This content is from: Transfer Pricing

A practical guide for operational transfer pricing excellence

A well-constructed and executed global operational transfer pricing (OTP) framework is essential to properly manage financial statements, taxes and reputational risk for multinational enterprises (MNEs).

By Richard Goldberg

Indeed, given the recent US tax law amendments and OECD BEPS developments, a competitive advantage may be the reward for MNEs with a strong OTP environment. For example, a strong OTP environment will facilitate effectivemodelling of the taxable income impacts of transfer pricing on the calculation of the base erosion anti-abuse tax (BEAT), and the global intangibles low taxed income (GILTI) and foreign derived intangibles income (FDII) provisions of the US’s Tax Cut Jobs Act (TCJA).

In addition, the widely adopted OECD response to Action 13 of the BEPS initiative requires significant information of a qualitative (master file and local files) and quantitative (country-by-country reporting) nature, there again well positioning MNEs with robust globally consistent OTP execution. Taxpayers not prepared to provide a consistent explanation of their TP practices to tax authorities, or if they are unable to effectively model the impact of transfer pricing on taxable income of legal entities, will be at a competitive disadvantage to those that can.

This article describes key elements of an effective OTP environment including the transfer pricing governance framework and the full transfer pricing ‘end-to-end’. The approach described in this article should be relevant to MNEs across industries. However, the bar may be higher to meet enhanced regulatory expectations for certain companies inside a MNE, such as a regulated financial institution, or to meet separate company audited financial statement materiality thresholds within a single MNE.

What is operational transfer pricing?

OTP is an integrated process consisting of a series of steps commencing with a process to identify and initiate a transfer pricing analysis of a potential intercompany transaction, moving through the arm’s-length pricing analysis, onto the record-to-report process, and lastly ensuring robust ongoing monitoring, maintenance and analysis of the overall process and the resulting financial impacts.

Key OTP success factors

A transfer pricing governance framework tailored to the structure and requirements of the MNE is the key to an effective OTP environment. This is further discussed below.

A second key OTP success factor is the designation of an intercompany global process owner (GPO). The GPO will play the essential role to ensure that all elements of the full OTP end-to-end are operating in a well-coordinated and effective fashion. The GPO will interface with management of both the provider and consumer units of OTP information to ensure that all parties are conforming to and/or satisfied with the transfer pricing governance framework. Importantly, the GPO will also be a lead point of contact to explain and provide relevant information to demonstrate compliance to both internal and external parties responsible for validating that the end-to-end is operating effectively. Given that a MNE is constantly evolving, the GPO will also be responsible for monitoring organisational structure, business, and system changes to ensure a culture of compliance with the TP governance framework.

The GPO will also consider potential opportunities to innovate by enhancing process efficiencies and leveraging technology within a framework of continuous improvement. The essential nature of the GPO is potentially heightened at the MNE-level with a decentralised operating company environment since there is increased risk of non-compliance with the transfer pricing governance framework potentially leading to unidentified intercompany transactions, inconsistent TP methodologies, disparities in data completeness, and miscommunication of relevant information required to meet tax and legal entity reporting requirements.

Lastly, an innovative MNE corporate culture, when combined with a like-minded GPO mindset within the context of a well-constructed TP governance framework, will naturally lead to an appropriate level of centralisation of people, processes and systems, as well as simplification, transparency, and meaningful stakeholder participation within the MNE.

The TP governance framework

The TP governance framework is the core set of minimum requirements that must be adhered to across a MNE relating to OTP (as broadly defined above). The top of the TP governance framework will generally consist of a intercompany transaction policy statement (ITPS). This is typically an enterprise-wide policy level document sponsored by one or more senior management team members (i.e. the chief financial officer, the chief accounting officer, or chief tax officer). Importantly, since the provisions in the ITPS will be fully auditable by both internal and external parties, the ITPS should be carefully drafted.

The ITPS should generally have three requirements:

1.      All Intercompany transactions must be valued at an arm’s-length price;

2.      All Intercompany transactions must be cash settled; and

3.      All intercompany transactions must be documented by a signed intercompany service agreement.

To allow for appropriate flexibility, the ITPS can specify limited exceptions to the above, for example where a materiality threshold is permitted or where it may not be possible or advisable to cash settle certain items, in which case the ITPS should refer to an exception authorisation process and consider other implications such as proper US GAAP or IFRS reporting.

In some cases, such as in a highly regulated banking environment or where there are material intercompany transactions across separately audited companies within a MNE, it may be advisable to establish a formal intercompany transaction subcommittee underneath a committee of the board of directors (i.e. the audit and finance committee). The intercompany transaction subcommittee will have a formal charter, membership structure, and responsibilities. The GPO may be a logical person to chair this subcommittee.

The next level of the TP governance framework, underneath the ITPS, is what can be called the ‘implementation layer’. This layer may consist of roles and responsibilities, training materials, operating manuals and procedures, and practical guidance (potentially in a FAQ format) to clarify and align OTP responsibilities across various relevant groups.

The roles and responsibilities document establishes clear accountability and expectations of each unit performing activities necessary to achieve an effective OTP process. The scope and assignment of roles and responsibilities depends on the OTP end-to-end operating model (this will be discussed further in the next section).

However, as a general rule, roles and responsibilities should at a very minimum address the following:

1.      The internal unit(s) responsible for identifying potential intercompany transactions and the information and process to initiate an arm’s-length pricing evaluation;

2.      The internal SME unit(s) responsible for performing the arm’s-length pricing and operational readiness perspective and associated timelines;

3.      The unit responsible for preparing and ensuring execution and cataloguing of intercompany agreements; and

4.      The unit responsible for reconciling intercompany accounts and ensuring timely and accurate cash settlement of intercompany transactions.

Depending upon the industry and materiality of transfer pricing, it may be appropriate for mandatory TP training and education, particularly to sensitise the key business and support unit members responsible as the first line of defence to identify new or revised intercompany transactions. In a more robust governance environment, step-by-step operating manuals may be expected to help ensure that core repeatable aspects of the end-to end are performed in a timely, accurate and complete fashion, and that any exception procedures are clear. A responsible, accountable, consulted and informed (RACI) matrix should be a useful tool to ensure that all relevant stakeholders are properly involved in key elements of the end-to-end. However, since these designations will be auditable, care should be taken to ensure that only key process points are included.

Designing the OTP end-to-end operating model

The OTP end-to-end operating model is the most important and tailored element of an effective OTP framework. It starts with an OTP process map collaboratively created from a ‘clean sheet of paper’ by a multidisciplinary team of stakeholders. The OTP process map involves a thoughtful exercise of designing each specific step in the OTP end-to-end to execute on the ITPS and other elements of the TP governance framework. A series of workshops may be useful to build the OTP process map. Like solving a jigsaw puzzle, these workshops may be organised to separately address each of the key phases of the OTP end-to-end and then connecting the edges to form a comprehensive end-to-end OTP process map.

Though there is no singular correct approach, it may be appropriate to divide the OTP process map into three phases:

1.      Intercompany transaction identification and initiation;

2.      Pricing and costing; and

3.      The record to report process.

In addition, a fourth phase overlaying the end-to-end consisting of monitor, maintain and analyse, could be useful to ensure that there is timely consideration and action to update and analyse key inputs and outputs of the end-to-end. This could include identifying key performance indicators (KPIs) to measure productivity and reduce instances of errors across the end-to-end.

Technology solutions

Process automation is a key element to achieving an efficient, scalable and well-controlled OTP end-to-end. The first step in developing one or more technology solutions is to identify what processes are amenable to automation.

The following activities are strong candidates for automation:

1.      Complex calculations requiring large amounts of data;

2.      Complex potentially error-prone output such as journal entries and invoices; and

3.      Query functionality to slice-and-dice output to generate key reports including intercompany transaction profit and loss (P&L) trends, variance analyses and KPI metrics.

In addition, the OTP process map should inform on whether workflow automation tracking tools may be helpful.

There is a wide assortment of OTP end-to-end technology vendor solutions available to MNEs. It is recommended that MNEs consider multiple vendors and in-house IT products. There are likely to be a number of pros and cons to consider. It is highly recommended that the in-house IT development team help guide the selection and effective implementation of the selected technology solution(s). The in-house IT development team is a valuable partner in this process given their subject matter expertise and understanding of compatibility of available technology solutions to current and potential future-state technology platforms used by the MNE.

OTP control environment

Timely control-related input is critically important during the design of the OTP process map. Section 404 of the US Sarbanes–Oxley Act of 2002 (SOX) requires management and external auditor to attest to the effectiveness of the internal controls for financial reporting. Other countries may have similar requirements. The OTP process map should be critically reviewed to ensure that there is a SOX risk assessment performed and that effective controls are implemented to mitigate risk. In addition, a broader category of operational risks should be properly assessed and mitigated through proper controls. An operational risk assessment is particularly relevant for financial institutions whose minimum capital requires such an evaluation. A SOX and operational risk self-assessment and testing program should be implemented relating to the OTP end-to-end.

Change management and sustainability

Two aspects of an OTP end-to-end implementation requiring foresight and close attention are the change management process and sustainability. Change management is necessary to communicate, transition and properly educate and train individuals impacted by conversion from legacy to the new TP governance framework and the related roles and responsibilities. Individuals likely to be impacted include the business and support units, controllers, tax, legal, IT, operations, compliance, internal audit, and various other internal and external stakeholders globally. Similarly, a sustainability analysis should be performed to ensure that each function is properly resourced and therefore positioned for success.

This article was written by Richard M. Goldberg, JD, CPA. Goldberg has led the transfer pricing functions at two of the world’s largest and most globally diversified financial institutions (Citigroup and MUFG Americas) where he was responsible for the design and sustainable implementation of effective OTP governance frameworks. Goldberg currently consults MNEs on transfer pricing technical and operational matters.The author welcomes comments at richard.goldberg@rgtps.com.

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