Nowadays, more and more attention is focused on enterprises and their tax behavior such as tax planning, tax compliance and tax controversy. Therefore companies are even more interested in the internal organization of their tax processes and responsibilities, resulting in tax risk management and tax governance. It also means that the company’s executives are tirelessly working to ensure that transfer pricing risk management is integrated in the company’s internal control framework (usually referred to as corporate governance framework or enterprise risk management).
Besides the transfer pricing documentation requirements, companies are expected to provide assurance to their stakeholders regarding transfer pricing governance in the current business environment. So they need to implement transfer pricing strategies in their corporate governance framework respectively their tax control framework. Whilst doing so the company’s executives become more aware of all transfer pricing requirements and legislative changes which will enable them to anticipate on legislative changes, assuring stakeholders that they will be provided with the right information regarding the company’s transfer pricing position in a timely manner. Aruba has codified the documentation obligation related to transfer pricing in its Profit Tax Ordinance (hereinafter: PTO; article 4, paragraph 4 PTO and other domestic regulations) effective since January 1, 2008. Transfer pricing concerns the rules and methods (policies and practices) for pricing transactions between affiliated companies and between natural persons and their affiliated companies. It relates to the applicable price for goods and services agreed upon by affiliated companies. The transfer pricing rules and methods intend to adjust the applied price for taxation purposes in transactions between affiliated companies to a business-like price (at arm’s length price). In other words: the price that would have been applicable between independent third parties.
This article not only concerns the Aruba transfer pricing documentation requirements, but also includes a brief introduction of transfer pricing risk assessment as well as transfer pricing risk management. It will demonstrate the importance of communication with tax authorities as well as the communication with the company’s tax function for adequate, well-functioning and flexible transfer pricing risk management within the entity’s corporate governance framework.
Documentation requirements
In order to control and mitigate transfer pricing risks the documentation requirements as set out in chapter five of the OECD Transfer Pricing Guidelines need to be complied with. According to these requirements taxpayers should make reasonable efforts the moment transfer pricing is established to determine whether the transfer pricing is appropriate for tax purposes. In this regard the taxpayer is, amongst others, required to prepare or refer to written materials that could serve as documentation of the efforts undertaken to comply with the arm’s length principle. These documents should also include information about how the transfer pricing was determined, which factors were taken into account and which transfer pricing method was selected.
Transfer pricing risk assessment
When dealing in intercompany or intra-company transactions, the concerning entities have to conform to transfer pricing rules and regulations. This can be done for instance by taking the OECD’s Transfer Pricing Guidelines into account. These rules aim to address potential mismatches between intercompany and intra-company profit allocation and the intercompany or intra-company distribution of risks, assets and functions. The tax authorities on their turn assess whether or not the applied transfer prices comply with the rules.
In general, the main transfer pricing risks are a result of inadequate attention to transfer pricing compliance of taxpayers. These risks can be overcome by taking into account that transfer pricing risks may be present and that tax authorities may ask questions in this regard. The main transfer pricing risks arise from recurring transactions, large or complex one time transactions and taxpayer’s behavior in governance, tax strategies or in the ability to deliver compliance. For taxpayers, the latter risk is the most manageable because that risk is more related to the taxpayer’s behavior rather than to the intercompany or intra-company transactions. Taxpayers should ensure they are compliant with transfer pricing laws and regulations by implementing sufficient and effective tax risk control measures, since non-compliance in this regard is often an indication of incorrect transfer pricing outcomes.
How to mitigate transfer pricing risks
Transfer pricing risks can be mitigated by conducting research on which transfer prices an independent third party would have taken into account in a similar transaction. This will be in accordance with the arm’s length principle. The main objectives of the application of the arm’s length principle in this regard would be to ensure a consistent basis for profit allocation and to help prevent taxation of the same profit by two different tax authorities (economic double taxation). Furthermore transfer pricing risks can be mitigated by means of implementation of a tax control framework which enables a company to identify the possible risks in a timely manner.
Risk mitigation by means of a well-functioning tax control framework
A company’s tax control framework should, for tax assurance purposes, identify, monitor and mitigate tax risks. Therefore, as part of the tax control framework, companies should identify whether or not the intercompany and intra-company transactions are in accordance with the arm’s length principle. Furthermore the transfer pricing documentation should fulfill the requirements as set out in the Transfer Pricing Guidelines.
Communicate a clear transfer pricing strategy
Although the implemented transfer pricing policy leads to at arm’s length intercompany and intra-company transactions, the company should constantly monitor and be in control of its transfer pricing risks and assure whether or not the implemented transfer pricing risk control measures are efficient and effective. The company’s executives should therefore communicate a clear transfer pricing strategy which should be implemented in the company’s corporate governance framework. This should enable companies to identify information with respect to the execution of the transfer pricing policy and strategy, as well as the transfer pricing processes. Furthermore well-functioning transfer pricing strategies and methodologies make it possible for companies to appropriately manage the tax accounting processes and the tasks and responsibilities related to transfer pricing.
To effectively monitor and test the implemented tax control measures, including the transfer pricing risk control measures, the inclusion of a remediation, an escalation as well as a communication plan in the corporate governance framework and in its internal monitoring and testing methodology is required. So in order to achieve appropriate and manageable transfer pricing risk controls the company should identify its tax function, keep them well informed about transfer pricing policies and strategies and ensure that these individuals are in constant communication with each other. The implemented transfer pricing risk controls should be regularly reviewed to ensure that the transfer pricing policies and strategies are appropriate and well managed. Therefore communication about the findings and amendments to the control measures is crucial. Furthermore, effective transfer pricing risk management not only includes communication within the company and within the group, but also with the tax authorities. The outcome of this communication concerning the assurance of the correctness and accuracy of the information that is required, needs to be shared, as well as the level of importation and the assessment whether or not a tax ruling regarding the applied transfer pricing methodology is needed.
Conclusion
In the current business environment companies are expected to take transfer pricing risk assessment into account and review their business circumstances to be able to assess and evaluate their transfer pricing risk exposure. A thorough review will enable the company’s executives to manage and mitigate the identified transfer pricing risks. In addition communication within the company, the group and with the tax authorities is crucial. Therefore, when implementing transfer pricing risk management into the corporate governance framework, companies should not only consider how to practically manage their transfer pricings risks and processes, but also ensure clear communication regarding the transfer pricing policy and strategy within the company, the group and with the tax authorities.