How do you drive transfer pricing certainty in uncertain times?

Assessing what the world says about the business involves understanding what is in the public domain and ensuring that TP policies and positions align with information available externally. Public regulatory filings, historical job advertisements, social media profiles, news articles and intellectual property (IP) registrations are all information sources that tax authorities can and will be able to analyze collectively to evaluate risk and challenge positions.  

Understanding the company’s data means going beyond functional interviews and the other processes typically used during fact-finding for transfer pricing analyses. New sources of information that tax authorities routinely review include e-mail data, the calendars of key executives, the mobile devices and computers of company officials, HR profiles, job descriptions and reviews, social media postings, regulatory filings and financial data.

In both assessments, businesses should expect to soon use GenAI tools to take proactive initial steps to align their TP policies while identifying and addressing risks. This will help equip their people to build stronger repositories of supportive information and evidence to buttress their positions.

“Global tax reform, including new levels of transparency, has completely changed how TP departments prepare, analyze and present data,” says Joe Lawson, EY Oceania Transfer Pricing Leader. “It’s more important than ever to make sure positions are clear, defensible and easily understood.”

Pre-filing agreements surge in popularity

Tax controversy is expensive and time-consuming for both businesses and tax administrators. In 2022 alone, respondents reportedly spent an average per company of US$37.4 million in tax costs over initial assessments in transfer pricing-related disputes. They also spent an average of US$15.4 million on penalties, interest and surcharges and US$16.4 million on legal fees, including litigation. While concerns about double taxation and the challenge of operationalizing TP functions topped the list of respondents’ concerns, traditional sources of disputes during TP audits, such as IP, payments for contract manufacturing, limitations on some deductibility and a variety of cross-border transactions, were all rated as posing “moderate to significant risk” by at least half of respondents.

Amidst all these pressures — implementation of global minimum taxes, technology-empowered tax examinations, digitally generated automatic assessments, and traditional sources of disputes on audit — the new TP survey shows a surge in enthusiasm for various programs and tools governments offer to taxpayers who want to negotiate TP positions before filing tax returns. There is also growing interest in programs designed to make disputes less contentious when they arise.

One of the survey’s most notable, yet unsurprising findings is the dramatic increase in interest in advance pricing programs. In the past, survey respondents have expressed some hesitation about participating in such programs, citing the time involved in setting them up, among other things. Now, however, the proportion saying these programs will be “very useful” to them in the future has more than doubled.

“APAs provide an element of certainty that has more value in a Pillar Two world,” Fultz says. “There is now far more downside risk to having a position challenged than there’s been in the past.”

Beyond Pillar Two-related concerns about double taxation and the increased risk of controversy, TP professionals have had to help manage the impacts of broader business decisions. Some of these in recent years have included responses to inflation, changes in supply chains and commitments to ESG objectives. The cascade of externalities complicating their roles has only grown since the pandemic. All of these have significant business impacts for cash flow, earnings per share and brand perception.

Inflation, for example, wasn’t even asked about in the previous 2021 survey; this year, 77% of respondents say inflation will have a moderate or significant impact on their transfer pricing policy over the next three years, second only to the importance of tax rate stability. Fifty-one percent of respondents say higher interest rates because of inflation have most impacted their medium and long-term intercompany debt pricing. In contrast, 27% say interest rates have had the biggest impact on factoring arrangement pricing. Twenty-one percent cite cash pool pricing as being most impacted by higher rates. 

Higher interest rates have also affected broader business decisions, many of which have implications for transfer pricing — 41% of respondents say their organizations have either increased or significantly increased their use of re-shoring or near-shoring strategies. In comparison, 54% say their organizations have significantly decreased expansion into new markets. Fifty-five percent of respondents say they are decreasing their expansion into new markets due to higher interest rates, while 61% say they are increasing the use of re-shoring or near-shoring. 

“Inflation and the higher interest rates to combat it will continue to have an effect on transfer pricing for years,” says Jay Camillo, EY Global Operating Model Effectiveness Leader. “To the extent it contributes to a trend of more bloc trading and less reliance on extended and linear supply chains, it will keep TP professionals busy dealing with the new value and supply chains that will be created as a result.” These are significant capital decisions that amplify the strategic value that transfer pricing professionals are providing.

Supply chains and ESG

Supply chains have also changed radically since the pandemic. Forty-two percent of respondents say their organizations have relocated production from one jurisdiction to another in the last three years because of geopolitical issues, the number one reason cited; thirty-nine percent of respondents say they’ve made changes linked to changing tax policies. Nearly a third (32%) cited disruptions related to the COVID-19 pandemic. Respondents also say supply chains will continue to be a factor, with 62% saying they anticipate changes to supply chains having a moderate or significant impact on their TP policy in the coming three years. 

ESG continues to be a major focus of C-suites, with initiatives affecting TP. Just 28% of respondents report already having changed their TP policy to account for their ESG policy, consistent with the 28% reporting their organizations are at an advanced stage of their ESG journey. With more than 70% of respondents still in the process of assessing supply chain changes to meet ESG goals, ESG will continue to represent a major workstream for TP professionals in the coming years.

A clear roadmap for standardizing tax and transfer pricing data is needed so that it can be efficiently accessed and analyzed to help businesses better react to these challenges. But Tax and TP professionals will also need to adopt a more proactive role in advising the C-suite. The survey found that fewer than half report being asked to weigh in on TP consequences of key business decisions at the beginning of the process.

Historically, TP functions have taken a linear approach starting with planning, then implementing, and ultimately supporting transfer pricing positions through compliance and during controversy. This often meant that TP teams were siloed and specialized. This approach will no longer work in a new environment where decisions must focus on transparency and certainty. This means TP functions must take a new iterative path that starts with understanding their company’s data and requiring that both external and internal data are fully aligned. They will need standard data in order to achieve quicker and multi-sided dispute resolution. In this new model, data is the starting point instead of something that needs to be gathered in the controversy phase of the current linear model.

Traditional TP operations are labor-intensive especially when focused on compliance and controversy inquiries. Intercompany data sets are, by nature, large and complex. Reconciliation between local statutory and central GAAP accounts is required. Adjustments to ensure prices match policy must happen throughout the year, not just at year-end. Aggregating the TP-required data from multiple systems is a major challenge in a TP audit. Many tax authorities think TP data requested for an audit can be easily produced and often expect responses within thirty days. Taxpayers find the requested data is unavailable, inaccurate, or incomplete. Files are saved in an ad hoc manner (e.g., by country or employee) with no ability to cross-reference to similar situations. Indeed, the survey finds that only a quarter of respondents say they manage compliance activities, routine or complex, centrally; 42% say their most complex and significant transactions are managed at the jurisdictional level.

Because of the complexities inherent in intercompany data, data is often sourced and managed through local relationships that are required to navigate tax audits. As a result, resourcing pressure across the globe is the most common pain point. Because TP touches controllers, broader finance, supply chain organization and tax, this appeal often presents within differing organizational silos and to varying degrees. Requests for more resources come from many different stakeholders, and thus the totality of the organizational pain may be grossly underestimated.

“This data complexity issue will not be solved by adding more people,” says Rebecca Coke, EY US Central Transfer Pricing Leader. Establishing new processes enabled by standardized data and technology can create more efficiency using existing TP resources. “The components of the TP roadmap may include a need for resources, but the starting point is likely a reorientation of internal data mapping and monitoring processes.” This mapping allows for technology to then handle disparate sources of TP related information.

How standard data and technology can facilitate certainty today

Even as they reshape the future data and comprehensive files of tax documentation, taxpayers must still deal with their open years. This means focusing on understanding the most efficient paths to dispute resolution. This can be achieved with two steps.

The first is to understand the totality of all TP transaction flows and what parties are on each side of each transaction. Once that is known, it becomes easier to identify common parties, which allows taxpayers to bundle multiple transactions into one dispute resolution forum. Consolidating key controversies can be used as a benchmark for negotiated settlements elsewhere.

The second step is to look across jurisdictions for common challenges. For example, a business may observe that several countries continually have large true-up adjustments or require maintaining tax reserves for uncertain TP positions. Businesses need to determine which elements, including data management, poor monitoring, price-setting, exchange rate volatility, or other issues, are contributing to deeper issues that must be resolved. Automating and standardizing data for one country equips the business to better deal with similar issues that arise in dozens of others. This is an exponential leap towards certainty, not an incremental one. “Even if businesses start with small use cases for setting up a data concept considering different possibilities of data sources and internal processes, it will help them exponentially,” says Hanna Moebus, Director, Operational Transfer Pricing, Ernst & Young GmbH Wirtschaftsprüfungsgesellschaft (EY Germany).

Every organization should examine all their TP processes through this new lens and ask whether they are linear or siloed (a key symptom of being siloed is keeping decentralized files that cannot be easily accessed or shared). If they are, businesses need to shift their focus to a systemic approach that involves standardizing data, moving up the TP technology curve and ultimately automating, eventually using GenAI or other machine automation. Our experience managing these transformations indicate organizations report saving 30% of all hours spent on TP-related matters in the finance department in a five-year period.

How to harness technology

Data and technology are notable game changers, providing companies with the ability to significantly reduce cost, reduce risk and drive more value. Today’s technology allows companies to ingest data into a data lake, validate the data, transform the data into a common data model, and drive reuse of the data via standard reporting, analytics, and computational engines. Yet, the 2023 EY Tax and Finance Operations (TFO) survey found that 72% of that survey's respondents have gaps when it comes to tax sensitizing their Enterprise Resources Plannings (ERPs). These challenges are magnified when they involve transfer pricing at the product, transactional or jurisdictional level.

Systemic reform is also necessary if businesses want to gain their expected benefits from GenAI. In the survey, 88% of respondents expect TP technology to save their organization money over the next three years. But they also acknowledge they have work to do in the interim — 76% of respondents say they need to have in place a robust TP policy that clearly defines TP processes, while 47% say they need to move data into a centralized repository. Thirty-six percent say they need to improve the quality of their data.

Businesses need a plan to harness the power of data, systems and third-party technology. They can either invest internally with data strategies, tax sensitization of ERPs and systems improvements, or partner with a service provider who has built these capabilities. Another option is pursuing a hybrid of the first two choices. The TP technology curve continues to expand with multiple technology options available. It is important that businesses start to think about their IT infrastructure and how to pull data together from different systems, Moebus says. Once they have tackled standard data questions, technology can readily be deployed.

Ultimately, components of the TP roadmap will reveal where automation cannot help. TP professionals can struggle to keep up with C-suite and business demands. Efficiencies from implementing the roadmap and automation will free up TP professionals to meet more value-added needs of the organization, such as tax authority negotiations and more active participation in R&D and supply chain planning. Better connectivity with the C-suite will also contribute to leveraging GenAI effectively — 69% of respondents say they need to improve their integration of the tax department with a broader business strategy over the next three years to reap the benefits of the technology.

The 2024 EY International Tax and Transfer Pricing Survey has a clear message: the old methods for doing TP are losing relevance. Cross-border businesses have a new path to prepare for the new realities. There are five things in particular businesses should do now:

1. Focus on TP certainty

Pillar Two is changing the international tax landscape. Ultimately, all businesses are going to need to have more precision around their TP. Due to the heightened risk of double taxation, getting certainty is at a premium. This means being as proactive as possible in dealing with anticipated and current controversies.

2. Map out future and current dispute resolution mechanisms

Future controversy is expected to be more intensive, but only for businesses that are unprepared. Those that invest now in a new approach to TP will be better positioned to engage tax authorities on future issues and better support positions taken today. Internally, that means ensuring TP and tax policies are aligned with the organization’s broader public face. Externally, it means investigating the variety of pre-filing and dispute resolution programs offered by governments, such as APAs, MAP and ICAP.

3. Center TP processes around standard data to decrease risk

Develop a three-year plan for TP processes that systemically decreases risk instead of continuing traditional TP processes that follow the outdated, linear approach of planning, implementing and ultimately supporting positions. “Traditional and siloed” TP processes are outdated and may not be reflective of a cross border, global footprint, and therefore, may become riskier in this new world where double taxation is a bigger concern than before, and tax authorities have more information and data capabilities than ever. The capabilities of tax authorities will continue to rise, perhaps faster than those of businesses. TP functions must rely less on country-by-country management, so they gain the “bigger picture” of the totality of their positions and identify anything auditors might find objectionable. The world’s tax authorities already share tax data at unprecedented rates due to Tax Information Exchange Agreements. It is imperative businesses do the same thing within their organizations and do not leave their data siloed locally.

4. Prepare for a world where data underpins your transfer pricing approach

Define your external and internal narrative and rely on standardized data to tell it and to align the business’ tax positions with broader business objectives. Standardized data will also help prepare the organization for TP controversy and to meet its expectations for GenAI-powered efficiencies and analytics that deliver better insights to the C-Suite.

5. Prepare to engage more with the C-suite

Ultimately, systemic change in TP processes will free up TP professionals to play a bigger role in advising the rest of the business. It’s critical that TP professionals advise on key business decisions that affect profits and losses and balance sheets. Gaining more certainty around TP and tax matters will also help TP professionals better help the business react to economic and geopolitical disturbances in a tax-neutral manner.