Do you need a year end transfer pricing adjustment?

Year end is one of the busiest times for accountants and tax people alike, whether they are in-house employees or working in professional services. 

The year end process needs to be as streamlined as possible so that all the various elements can be completed before the books close. Given the complexities associated with transfer pricing, this is often overlooked as part of the year end close, requiring late adjustments or subsequent year adjustments to be made. 

Why do I need to worry about transfer pricing?

Transfer pricing is the process of pricing international related party transactions involving two different tax jurisdictions, to ensure each counterparty has received adequate profit or compensation for their involvement in the transaction. Transfer pricing is one of the key focus areas for the ATO and as such companies should be ensuring their profit on intercompany transactions has been priced and given effect in line with Australia’s transfer pricing rules. 

Ideally, each group should have a transfer pricing policy which governs how these transactions should be based. These are generally in line with the Organisation for Economic Co-operation and Development (OECD) Transfer Pricing Guidelines, while also taking into account local regulations. The transfer pricing policy should be legally enforced by intercompany agreements and indicate how often the charges should be reconciled or “trued-up”. 

The most commonly applied transfer pricing methodology in Australia is the Transactional Net Margin Method (TNMM), which is usually applied on a whole of entity basis for simplicity purposes. The two most common profit level indicators would be the Operating Profit Margin (OPM), and the Net Cost Plus Margin (NCPM). Both methods seek to ensure the taxpayer has an arm’s-length profit margin or mark-up based on their functional profile or contribution to the Group, when compared to other third parties performing similar services or functions.   

Do I need to consider a transfer pricing adjustment?

In line with Australia’s self-assessment system, the Australian taxpayer’s transfer pricing position should also be self-assessed each income year prior to the lodgement of the income tax return. Accordingly, where this methodology is applied on a whole of entity basis, this should be reconciled at least once a year against the final year-end figures included in the income tax return. This could be for the Australian taxpayer or the counterparty, depending on the transaction involved. It is best practice to ensure that any adjustments are included in the relevant accounts before the books have closed, as transfer pricing can have a material impact on the final position if not properly addressed. 

There are also several significant effects and considerations of any transfer pricing adjustment: 

• Deductibility: one of the pre-requisites for an amount to be “deductible” under s8-1 for Australian income tax purposes is that the expense needs to be “incurred”. Therefore, it is essential that there is a legal basis for the expense, the mechanism for any transfer pricing adjustment should be clear in an intercompany agreement. In the absence of a written intercompany agreement, any “transfer pricing adjustment” may not be deductible to the Australian taxpayer. 
• Capital:  a negative limb under s8-1 is that an expense cannot be capital or capital in nature. An adjustment made to an international related party of an Australian taxpayer to ensure it derives a certain overall profit indicator, in the absence of a written legal agreement, may be considered a capital support payment and potentially non-deductible to the Australian taxpayer. 
• Impact on customs duty: where year-end adjustments are made as an adjustment to the value of trading stock this may also affect the dutiable value of those goods. Aside from any underpayment of customs duty owing, penalties may apply for incorrect import declarations.

Action items for companies operating internationally

In light of the above, if your company operates internationally, there are three action items you should consider as part of your year-end process. 

1. Review the transfer pricing policy of the Australian taxpayer

• Does the functional profile continue to align?    
• Is the relevant benchmarking current or does it need to be updated? 

2. Review the transfer pricing calculations 

• Have the transfer pricing calculations been performed based on year-end figures? 
• Are any subsequent adjustments required and which income year should they be booked? 
• Do any provisions need to be made in the financial statements under Australian Interpretation 23 – Uncertainty over Income Tax Treatments?

3. Consider any new provisions or guidance which may be relevant 

• This could include new ATO guidance, changes to the thin capitalisation legislation, royalties and intangible related payments, hybrid mismatches to name a few.  
• How will these affect me this year or next year?   
   

For more information

RSM is a fully integrated accounting firm, offering accounting, international tax, and transfer pricing services, which can provide a seamless service offering to our clients. If you require any assistance with simplifying your year process, understanding your transfer pricing requirements or would like to discuss any international tax related issues in further details, please contact Danielle Sherwin.