Transfer Pricing: Tax Risk or Measuring Rod?

A new study shows CFOs rank transfer-pricing risk almost as high as global compliance.
Kathy HoffelderMay 30, 2012

Multinational CFOs are increasingly looking to avoid the double taxation that can occur from selling a product in one jurisdiction when it is manufactured in another. Transfer pricing, or the movement of goods and services in order to allocate profits, has become a high-ranking concern for CFOs, according to a survey by Alvarez & Marsal Taxand, an affiliate of Alvarez & Marsal advisory firm.

Senior financial executives of more than 30% of the 60 businesses with more than $1 billion in annual revenue that were surveyed said transfer pricing was the greatest risk they were facing, just behind global compliance at 32%. The same pattern held for the 158 smaller firms surveyed that took in less than $1 billion in annual revenue. Out of the latter group, 20% claimed transfer pricing was a main risk, while 23% said global compliance was their greatest risk. Overall, more than 300 financial executives were surveyed in the study, with more than 70% representing smaller firms.

“Once something goes wrong in the transfer-pricing area, it becomes a huge controversy very quickly, especially if there are two countries involved by definition,” says Kent Wisner, managing director of international tax at Alvarez & Marsal Taxand. “Even in a lower tax jurisdiction like Ireland, they need tax revenue just like the United States does.”

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Staying one step ahead of the tax penalties that may accompany trade distortions involving tangible or intangible assets, for example, is a key concern of businesses today. The risks become more pronounced as more merger and acquisition activity picks up, according to industry professionals.

Aside from tax concerns, executives of multinational firms focus on transfer pricing as a means to compare products, according to Kent Westerbeck, president of Westerbeck Risk Management. It can help identify which product areas of a firm are doing well and which are falling behind, he says. Generally, if an asset-liability mismatch is discovered in a product area through transfer pricing, “the hope is to figure out how much that mismatch is earning or costing.”

Transfer pricing involving financial instruments, or “funds transfer pricing,” has always been an important measure for banks, Westerbeck adds. But with the uncertainty characteristic of financial markets today, having accurate transfer pricing is even more helpful for executives. Westerbeck notes that this is particularly the case with nonmaturity demand deposits, such as savings accounts, which were profitable in the past but now often earn negative returns. Compared with years ago, the interest income for many of these products has fallen, which has hurt margins, he says.

Once a physical transfer-pricing structure is in place in a company, however, keeping that operating generally becomes less of a burden to financial executives, according to Alvarez & Marsal’s survey. Only 7% of the largest-company executives surveyed saw transfer pricing as a burden to their ongoing operations. “Its level of risk did not match its level of burden, at least for many companies,” explains Wisner. “It’s relatively easy to maintain until someone takes issue with it.”