Transfer pricing practices in the dock

How businesses can avoid further scrutiny

The issue of transfer pricing has hit the headlines in the UK and the US over recent weeks due to the relatively low level of corporation tax multinationals such as Amazon, Apple, Google and Starbucks.

For the non-tax professionals, transfer pricing occurs when a division of a multinational in one country charges a division in another country for a product or a service. These ‘transfer prices’ are supposed to reflect what two independent parties would have agreed upon in identical circumstances.

For multinationals, transfer pricing rules say that profits need to be allocated from one subsidiary to another where goods or services flow between them. In the case of Starbucks, profits from UK sales are transferred to its roasting subsidiary in the Netherlands and the trading arm in Switzerland. This is completely normal practice.

The issue is how much is being transferred.

Starbucks made £398m in revenues in the UK in 2011/12 but recorded a net loss once costs to subsidiaries were factored in. No profits means no corporation tax.

As I have mentioned previously, the issue has now moved into the realms of morality with campaigners calling for the multinationals to pay their ‘fair share’. A nebulous concept but brands can suffer if they are deemed in violation. Consumers can vote with their feet. Note the extra £10m Starbucks has offered to pay.

And scrutiny looks set to increase with global bodies such as the G20 and the OECD under pressure –  not least from cash-strapped exchequers – to tighten rules. Companies need to make sure their transfer pricing policy justifications and associated documentation can stand up to intense scrutiny and challenge.

It is far from an exact science but businesses should adopt pragmatic transfer pricing policies which balance the trade-off between certainty, risk and tax optimisation. Those that do pull back some of the time and resources spent on resolution.

Francesca Lagerberg is global leader for tax services at Grant Thornton.