiveness. Implementing robust documentation procedures is crucial for navigating this complex landscape.

Looking ahead, the interplay between transfer pricing and tariffs will continue to evolve. Geopolitical uncertainties, the rise of digitalisation, and increased cooperation among tax authorities will shape the future in this field. Businesses must remain aware to adapt their strategies to these dynamic forces.

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