Transfer Pricing Audit
The chances of a multinational being confronted with a transfer pricing audit have substantially increased over the last few years. Due to the intense focus on transfer pricing by almost all tax authorities around the globe, together with growing focus on international exchange of information, it seems only a matter of time before any multinational will be subject to transfer pricing audit scrutiny. Such audits may provide for substantial risks and disputes, and proper preparation by the multinational is a key in managing these risks.
In order to best manage audit exposure, it is essential to understand that this involves not only the actual audit proceedings but also the time before and after the actual audit takes place.
Followings are inter-dependencies between the pre-audit, audit and post audit phases:
Pre audit phase:
- Manage Transfer Pricing Risks proactively
- Develop Controversy Strategy
- Transfer Pricing Documentation
- Rulings and/or Advance Pricing Agreements
- Post audit knowledge transfer and Implementation
- Global audit monitoring/ dashboard
- Consider Industry and other relevant developments
- Manage client expectations
- Develop and apply audit strategy (adopt if necessary – i.e. Advance Pricing Agreement + Roll back)
- Audit process management:
(ii) Negotiations (adjustments/ penalties- if applicable)
(iv) Manage client expectations
Post Audit Phase:
- Evaluate audit results
- Evaluate Transfer Pricing policy
- Evaluate controversy strategy
- Consider impact for other countries
- Advance Pricing Agreement/ Litigation
- MAP and competent authority procedures (if necessary)
- Manage client expectations
Transfer Pricing Audit Checklist: Transfer Pricing Associates has created a transfer pricing checklist to assist multinationals in preparing for a transfer pricing audit. This checklist addresses relevant issues to consider in all three phases (pre-audit, audit and post audit) and provides for relevant guidance in managing the actual audit process. It also includes an example disclosure manual and an indicative list of relevant information. Although it is understood that local requirements and circumstances may call for specific attention, the checklist addresses general issues that will be important in all situations.
Some best practices from Transfer Pricing Associates’ experience are as follows:
• Prepare well in advance;
• Involve your Transfer Pricing advisor as early as possible;
• Establish structured communication with tax auditor;
• Use a disclosure manual; and
• Consider a structured transfer pricing control framework
Generic Transfer Pricing (“TRANSFER PRICING”) Audit Checklist
Pre-Audit Period – Daily Preparation of Transfer Pricing General Documents
1. Determining the need and the purpose of the Transfer Pricing documentation.
2. Creation/preparation/maintenance of global/regional/local Transfer Pricing documentations and legal agreements to support inter-company transactions.
3. Check whether the Transfer Pricing documents which are likely to be reviewed are complete or not. If not, complete the documents.
4. Check your “Transfer Pricing Maintenance and Disclosure Manual”
1. Upon the receipt of the announcement, make sure there is sufficient and reasonable time to get prepared for your Transfer Pricing audit. Do not simply accept any starting date if it is too rush for your preparation.
2. Ask the tax inspector or the tax auditor in advance for the relevant information of the audit, i.e. the estimated time scope of the complete audit; which financial years and which taxes will be examined.
3. Inform your Transfer Pricing adviser of the coming audit as early as possible.
4. Try to determine the character of the audit: is it a normal, periodic audit or are there specific reasons for the audit to be performed.
5. In case of any possible dispute on transactions related to goods, check with your Transfer Pricing advisor as soon as possible on whether there is a need to consider possible customs impact on your Transfer Pricing policy.
6. Try to preview what information will possibly be asked and check whether this information is readily available.
7. Prepare yourself in consultation with your Transfer Pricing adviser for those topics which are likely to be examined.
8. Conduct a high level check on potential transfer pricing risk areas, such as:
• Check recent /relevant business changes which might have had impact on your Transfer Pricing policy and accordingly the relevant documentations; and
• Specific recent business development on Transfer Pricing policy;
• Check previous discussion/issues with tax authorities relating to Transfer Pricing, e.g. questionnaires from Transfer Pricing auditor; minutes of the meeting with Transfer Pricing auditors.
Actual Audit Period
1 When the Revenue officials present themselves at your premises for the audit, ask for their ID.
2 Prepare for an opening meeting during which some background information is given on the company. An offer to be shown around the company is often appreciated.
3 The opening meeting should be used to make procedural arrangements such as:
• To present a Direct Contact Person to whom the auditor can turn for questions. Assign an employee as a direct contact person who can then supply the information requested by the auditor and see to his other needs;
• To show the TRANSFER PRICING auditor which facilities can be used. Make sure that the TRANSFER PRICING auditor has a comfortably situated room (not dark or noisy) for use for the entire tax audit period. This room should be cleared of any kind of information, whether stored, lying about or available through a terminal in the room;
• To lay down procedural arrangements in writing and be sure to be explicit on the point that the TRANSFER PRICING auditor is forbidden to wander aimlessly around the company or to loiter about; and
• To alert the other personnel of the Transfer Pricing audit and inform them that communication with the TRANSFER PRICING auditor is to be channelled through the assigned Direct Contact Person.
4 The functions of the Direct Contact Person are:
• To manage questions/questionnaires from the Transfer Pricing auditor;
• To manage/centralize answers to be provided to the Transfer Pricing auditor;
•To keep track on questions/questionnaire from the Transfer Pricing auditor and answers/information/documents provided (written records are preferable);
• Make sure that any questions/questionnaires from the Transfer Pricing auditor will be put in writing;
• To arrange meeting(s) and conduct the communication meeting if the Transfer Pricing auditor has questions to ask any specific employees in the company; and
• To offer/make copies of documents which the Transfer Pricing auditor requests or considers to be important for his audit.
5 Throughout the audit period, try to stay regular updated between auditor and company, such as:
• To stay in regular contact and interaction with the Transfer Pricing auditor;
• To have Daily/regular conversations with the Transfer Pricing auditor;
• To schedule periodic evaluation meetings to discuss progress and/or potential issues.
• To arrange a closing meeting on the finding from the Transfer Pricing auditor, e.g. the possibility of the adjustments.
6 In the course of the TP audit, determine/evaluate your audit strategy with your TP advisor.
1 Ask for a written final audit report from auditor.
2 Check whether written adjustment has been made.
3 Internal evaluations between company and TP advisor for the result of the TP audit for the purpose to prevent potential TP dispute, and/or to build future APA.
4 Determine strategies on how to address further outstanding issue after TP audit.
Documents which the Tax Inspector or the Tax Auditor May Request for the Transfer Pricing Audit (Non-exhaustive summary):
1. Specific TP report:
• Latest Transfer Pricing Master file
• Regional Transfer Pricing report(s); and
• Local Transfer Pricing report(s).
2. Transfer Pricing policy papers:
• Transfer Pricing Policy Statement;
• Intellectual Property Rights Policy Statement; and
• Country Risk Assessment.
3. Legal agreements:
• Agreements related to inter-company transactions; and
• Employment agreements.
4. Minutes of the (annual) general shareholder's meeting and minutes of the meetings of the Board of Directors.
5. Substance related documents:
• Intellectual Property Rights approvals;
• Intellectual Property Rights registration; and
• Income Tax authorization documents.
6. Profile descriptions of key personnel functions.
7. General audit information
• Tax returns for corporate income tax, wage tax and VAT;
• Financial Statements (e.g. financial accounts; balance sheet; ledgers etc.)
• Receipts sent by the court registrar to a lawyer (advocate);
• Notes payable/receivable;
• Depreciation schedules/amortisation schedules;
• Shareholders Register;
• Bills, receipts and box office draws;
• Business correspondence;
• Pocket diaries;
• Bank account statements; and
• Client files, management files and correspondence with the shareholder(s)/parent company.