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How can you manage risk with transfer pricing?

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Transfer pricing is the practice of setting the prices of goods and services exchanged between different units of the same organization. It can have significant implications for the profitability, tax liability, and performance evaluation of each unit. However, it also involves various risks, such as compliance issues, disputes, and misalignment of incentives. In this article, you will learn how to manage risk with transfer pricing by following four steps: setting clear objectives, choosing appropriate methods, documenting transactions, and monitoring outcomes.

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Mohamed Hamed, MBA, CIA, CMA

Financial Manager: MBA, CIA, CMA, CISA, FMVA | Strategic Financial Planning & Analysis | Treasury & Cash Management |…
Tomi Akinwale ACCA, ACA, ACTI, B.TECH, FMVA, AAT.

Tax | Deloitte | Financial Reporting & Modelling |

1 Setting clear objectives

The first step to manage risk with transfer pricing is to define the purpose and goals of your transfer pricing policy. Do you want to optimize your tax position, allocate costs and revenues fairly, motivate managers, or achieve a combination of these objectives? Depending on your answer, you will need to consider different factors, such as the legal requirements, the market conditions, the internal policies, and the stakeholder expectations. By setting clear objectives, you can align your transfer pricing strategy with your overall corporate strategy and avoid confusion and conflict.

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Mohamed Hamed, MBA, CIA, CMA

Financial Manager: MBA, CIA, CMA, CISA, FMVA | Strategic Financial Planning & Analysis | Treasury & Cash Management | Risk Management | Corporate Valuation | Financial Modeling
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Managing risk with transfer pricing involves several strategies to ensure compliance and optimize tax obligations while aligning with business operations. Here are some ways to manage risk in transfer pricing: 1. Documentation: Maintain comprehensive and contemporaneous documentation to support transfer pricing policies and practices 2. Policies and Procedures: Establish clear transfer pricing policies and procedures that are consistent with the arm’s length principle 3. Benchmarking Analysis: Conduct benchmarking studies to compare your company’s transfer pricing with similar transactions by independent entities 4. Regular Reviews: Periodically review and update transfer pricing policies to reflect changes in business operations

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2 Choosing appropriate methods

The second step to manage risk with transfer pricing is to select the most suitable methods for determining the transfer prices of your transactions. There are various methods available, such as the comparable uncontrolled price method, the resale price method, the cost plus method, the profit split method, and the transactional net margin method. Each method has its own advantages and disadvantages, depending on the type, volume, and complexity of the transactions, as well as the availability and reliability of the data. You should choose the methods that best reflect the economic reality, the arm's length principle, and the consistency with your objectives.

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Tomi Akinwale ACCA, ACA, ACTI, B.TECH, FMVA, AAT.

Tax | Deloitte | Financial Reporting & Modelling |
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Establish documented transfer pricing methods: Clearly define the approach used to set prices for internal transactions, ensuring compliance with relevant regulations and industry best practices. Common methods include comparable uncontrolled transaction (CUT), resale price method, cost-plus method, and profit split method.

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3 Documenting transactions

The third step to manage risk with transfer pricing is to document your transactions and your transfer pricing methods in a clear and comprehensive manner. This is important for complying with the tax regulations, supporting your transfer pricing positions, and resolving any disputes that may arise. You should prepare a transfer pricing documentation that includes information such as the nature and scope of the transactions, the parties involved, the functions performed, the risks assumed, the assets employed, the methods used, and the outcomes achieved. You should also update your documentation regularly and keep it in line with the changes in your business environment.

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4 Monitoring outcomes

The fourth step to manage risk with transfer pricing is to monitor the outcomes of your transactions and your transfer pricing policy. This is essential for evaluating the effectiveness, efficiency, and fairness of your transfer pricing system, as well as for identifying and addressing any issues or opportunities that may emerge. You should use various tools and techniques, such as benchmarking, variance analysis, feedback mechanisms, and audits, to measure and compare your actual results with your expected results, your internal standards, and your external benchmarks. You should also review and adjust your transfer pricing policy as needed to ensure its continuous improvement and alignment with your objectives.

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5 Here’s what else to consider

This is a space to share examples, stories, or insights that don’t fit into any of the previous sections. What else would you like to add?

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How can you manage risk with transfer pricing?

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1 Setting clear objectives

2 Choosing appropriate methods

3 Documenting transactions

4 Monitoring outcomes

5 Here’s what else to consider

Corporate Accounting

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