Operational Transfer Pricing

Setting intercompany pricing policies is challenging but achievable for most organizations. It’s a much bigger task to align these policies with your transfer pricing processes and controls and implement. Transfer pricing perfection is impossible in today’s environment, and it’s getting even harder as business models grow more complex and demands for tax transparency intensify.

Operational Transfer Pricing (OTP) can help. OTP is the management of transfer pricing data, processes and governance using technology. An effective OTP program aligns transfer pricing requirements with commercial goals, thereby promoting compliance, reducing complexity, delivering strategic insights and driving better business decisions.

In this article, we explore why OTP is now attracting renewed attention. We also dispel some common misconceptions about OTP and highlight its potential benefits.

Historically, multinational organizations upgraded their finance systems by investing in enterprise resource planning (ERP) systems. But these investments tended to focus on managing the business overall, rather than specific legal entities, and the alignment of the commercial, finance and tax functions were often not considered.

Financial system readiness is a key tenet of OTP. As organizations implemented their transfer pricing policies, ERP systems were found to be less effective for managing the tax and transfer pricing processes. Organizations took to using offline manual processes or external tools (e.g. spreadsheets) to set, test and monitor their intercompany price setting and accounting.

Nevertheless, organizations could accept this state of affairs. The prevailing tax environment gave them ample time after year-end to calculate, adjust and re-calculate their intercompany prices and manage the impact on their entities’ bottom lines.

Today, however, tax authorities’ data requests and digital capabilities are leaping ahead of many businesses toward real-time reporting and analysis — and the luxury of time has vanished.

Perhaps the biggest reason OTP is back in the spotlight is the regulatory burden put on transfer pricing by the Organisation for Economic Co-operation and Development’s (OECD) project to address base erosion and profit shifting (BEPS). As a result of the OECD’s BEPS recommendations, tax authorities can now access tremendous amounts of data from, among other things, detailed digital (i.e. real-time) tax filing requirements, automatic exchange of information and country-by-country reports.

Political pressure from governments across the globe also means that each tax authority has a vested interest in transfer pricing and making sure that they get their “fair share” of profits.

These developments make it important to have a consistent narrative for compliance purposes that covers both policies and data. As tax authorities sharpen their focus on data integrity and transfer pricing governance, they expect taxpayers to be able to show they have adequate processes and controls in place to ensure transfer pricing outcomes at legal entity level match expectations. Organizations are being assessed on whether their transfer pricing policies match what’s happening on the ground. Tax authorities are also looking at whether companies’ year-end results are in line with what they projected when the year began, and, if not, whether they have a good business reason for any true-up adjustments.

Another reason OTP is gaining attention is that transfer pricing errors now have more significant financial statement impacts. For example, US tax reform requires global companies to manage data that is precise enough to produce entity -level results that may require further segmentation (i.e. for computing foreign tax credits and global intangible low-taxed income (GILTI)). US tax reform has also spurred substantial restructuring activity, creating more transactions and more OTP obligations.

So in today’s climate, the need to align business with compliance is crucial. Transfer pricing requires input from and alignment between various stakeholders within the company, and automation can help achieve this alignment. Technology solutions are also being used to ingest, decipher and analyze large amounts of data, enabling tax and finance to successfully manage stakeholders’ concerns.

OTP means different things to different people. The OTP process can differ by type of transaction, and there are some misconceptions about what OTP is all about. Below we seek to dispel some of these myths and highlight how an effective OTP process is critical for effective transfer pricing management in today’s environment.

“OTP only focuses on the end-to-end process.”

OTP certainly focuses on the end-to-end process, following the numbers from forecasting through to financial statement reporting. This is the recurring aspect of the transfer pricing lifecycle, and automating parts of this process is often seen as the bedrock of OTP.

But OTP also goes beyond the end-to-end process to cover standalone projects such as the automation of management service allocation charges or profit split calculations.

“OTP involves large finance transformations, so it’s not for us.”

It’s true that OTP is important for aligning finance, enterprise and tax on projects such as moving ERP systems to the cloud or consolidating multiple systems into one. But OTP is also relevant for smaller projects, like making a manual spreadsheet process a little less manual. This means reviewing internal processes and locking down elements that may be calculated in spreadsheets to prevent transposition and other errors or eliminate time spent checking and double-checking calculations.

“OTP always includes automation.”

Technology should be a key component but not an integral one. People are also key to OTP. Processes only work smoothly when people fully understand their roles and responsibilities, including those of people outside of the tax or transfer pricing teams.

For example, the transfer pricing team may receive market prices from the sales department and forecasts from financial planning and analysis department to set a transfer price for products that move through a complex intercompany supply chain. At the same time, the accounting team needs to ensure the prices for each product or product group are applied properly to generate the correct journal entries for posting to the ERP system.

Clear accountabilities can significantly reduce the amount of time transfer pricing teams spend simply finding and mapping the correct data. It’s also important to revisit and reinforce these accountabilities over time to ensure transfer pricing practices continue to reflect the model. For example, a change in personnel could lead to errors in journal entries that may not become apparent until years later during a tax audit.

“Automation means I won’t be needed anymore.”

As with other aspects of digitalization, transfer pricing technology is moving from the lower end of the spectrum, where people follow processes supported by technology, to the higher end, where technology follows processes supported by people. 

Some people think technology is capable of full automation that eliminates the need for people. This may happen down the road, but current technology primarily supports and augments repetitive and routine manual transfer pricing activities that people remain responsible for, freeing up their time for more value-adding work.

“Why use OTP when it’s easier and cheaper to use a ready-made tool?”

While this might have been true in the past, OTP technology and tools have evolved to meet increasing data demands with quicker, more flexible, and more efficient deployment. New solutions are available that can improve the efficiency of transfer pricing calculations by integrating the data that comes directly from company’s various processes for, for example, financial statement journal entry, monitoring and invoicing.

An effective OTP process depends on an organization’s business, industry and systems. These are unique from entity to entity, so the best solutions are tailor-made. They do not have to break the bank, however, especially for organizations that are automating an aspect of your transfer pricing process rather than installing an automated end-to-end solution.  Specific OTP software solutions are available that can enhance the implementation of technology due to standard functionalities and customizable reporting capabilities. 

Whatever technology is selected, success requires in-depth consideration of your process and the people who sustain it.

A transfer pricing process review and implementation of technology can yield substantial returns in these areas:

• Savings and efficiency gains: OTP process improvements and technology implementations can be deployed quickly and reduce process turnaround and cycle, thereby freeing resources for other activities.
• Managing risk: Reducing manual activities through standardized transfer pricing solutions mitigates risks of human error.
• Better process controls: OTP processes can be outfitted with control solutions that are traceable, auditable and robust, and can be followed when transfer pricing team members change.
• Stronger collaboration: Clarifying roles and responsible among tax, finance and other stakeholders can enhance coordination and collaboration across functions.
• Improved processes: The augmented review that comes with OTP stands to significantly improve the accuracy and reliability of transfer pricing processes.
• Scalability: OTP solutions can be built through flexible, modular designs that can be scaled up as needed.
• Driving insight: A common data model or data visualization can provide a powerful platform for both reporting and advanced analytics.

Before embarking on an OTP project, remember to be realistic. Automating a process or managing risk is not as simple as clicking a button. You must ensure that you fully understand the issue you are trying to solve and win crucial buy-in and support from business leadership. Doing so will make it much more likely that your project will succeed.

Dianne Berry
Director
Meijburg & Co, KPMG in the Netherlands

Jack O'Meara
Principal
KPMG in the US

Tim Wong
Partner
KPMG in the US

Meenakshi Iyer
Director
KPMG in the UK