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Demystifying Transfer Pricing Execution and Intercompany Accounting

by Andrew Hwang, Managing Director and Sharabh Ivaturi, Advisory Director | insiderPROFILES, Volume 6, Issue 1

December 23, 2014

insiderPROFILES PWC column

Transfer pricing has always been a complex topic, but as companies increasingly expand into global markets, it is more important than ever. In this column from PwC, gain in-depth insight into the system design and frameworks necessary to support transparent and compliant transfer pricing policies.

 

For large multinational companies that must comply with myriad tax policies and regulatory agencies all over the world, transfer pricing has always been a complex undertaking. With more organizations expanding into international markets, and with new regulations shining a spotlight on the source of profits and where those profits are being reported, transfer pricing has never been more important than it is today. 
 
A case in point is the recent commitment by 44 countries, made at the G20 Summit in Cairns, Australia, in September 2014, to accept the Organization for Economic Co-operation and Development (OECD) country-by-country reporting template by the end of 2016. This commitment — to disclose to local tax jurisdictions (once they adopt matters into local law) where profits are made and how they are allocated across jurisdictions — was a big step for organizations that are multinational.
 
As companies frequently do not have pricing aligned for how they record and report transfers of tangible goods, licenses, or sales of intellectual property or the provision of services and financing between related parties, country-by-country reporting will bring greater transparency to how multinational value chains are distributed globally.
 
The leading practice is for corporate executives to work cross-functionally — bridging operational, financial, and information management systems — aligning transfer pricing with the pricing and execution approach within their ERP and reporting systems. However, in a February 2014 survey conducted by PwC1 that asked senior tax executives about the technology gaps with tax functions, the majority of the respondents felt that intercompany transfer pricing execution and compliance have been neglected in their ERP and business intelligence designs. Our experience with clients confirms that thousands of hours and millions of dollars are frequently spent on highly manual processes, fraught with risk, to work around this identified gap.
 
Having an IT infrastructure that supports complete transfer pricing transparency, is of paramount importance for any multinational. System design must support a full integration of ERP transactions with tax reporting. A challenge for many organizations that run SAP software, however, is that their initial system designs did not factor in this granular level of transactional oversight or the processes to support a global transfer pricing solution. Just as segmented financial reporting created challenges for aging systems, so too does increased transfer pricing scrutiny.

Having an IT infrastructure that supports complete transfer pricing transparency is of paramount importance for any multinational.

Strategy Starts with Design

From a strategy standpoint, the key question for transfer pricing execution is this: How does an organization ensure that the right information is being captured at the transaction level? Greater transparency is required not only to drive compliance, but also to enable a pricing forecasting model so that an organization can defend its pricing adjustments in the event of an audit. An analytics tool is also required to analyze and monitor changes in price adjustments necessary to conform with the company’s transfer pricing policies.
 
The reason initial system designs did not factor in the level of transactional oversight required to satisfy transfer pricing considerations is that ERP systems traditionally have been designed to support only the core business operations, and not tax or legal reporting requirements. Current leading practices call for tax and transfer pricing requirements to be incorporated in the blueprint of the ERP design, with IT professionals working closely with tax colleagues to achieve appropriate integration. Many companies have rejected this approach because the upfront setup costs can be high. However, when compared to the cost of remediating these disparities on an annual basis, the initial expense is often significantly less in the long term.
 
Moreover, ERP system upgrades do not always keep pace with growing geographic footprints or operational expansion, particularly in newer companies. Often the cost-conscious and entrepreneurial mindset of an emerging multinational enterprise translates into systems that lag behind the needs of the business over time. As a result, companies often have to deal with disparate transactional systems, redundant and decentralized data, and massive data volumes.
 
Designing an ERP system to support transfer pricing requires an understanding of transfer pricing functions and processes. Tasks include setting legal entity profit levels during budgeting, calculating target transfer prices or markups, allocating intercompany services costs, monitoring the interim results, preparing adjustment entries, forecasting pricing changes, simulating possibilities, and maintaining supporting documentation and audit defense, to name a few, all of which entail detailed analysis. The need for all these activities to take place with reference to legal entity results (factoring in local Generally Accepted Accounting Principles and timing adjustments) creates significant additional complexity.
 
For example, consider an intercompany transfer price that needs to be updated for a specific product line or stock-keeping unit (SKU) based on a review of the latest quarterly financial results. This would, in turn, require analyzing the cost and selling price of a given product at a global level as well as the entity level to ensure both the local and global margins of the product remain within policy guidelines. Furthermore, transfer pricing policy targets are typically set at an operating margin level, meaning indirect and overhead costs also need to be assigned or allocated at the product or even SKU level. When combined with the need to forecast transfer pricing results — and not just monitor actual results — transfer pricing execution requires much more of an analytical technology framework than just the transactional system.
 
For companies that are setting up operations overseas for the first time, transitioning from a traditional transaction-based ERP system to an analytical and predictive model to support transfer pricing is nothing short of a financial transformation. Helping clients understand the magnitude of this transformation is where PwC starts on a transfer pricing roadmap. Once a company grasps the concept from a global perspective, PwC advisors can then help strategize at a local level to improve transfer pricing for each legal entity based on its tax requirements, products, and geography.

A Monitoring Framework

Today, there is an increasing need to monitor and evaluate changing conditions at different levels within the organization. As a result, many ERP systems do not have the capability to monitor or evaluate changes on a real-time basis. To fill this gap, enterprise performance management (EPM) solutions extend the capabilities of ERP systems by offering real-time modeling. SAP’s solutions for EPM provide a platform to build a fully integrated tax reporting solution for an ERP system (an SAP or non-SAP transactional system). SAP provides two applications — SAP Business Planning and Consolidation and SAP Profitability and Cost Management — either of which companies can deploy as a key component of an extensive platform for tax users to monitor and provide audit defense, as well as to enable the needed transparency into intercompany pricing policies and fluctuations. EPM applications such as SAP Business Planning and Consolidation and SAP Profitability and Cost Management can help solve the challenges inherent in any financial transformation to support transfer pricing policies by providing a multiuser, multilanguage, and multicurrency environment where users can easily analyze and monitor data. SAP Profitability and Cost Management provides the business with a flexible and interactive experience in developing multiple financial models by centralizing financial data. For example, the powerful calculation engine of SAP Profitability and Cost Management enables the analytical modeling of the information from SAP ERP to help support transfer pricing auditability.
 
SAP Business Planning and Consolidation and SAP Profitability and Cost Management are compatible with ERP transactional systems and data warehouses. In addition, both applications can accept data from non-SAP systems, which is usually a critical requirement for most multinational companies given their diverse system application landscapes. The decision of which solution to use to monitor transfer pricing rests on a company’s overall enterprise architecture, system landscape, and other business processes in scope. Both applications can serve as transfer pricing engines, leveraging information flowing from ERP systems to support intercompany price-setting strategies that satisfy local tax jurisdiction regulations. Also, both solutions are highly integrated with Microsoft Office since many companies extract information from their enterprise systems into Microsoft Office tools. 

An Opportune Time

Financial planning and analysis teams are looking for customer, channel, and product profitability, and cost to serve to all be fully loaded. So the opportune time is aligned not only to comments on US Security and Exchange Commission (SEC) reporting but also to other needs in the finance organization. In many ways, transfer pricing is following the segmented financials reporting requirements in terms of how an organization responds to increased external pressure, both from technological and strategic points of view. An ERP installation of a decade ago, for example, was ill-equipped for the automated segmentation of financial data that was needed to comply with SEC regulations, and manual workarounds were common until the release of the SAP New General Ledger Financial Planning rapid-deployment solution with SAP ERP 6.0.
 
Similarly, with transfer pricing scrutiny on the rise, it is critical that an organization design its ERP system so that it is the key data source for all information relevant for full transfer pricing transparency. Finance IT professionals need to involve tax department colleagues to understand any additional necessary reporting or data capture as the business evolves, enters new markets, or encounters tax law changes such as country-by-country reporting. Business planning and profitability applications now offer integrated solutions that can address complex tax and transfer pricing reporting requirements, and they provide an organization with the confidence that it is engaging in international trade in a compliant and defensible manner.
 
The failure to comply with transfer pricing regulations can incur steep financial penalties. As such, IT professionals must work together within their companies — especially with tax, treasury, and finance — to guide the development and implementation of the integrated ERP and EPM solutions. The cost of non-compliance is too great to leave transfer pricing to chance.

1 Responses to senior tax executives’ polling at TP Minds Americas Conference in Florida (February 2014). [back]

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Andrew Hwang
Andrew Hwang

Andrew Hwang is a Managing Director in PwC’s Transfer Pricing practice. He has 19 years of tax management consulting experience, working with tax, finance, business, and IT functions of large multinational companies. He focuses on projects enhancing tax and transfer pricing management over the enterprise value chain — end-to-end execution of transfer pricing structures; “tax sensitizing” the forecasting and financial close processes; enhancing data quality through design of clients’ ERP systems and BI applications; developing custom tax modeling and planning applications; and implementing third-party tax provision and compliance software.


Sharabh Ivaturi
Sharabh Ivaturi

Sharabh Ivaturi is an Advisory Director at PwC with over 23 years of experience including 16 years in client service. He specializes in technology-enabled enterprise transformations. His industry experience includes several multinational energy, chemicals, high-tech, pharmaceutical, and industrial manufacturing companies.



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