Transfer pricing is no longer just a documentation exercise

Ten years ago, I was sitting across from a client of mine who asked a question I am yet to forget. I was advising a Swiss manufacturing multinational on its global operations. It had operations in more than fifty countries, and its CFO wanted to know how to ensure that his transfer pricing framework was watertight. “I comply with transfer pricing documentation requirements in every country, but in two out of every three jurisdictions, I still go through painful audits shouldn’t the documentation be enough?” Those running or working for companies operating across multiple jurisdictions will relate to this question. In Tanzania, we have had transfer pricing regulations for close to a decade now. Yet transfer pricing remains a sticking point for many businesses. There seems to be no guarantee of safety for taxpayers who invest time and effort in good transfer pricing documentation. If you are wondering why that is the case.   Here are some key points to remember: 1. Documents are foundational. But foundations alone don’t make for good houses. There is a legal requirement to have contemporaneous transfer pricing documentation in almost every jurisdiction these days. Accordingly, every tax authority will see transfer pricing documentation as a starting point for any audit. It is therefore important to have robust, detailed, and well-benchmarked transfer pricing documentation. Functional analyses tend to be key to getting documentation to stand up to scrutiny. This is because a functional analysis allows a reader to really understand the nature of the parties to the transactions and how they get remunerated. It is critical to prepare the documentation with the tax audit in mind. In other words, every component of the documentation should be supported by actual information demonstrating the validity of such a transaction.  No supporting information is insignificant. Given the unpredictable length of time within which the documentation and its supporting information may be required, it is advised to put in place such supporting information when the documentation is being prepared. You really do not want to be scrambling to put such information together when going through a tax audit. When this is done, your documentation becomes a solid foundation.  2. Easily accessible data is the real defense. Once the documentation is in place, one should not rest on their transfer pricing laurels. What revenue authorities are really after is the actual substance behind the documented transactions.  This is a critical component of a solid defense. The strategy therefore must be to have a system that is able to retain and, more importantly, retrieve information related to related-party transactions in a timely and neat manner. This means that transfer pricing must be part of the information management system. My experience with successful taxpayers is that they are conscious of the related party transactions and their transfer pricing impact when putting the architecture of their information systems.  This would include things like a transfer pricing dashboard that has clear related party transaction volumes as well as breakdowns, movements during the year, and source documents that are easily identifiable when such information is required. These businesses also know what information is useful to retain in case a transaction is questioned. The rule of thumb is that the more information available to support the transaction, the less likely it will be challenged.  3. Operational value chains must align with documented policies. Perhaps the most important component of a solid transfer pricing strategy is the alignment between the company’s value chains and what has been documented. It is risky to have actual facts on the ground diverge from what has been documented in the TP policy. It is therefore important to constantly review how the business operates so that there is certainty that the documented information is aligned with what is happening on the ground. A recurrent flaw for businesses is when documentation is blindly updated by tax teams that may not be aware of the operational side of the business. This therefore leads to a difference between what actually happens on the ground and what is documented. This invites the suspicion of the revenue authority, unnecessarily creating an air of mistrust. It is therefore important to always have that alignment between business operations and transfer pricing documentation. After all, the documentation is supposed to be born out of the way the business operates, not vice versa.