Implementing Global Transfer Pricing in Multilateral Netting
Transfer pricing is a key issue identified by multinational companies operating in multiple currencies that need a netting system.
Implementing Global Transfer Pricing in Multilateral Netting Transfer pricing is a key issue identified by multinational companies operating in multiple currencies that need a netting system. December 1, 2020 | Author: Andrew Cripps
Market research shows that Transfer Pricing is one of the key issues identified by companies operating in multiple currencies worldwide that need a netting system. This is because they have several entities engaging in complex intercompany transactions on a monthly basis which are regulated by countries for tax purposes and consistent with the intercompany netting of those respective currencies.
What is Transfer Pricing ? Transfer Pricing is the establishment of acceptable pricing for arm’s-length transactions between a global company’s entities. There are various acceptable ways for calculating the transfer price, but it is the routine monthly calculation, payment, and reconciliation of these transactions amongst a set of global currencies that intertwines the concept with multilateral netting.
Unrelated companies regularly buy and sell goods and services at an established price that does not differ dramatically between different buyers and sellers. Not only are trade payables accounted for in Transfer Pricing, but global shared services such as legal, marketing, and human resources are re-allocated amongst the group of companies because they are often based in the most cost-effective entity, country, or region. In addition, the cost sharing of intellectual property also has its own transfer pricing.
The concept and laws of transfer pricing deters companies from establishing prices that are not fair to the overall market. If a price is considered unfair, or a company does not make payment for goods and services provided by a related entity, the amount due can be considered an intercompany loan that has different tax law implications to the respective entities depending on the jurisdiction under which they must report and pay income tax.
The Importance of Settling Intercompany Obligations If companies do not settle their intercompany obligations on a regular basis, there is a risk that these might be reclassified for income tax purposes as an intercompany loan or a deemed dividend (in the United States). The tax impact of an intercompany loan would include the addition of interest charges determined by government auditors that would result in a negative profit and loss (P&L) and cash liabilities. A deemed dividend would also be taxed at the company’s regular income tax rate.
To prevent these tax impacts, a company must establish proper transfer pricing arrangements in accordance with acceptable standards for the type of transaction involved.
How Transfer Prices are Established Factors that impact a transfer price include company size, nature of the transaction, location of the parties, and whether the entities involved are public or private.
In addition to calculating the correct transfer price, a global economic study of the transaction needs to be prepared in support of the transfer price and corresponding method used under certain transfer pricing regimes. Apart from US transfer pricing, certain countries, 80 as of the publication of this article, follow OECD (“Organization for Economic Co-Operation and Development”) guidelines. These countries follow methods “including the arm's length principle, transfer pricing methods, comparability analysis, intangible property, intra-group services, cost contribution agreements, transfer pricing documentation, administrative approaches to avoiding and resolving disputes, safe harbors and other implementation measures.”
Ultimately, it is an economic analysis of other transactions in the market based on either public or private entities that determines what the pricing or markup of the arrangement should be. This study is performed on an annual basis using data that is publicly available that is representative of the parties involved.
Most companies will ultimately be using a revenue sharing, comparable uncontrolled price, cost or cost plus method which, once the cost and mark-up are determined, is allocated as a payable and receivable amongst the parties involved.
Putting it into Action Here is a simple example for the cost sharing of legal services:
ParentCo, an organization headquartered in the United States, has a legal team with annual overhead costs of $5,000,000.
The legal team splits its time as 65% U.S., 15% Ireland, 10% Netherlands, 5% Austria, and 5% Singapore respectively.
ParentCo will conduct a transfer pricing analysis to determine how the costs will be allocated (i.e. by these example percentages), and the percentage markup that will be applied to each individual entity; for example, an Ireland markup could be 5%, but a Singapore markup could be 15% (these figures are not representative of any actual market data).
ParentCo will establish a separate transfer pricing agreement for the overhead cost allocation between itself and Ireland, Netherlands, Austria and Singapore, structured according to the percentage allocation and markup that has been determined for each entity.
On a monthly basis, ParentCo will calculate the allocation and markup of that month’s legal fees to each of the four entities, and each entity will pay their respective obligation to ParentCo.
How Netting Can Help Transfer pricing is a topic that is often addressed in multilateral netting due to the high volume of intercompany transactions typically inherent in the operations of manufacturing and distribution companies. When global organizations use a netting system such as EuroNetting, these transactions can be recorded and setup to be reconciled as transactions on a monthly basis to receive the most effective foreign exchange rate for the currencies involved.