Strategic Insights into Transfer Pricing: Unveiling Common Audit Red Flags (Part II)
This blog is the second of our two-part series calling attention to common red flags that stand out for tax authorities during audits. In these blogs we share our experience with tax audits, specifically pointing out some pitfalls to watch out for while framing Transfer Pricing (“TP”) policies and compiling TP documentation.
Our insights are meant to serve as a starting point for companies to assess and refine their approach to TP in order to be better prepared for audits and scrutiny. If you find the insights in this blog helpful, do also read our other blog on this topic, in which we listed our first four tips for effectively managing and mitigating these “red flags”.
04 Mar. '24 Neha Mohan
5. GENERIC AND TEMPLATE STYLE TP DOCUMENTATION
With regard to TP files, generic or standardized templates are strongly discouraged. Tick-the-box and fill-in-the-blank overviews fail to capture the unique aspects of a business. Oversimplifying and using generic content or a one-size-fits-all approach can expose the company to increased scrutiny. And on close inspection, generic documents (often and easily) reveal inconsistencies or inadequacies in a company's TP practices. This could put the company in a precarious legal position by (possibly) shifting the burden of proof onto the company to demonstrate that its TP arrangements are in accordance with the applicable laws and regulations.
It is also advisable to steer clear of incorporating “page-fillers” in TP documents, like extensive sections straight out of the TP Guidelines. This only serves to annoy the reader, be it the tax inspector or anyone else. It does not in any way contribute to the goal of clarifying the TP policies and practices to the reader. Copy-pasting TP Guidelines or other such material does not give the tax authorities the impression that the company is compliant with the TP documentation requirements or that the company’s TP model is aligned with the arm’s length principle.
Tax authorities tend to pick up on TP documentation that appears to be prepared as a compliance formality, prompting a closer look. They look unfavourably on master and local files that have a generic and template-style approach. Instead they prefer tailored documents that provide a sufficient degree of detail, allowing them to assess the TP model without having to ask for extra information and supporting documents. Companies should, therefore, ensure that their TP documentation is as detailed and specific as possible, accurately reflecting the operations. This involves moving beyond a tick-the-box mentality to provide a comprehensive and nuanced analysis of the functions, assets and risks employed/undertaken by the entities involved in the intercompany transactions.
