Back to the basics – same same but different?

We have Transfer Pricing (“TP”) policies, TP agreements, TP declarations/returns, and TP documentation including TP local files and TP Master Files. Are they all the same?? Let’s try to clarify the gobbledygook!

The TP policy

The TP Policy is the pricing arrangement applied to the related party transaction for example cost plus 5%, or royalty of 8%. The TP policy outlines the pricing formula for the transactions to comply with the arm’s length pricing of the transaction. This will come in handy when it is time to prove the arm’s length compliance to a revenue authority. The TP policy is typically disclosed in the TP Local file.

TP agreements

There are (or should typically be) legal agreements between connected persons governing the legal terms and conditions of the arrangements and remuneration agreed between the parties. These legal agreements should be akin to those between third-party persons.

TP return versus TP Files

A TP return/ declaration is prescribed by certain revenue authorities and is usually submitted along with an income tax return. The TP return does not touch on the issue of evidencing at arm’s length, it is merely a form outlining certain factual details about the related party transactions that the taxpayer engaged in during the year. To put things into perspective, we will take Zimbabwe as an example, where a taxpayer is required to submit a TP return, along with the income tax return. From the TP return, the revenue authority can ascertain what related party transactions the taxpayer engaged in and based on the value of the transaction (or other factors), can decide to request a TP Local File. Correct disclosure is of course critical.

What is TP documentation anyway?

TP Local File

TP Document or Local File (“LF”) is an entity bespoke document wherein the taxpayer details its business activities, and industry analysis, and demonstrates how the parties involved in the related party transactions share the functions, assets, and risks associated with these transactions. Further, the LF will demonstrate whether or not the related party transactions were undertaken at arm’s length, through the economic analysis section. This document, depending on each revenue authority, is required to be submitted annually at a specific date to the revenue authority (normally the date of filing tax return). In some instances, it is submitted only on request (typically 7-30 provided to submit).

Considering the level of detail required in the LF, the importance of having a robust LF can never be stressed enough. This document serves as the first line of defence should the revenue authority come knocking and enquiring about the taxpayer’s TP dealings. This document can determine whether the revenue authority initiates TP audit or not.

TP Master File

A TP master File (“MF”) is a document that provides an overview of the global business operations and TP policy of the multinational group. Typically, the MF will contain information such as organisational structure, value drivers, main geographical locations, description of the business activities of members of the group (i.e. products, services, supply chain, etc.), information about the group’s intangibles, activities within the group (including external funding) and financial and tax positions of the multinational group. This document is usually prepared by the ultimate holding company of the group and made available to group entities.

Conclusion

If you need any help with your TP compliance, please contact our team of experts.