1. Big swings in profits
Large fluctuations in a company’s profits one year to the next naturally draw the attention of the tax authorities. In every such case, there is bound to be a discussion. Hence, it is critical to understand the reasons behind profit fluctuations to assess the appropriateness of the TP model and its alignment with the company’s actual operations and market conditions. In the absence of a clear and reasonable explanation, tax authorities may propose an adjustments to the taxable profits, assuming that the variance is caused by a deliberate attempt to shift profits.
Surely, big swings in profits could well be caused by an external commercial factor, such as a decrease in demand for the company’s products or a supply chain issue. However, if the variance in profits reported is not clearly explained in the TP documentation and linked to a verifiable external commercial factor, tax authorities will definitely take a closer look into the internal transactions to verify the cause of the variance. This is particularly true if profits appear to be shifted from a jurisdiction with a higher tax rate to a jurisdiction with a low tax rate.
This could imply that there has been a cross-border re-location of functions, assets and/or risks (“FAR”).
