Elevating operational transfer pricing in a complex data ecosystem

In the brave new world of transfer pricing (TP), the way multinational taxpayers operationalise their transfer prices continues to find itself under the spotlight. Gone are the days when disputes revolved around the minutiae of your benchmarks and local entity margins; where the disarming smile one gave to the local tax officer could be the first defence to support your TP positions.

With tax authorities going digital and data-heavy compliance requirements reigning, taxpayers need to adopt a broader lens when formulating their TP strategy. Taxpayers must recognise the growing need to maintain a cohesive, end-to-end data ecosystem linking their financial, tax, and operational data for TP purposes.

Operational transfer pricing (OTP) is no longer confined to the management of multinational entities’ TP policies but also to the creation of a cohesive framework throughout the TP life cycle (i.e., data extraction, policy implementation, documentation, dispute mitigation, and active controversies).

Technology has become the main enabler of change, and it is critical for a company’s tax/TP function to have a seat at the table when deciding on the company’s digital strategy.

The global push for tax transparency has created the momentum needed for tax leaders to be part of financial transformation discussions. As technology continues to entwine itself with a company’s business, the expectation that technology also becomes a critical part of solving a company’s tax and TP challenges is a recurring theme.

To understand the digital tax transformation landscape, reference is made to Deloitte’s three-part Tax Transformation Trends series. The articles were published based on the findings from part of Deloitte’s 2021 Global Client Survey and give insights on the recent thinking in digital tax management by tax and finance leaders.

The main focus of tax leaders has increasingly been, and should be around, the following:

• Improving data quality – all roads begin with data. No TP policy, compliance and dispute management strategy is viable without accurate, accessible, and analysed (3As) data. For large groups in particular, fragmented data, the use of multiple ERP systems, and setting up master data and a design covering all possible scenarios pose significant challenges. Next-generation ERP projects are being implemented, with SAP S/4HANA and Oracle Cloud leading the way (according to the Deloitte survey, 86% of respondents are in the midst of next-generation cloud-based system transformations). It is imperative for tax functions to be deeply involved in the process to ensure all required data points are considered during ERP implementation and tax is not considered as only a bolt-on to the organisation’s technological journey.

• Automating processes – taking away manual functions and automating analytics. The sheer volume of data means companies cannot rely on manual processes to meet compliance obligations and manual analytics to identify potential risks. The use of enterprise business planning, compliance, and analytics solutions is on the rise.

• Rethinking operating models – with evolving business models, there is a strong need to focus on developing a coherent tax/TP strategy beyond routine compliance.

Tax leaders have been acknowledging OTP as a priority and a main driver of their investment in the short term. Though tax/finance leaders agree that technology is the way forward, the challenge is to bring in other stakeholders on the same side, considering the large investment required to digitalise the tax function.

TP leaders grapple with a common challenge of balancing the need to meet growing TP complexities while optimising tax budgets. To TP leaders, part of this answer is to outsource (internally within the organisation or externally) their digital transformation initiatives.

Until recently, the ‘push’ factor to digitalise OTP and compliance was driven by the need to increase efficiencies and proactively anticipate potential tax/TP risks. The results had been mixed, with TP/tax technological improvements being haphazard, and tax being an afterthought in the financial transformation journey.

Now, the increasing compliance requirements dictated by the tax authorities and their own digital transformation journey have, themselves, become inexorable pull factors. Transparency and governmental/public scrutiny amplify the consequences for taxpayers that maintain a reactive policy. Failure to manage these risks has a heightened reputational impact for a company, a potential outcome that has also brought tax data management and reporting to the attention of C-suites.

The emphasis on compiling group-level or cross-border financial, tax, and business data for TP compliance started with country-by-country reporting (CbCR). The automatic exchange of information for CbCR data between competent authorities allowed for the cross-border sharing of taxpayers’ data and raised the stakes for taxpayers to maintain accurate and consistent global tax data.

The recent move to make such CbCR information public (i.e., the Directive of the European Parliament and of the Council amending Directive 2013/34/EU, and a proposal in the Australian 2022–23 federal budget) puts a further spotlight on the need to maintain robust data.

In addition to CbCR, the need for group financial, tax, and business data has spread to local compliance requirements. In Australia, the various pieces of practical compliance guidance issued require access to group-level data in making risk assessments; for example, cost structures of sales, marketing, and procurement hubs to assess profit shifting risks through hub structures, and insights to group/affiliate entity debt structures as part of financing risk assessments.

With the introduction of BEPS 2.0, the need for fully integrated global tax, financial, and operational data for risk assessment and compliance grows even more prominent. Several key aspects of the computation, such as the determination of Amount A and Amount B under pillar one, would require companies to link operational and financial/tax data robustly. For example, the primary sourcing rule requires revenues to be sourced on a transactional basis in accordance with the nature of the transaction (reliable indicators for the sale of tangible/digital goods include the place of delivery of the goods, online advertising services requires data regarding where viewers view the advertisement, etc.).

For Amount B, the need to implement and monitor the applied TP policy to group distributor returns accurately will be critical. Companies will need enterprise planning software to consolidate the financial data of the group’s distributors entity returns, conduct TP adjustments, and assess the potential impact to the broader group. To apply pillar two top-up taxes, companies would need the financial accounting data of group entities and to keep separate tax calculations to implement the income inclusion rule and the undertaxed payment/profits rule properly.

The need to monitor the effective tax rates of affiliate entities and manage the deferred tax asset calculations of affiliate entities, calculating the necessary top-up taxes and tracing the different paying entities, highlights the urgency of maintaining a coherent, end-to-end data ecosystem. Tax leaders would need to ensure it has integrated, accurate, and reliable data to meet these requirements.

Many tax leaders recognise that tax authorities have rapidly accelerated their technological journey and have done so at an unexpected rate.

The substantial technological investments made by competent authorities is illustrated in OECD surveys from the Forum on Tax Administration. Based on the latest 2022 survey, the digitalisation of data-gathering functions has been heavily focused on. Most mature jurisdictions have the technological infrastructure to receive, compile, and collate taxpayer data through business systems, third-party financial institutions, and agencies.

Most tax administrators share bulk information with other government agencies and provide them with direct access to information. Tax administrators have started using big data to identify risk areas, and have the necessary people, skills, and infrastructure to utilise this effectively. They have also adopted enterprise business intelligence and visualisation tools, along with real-time analytics for tax fraud detection and prevention.

Furthermore, tax authorities have enhanced their focus on transactional analysis and the implementation of TP policies by taxpayers. Given these developments, taxpayers cannot afford to lag behind.

The creation of a TP data ecosystem involves the creation of a platform that extracts and consolidates all TP data for common use. It also includes developing the infrastructure that allows companies to structure, analyse, and prepare data for specific TP outputs. This goes beyond the traditional understanding of OTP, which focuses on the management of TP policies.

The tax/TP function typically has limited visibility of the genesis of data. It has traditionally relied on the finance function, with limited visibility of the accuracy and consistency of TP policy implementation, which leads to audit risks. Tax leaders need to ensure they have full visibility of, and agree with, the methodology and data sources used by the finance function when implementing TP policies. The lack of a single, unified source of data and consistent computation methodology may result in various risks:

• Relying on fragmented, local- or country-specific financial information without visibility of the potential impact on the broader group;

• Reconciliation issues between local country versus group consolidated data, and between various outputs and underlying financial/tax data (for example, TP segmentation versus financial accounts);

• Inconsistency in the implementation of policies, such as differential treatment of the same profit and loss (P&L) items in TP computations, or the application of different allocation drivers across legal entities;

• Difficulty in meeting tax and TP governance standards, with a growing focus by competent authorities;

• Lack of scalability with the expansion of a company’s business and compliance; and

• Lack of analytical potential – the lack of cohesive and accurate data limits the type and effectiveness of potential analysis.

A cohesive TP data ecosystem ensures a high level of data integrity with full transparency for the tax/TP functions, as well as for the competent authorities.

An end-to-end approach should encompass and deal with the below issues:

1. Data sourcing: taxpayers typically deal with multiple data sources of varying quality and formats – creating a single data lake of structured and unstructured data which all participants may utilise would be vital. This will also allow consistent data to be used for all TP, tax, and financial needs.

2. Data wrangling and import: taxpayers need to ensure the source data is similarly structured and cleaned up for use – the creation of an analytical and processing framework allowing participants to structure, analyse, and prepare data, including the ability to undertake TP scenario analysis, segmentation, and monitoring.

3. Processing and dashboarding: the TP/tax team use manual processes to process/monitor a large volume of data – automate the analytics processes with smart dashboarding capabilities to provide a bird's-eye view, with traceability.

4. Adjustments and alignment: the TP/tax team use manual processes to compute/monitor adjustments, resulting in delayed actions/adjustments across a period – deploy analytical capabilities for real-time monitoring and timely action.

5. Documentation: TP documents prepared manually. Financial data collated manually – automate documentation, including the sourcing of key data from a data lake, and ensure there is an audit trail for a company’s governance framework.

6. Reporting: taxpayers prepare local TP reporting documents manually and have limited control over local country outputs – leverage on technology to ensure consistent data application and meet TP compliance obligations; for example, TP forms, local files, CbCR XML. Pre-made local country templates for automated report preparation could be considered.

Taxpayers and their advisers have typically focused their attention on steps five and six in the above framework. The creation of a cohesive TP ecosystem will require an enhanced focus on steps one to four.

A question frequently posed before tax leaders is how to navigate through OTP implementation involving multiple internal stakeholders. There is more than one way to move forward in the digitalisation of a TP function. One must assess the organisation’s readiness and its resource availability to develop a plan specific to the organisation. Some of the best practices to consider are:

• Identify pressure points – the TP team will need to identify specific priorities and rank these based on importance. Transactions and/or businesses with the highest volume of data and manual processes, with the largest expected benefits, ought to be prioritised.

• Go modular but keep the big picture in mind – it may be easier to obtain quick benefits, though the objective of developing an end-to-end TP ecosystem should be the driving force. One can focus on a single use case (for example, cost allocation, TP P&L segmentation, CbCR, and tax and governance reporting) to begin with, and expand in phases to derive incremental value. In the case of a diverse/fragmented group, focus on single business units, or clusters of companies/business divisions, to develop a proof of concept.

• Take stock of the available resources – this includes existing ERP systems, software, and skill sets, which would allow taxpayers to capitalise on the existing resources.

• Identify and align internal stakeholders (i.e., finance, risk, tax, IT, and operations).

• Be technologically agnostic to begin with – taxpayers should be open to assessing which solution offers the best outcome for the specific circumstance. Each solution, though technically working within the same space, has different characteristics and features better geared to specific issues.

• Formulate a coherent outsourcing plan – the large investment of creating a data ecosystem may mean outsourcing some functions. Be flexible in what may be outsourced (for example, outsourcing or digitalising the TP documentation activity to allow in-house teams to focus on strategic decision making) and adopt a soft-touch approach of engaging on-call advisers. These decisions need to be driven by the existing skill set and technological/process maturity of the company.

A taxpayer’s ability to transition from a reactive tax/TP strategy by harnessing technology is critical to operationalise its TP policy successfully.

The creation of a digital infrastructure to extract, analyse, and prepare data throughout the TP life cycle will be key to minimising the potential risks. The increased scrutiny faced by taxpayers has elevated this to become a priority issue and the tax function can no longer afford to maintain the status quo.

It is imperative for multinational entities to have a comprehensive and customisable tax platform with modules/solutions to address specific tax requirements, with flexibility and scalability. The ability of taxpayers to deliver this is no longer a question of ‘if’, but ‘when’.

Given the enhanced business complexities, the regulatory landscape, and the technological drive adopted by the tax authorities, it would be an apt time for tax leaders to press for, and expedite, the digitalisation of an integrated TP function.