What is transfer pricing?
A price set-up by two group companies operating internationally when they buy or sell goods, services, intellectual property, or financing with each other. This is also known as Arm’s Length Price i.e. a price assuming the group entities or related entities were independent of each other as if they were dealing with an unrelated party.
With the recent U.S. stance on climbing tariffs, the repercussions would naturally be felt across global supply chains along with a closer eye on transfer pricing models.
Higher tariffs could impact US importers and distributors importing from both related and unrelated parties – pushing the purchase costs and squeezing profit margins. This can be especially painful when these costs aren’t passed on to customers or when intercompany pricing fails to adjust for the new cost realities. The distortion can trigger compliance risks, and controversy.
What was once a stable, low-margin business might suddenly become a loss-making entity simply due to tariff exposure or in other cases, a high margin business may become a lower margin business.
Tariffs distort profit allocations, and for companies that don’t proactively adjust their TP models, this can lead to financial and reputational damage. Unless pricing or structural changes are implemented and documented appropriately, it could undermine transfer pricing outcomes leaving global businesses vulnerable.
For global businesses, increase in tariffs isn’t just a trade issue – it’s a transfer pricing challenge! The common pain points being:
- Benchmarking third party comparable data
- The functional similar comparables may no longer be reliable – even companies operating in the same jurisdiction may have vastly different cost structures depending on their sourcing geography.
- Methodologies to adjust comparable data for tariff impact – such adjustments inherently reduce reliability. Moreover, they are unlikely to be uniformly accepted by counterparty jurisdictions during disputes or audits.
- Supply chain reviews
- Higher tariffs could influence restructuring decisions and profit allocation strategy, for instance considerations around shifting manufacturing operations from one country to another, or redesigning intercompany flows.
- Robust transfer pricing documentation
- Failure to align TP policies with the real substance and economic risk of the business could increase the risk of scrutiny, controversy, and adjustments by tax authorities.
- The industry analysis section now matters more than ever – vital to show how tariffs and market volatility affect operations, pricing, and margins.
- Customs valuation and TP need to speak the same language
- Enhanced coordination between customs and tax teams is critical to avoid inconsistent disclosures.
- Intercompany agreements
- Ensure contracts reflect party responsible for events such as imposition of higher tariffs and whether pricing mechanisms allow for adjustments.
While we have started seeing a panic button being already pressed, now’s the time to re-evaluate supply chains, pricing structures, and intercompany agreements and bring your TP models back in line with commercial reality.
Have you already started adjusting TP policies for tariff exposure? Would love to hear how you’re tackling it.
We’ll continue to break it down in our upcoming insights.
