Understanding Transfer Pricing: Implications for Global Businesses

What is Transfer Pricing?

In today’s global economy, multinational businesses operate across multiple jurisdictions, and often transfer goods, services, and intellectual property between their related entities. Transfer pricing refers to the pricing of these inter-entity transactions and plays a crucial role in determining taxable income for different entities within a multinational organisation.

Governments and tax authorities around the world, including New Zealand’s Inland Revenue (IR), closely scrutinise transfer pricing arrangements to prevent tax avoidance and to ensure entities operating within the relevant jurisdiction are contributing equally to the tax base. Understanding how transfer pricing works, and its implications are essential for multinational businesses to remain compliant, mitigate risks, and optimise tax efficiency.

Why does Transfer Pricing matter?

It would be a mistake to think of transfer pricing solely as an accounting or tax compliance issue.  Transfer pricing directly affects business strategy, profitability, and risk management and is critical in the following ways:

Tax Compliance and Risk Mitigation: Improper transfer pricing arrangements can result in significant tax penalties and reputational damage where a tax authority deems them to be arrangement to avoid tax

1. Profit Allocation and Financial Reporting: Transfer pricing impacts where profits are reported, influencing financial statements and business performance metrics.
2. Cross-Border Tax Efficiency: Well-structured transfer pricing policies help multinational organisations manage their tax obligations efficiently and mitigate double taxation.
3. Regulatory Scrutiny: Governments are increasingly implementing stringent regulations to ensure that multinational businesses pay their fair share of taxes in each jurisdiction.

How is an arrangement ‘fairly’ priced for transfer pricing?

To establish fair transfer pricing, businesses must use internationally recognised methodologies that align with the Organisation for Economic Co-operation and Development (OECD) guidelines. The main transfer pricing methods include:

1. Comparable Uncontrolled Price (CUP) Method
   The CUP method compares the price charged in a controlled transaction (between related entities) with the price charged in a similar uncontrolled transaction (between independent entities). The CUP method is considered to provide the most accurate measure of the arm's length price as it directly references the market price adopted by independent parties in similar circumstances. If the prices significantly differ, adjustments may be required to ensure an arm’s length price and that the arrangement able to withstand challenge.
2. Resale Price Method (RPM)
   The RPM determines the appropriate transfer price based on the resale price of a product sold to a third party. A suitable gross margin is applied to calculate the transfer price and subtracted from the resale price, ensuring a fair profit margin remains for the reseller. The remaining amount is considered the arm's length price for the original transaction between the related parties. 
3. Cost-Plus Method
   This method calculates the transfer price by adding a reasonable profit margin to the cost incurred by the supplier in an intercompany transaction. The mark-up is determined by reference to the mark-ups earned by independent suppliers in comparable transactions, taking into account the functions performed, risks assumed, and assets employed by the supplier. This methodis commonly used for manufacturing and service-based transactions.
4. Transactional Net Margin Method (TNMM)
   TNMM compares the net profit margin of a controlled transaction to the net margins of comparable independent transactions. It focuses on the net profit margin rather than the gross margin, making it sensitive to the relative cost structures of the entities being compared. This method is often used when reliable information on gross margins is difficult to obtain, or when gross margins are inappropriate for the transaction in question.
5. Profit Split Method
   Used for complex transactions involving valuable intangibles, this method allocates profits between related entities based on their respective contributions to the value chain.

Transfer pricing in New Zealand

New Zealand follows OECD guidelines on transfer pricing which are enforced by Inland Revenue. The key regulatory features include:

Arm’s Length Principle: Businesses must price inter-entity transactions as they would have occurred between unrelated parties.

• Documentation Requirements: Entities are required to maintain detailed documentation demonstrating compliance with transfer pricing rules.
• Country-by-Country Reporting: Large multinational organisations with revenue of more than EUR750 million must provide detailed reports on their global activities to ensure transparency.
• Advance Pricing Agreements (APAs): Businesses can seek APAs with Inland Revenue to obtain pre-approved transfer pricing methodologies and thereby reduce the risk of future challenge.

Failure to comply with transfer pricing regulations can lead to audits, adjustments, penalties, and reputational damage.

Common Transfer Pricing Challenges

Multinational organisations face several challenges in managing transfer pricing effectively, including:

1. Regulatory Differences Across Jurisdictions: Each country has its own set of transfer pricing rules, making global compliance complex.
2. Valuation of Intangibles: Intellectual property, brand value, and proprietary technologies can be  difficult to price accurately.
3. Economic and Market Fluctuations: Transfer pricing strategies need to adapt to changing economic conditions and market realities.
4. Increased Tax Authority Scrutiny: Governments worldwide are taking aggressive stances on tax avoidance, which manifest in a higher risk of audit and potential for adjustments.

Best Practices for Managing Transfer Pricing

To effectively navigate transfer pricing challenges and ensure compliance, businesses should adopt the following best practices:

1. Develop a Robust Transfer Pricing Policy
   Multinational organisations should establish clear and well-documented transfer pricing policies that aligns with OECD guidelines and local tax regulations. These policies will support pricing decisions and assist with any Inland Revenue audit. 
   
   
2. Maintain Comprehensive Documentation
   Detailed transfer pricing documentation is critical for compliance and records detailing the following should be retained:
   
   The chosen transfer pricing methodology.
   Financial and economic analyses supporting pricing decisions.
   Comparability studies and benchmarking data.
   
   
3. Conduct Regular Compliance Reviews
   With tax laws constantly evolving, organisations should have a plan in place to review their transfer pricing policies to ensure ongoing compliance with global and local regulations. 
   
   
4. Seek Professional Advice and Advance Pricing Agreements (APAs)
   Consulting tax specialists can help businesses structure their transfer pricing arrangements effectively. Advance Pricing Agreements (APAs) can provide certainty by securing tax authority approval on pricing methodologies in advance.
   
   
5. Implement Technology for Data Analysis
   Leveraging data analytics tools can help businesses assess transfer pricing risks, conduct benchmarking studies, and ensure accuracy in financial reporting.

How Can Andersen Help?

Managing transfer pricing effectively requires expertise in international tax laws, financial reporting, and regulatory compliance. At Bellingham Wallace, we specialise in providing strategic tax and advisory services tailored to the needs of multinational organisations operating in New Zealand.

We can assist with: 

• Transfer Pricing Policy Development: Crafting and implementing a robust transfer pricing strategy aligned with regulatory requirements. 
• Compliance and Documentation: Ensuring accurate and up-to-date documentation. 
• Risk Management and Audit Support: Identifying potential risks and assisting with transfer pricing audits. 
• Advance Pricing Agreements (APAs): Assisting in the preparation and negotiation of APAs with Inland Revenue to provide certainty on transfer pricing arrangements.

Taking a Proactive Approach to Transfer Pricing

As governments worldwide tighten tax regulations, transfer pricing has become a critical area of focus for multinational businesses. Ensuring compliance, managing risks, and optimising tax efficiency require a well-structured and strategic approach.

By implementing best practices and seeking expert guidance, multinational organisations can navigate transfer pricing complexities effectively, reduce exposure to disputes, and enhance their long-term financial sustainability.
Are you prepared for evolving transfer pricing regulations?

Contact the team at Andersen to discuss how we can help you stay ahead in a competitive global landscape.

Author - Michelle Turner