Transfer Pricing Audit Challenges and Dispute Resolution Effectiveness in Developing Countries with Specific Focus on Zimbabwe

They conclude that the unilateral adoption of TPRs may harm MNCs’ ability to invest effectively and underline the necessity for coordinated global efforts to stop MNCs from shifting profits for tax reasons. In their study of the OECD/G20 Base Erosion and Profit Shifting process, Büttner and Thiemann (2017) contend that gradual changes to transfer pricing principles add to the standards’ complexity and incoherence, leading to an increase in conflicting assessments and ambiguity. For example, two businesses that both earn $100 in sales revenue with a 10 percent profit margin in normal times would face different impacts based on differences in fixed costs. If one business has fixed costs that make up 10 percent of total costs and the other has fixed costs that make up 20 percent of total costs, a downturn that reduces revenues by 20 percent would lead to a 40 percent profit margin reduction in the business with lower fixed costs. The business with higher fixed costs would see a 60 percent reduction in its operating margin in that scenario. However, the notion of substantial tax benefits arising from the manner and location in which multinational affiliates implement transfer pricing via the arm’s length standard—i.e., traditional tax arbitrage—could be a distant memory given changes in tax legislation as of late.

Technology solutions can enhance collaboration and communication among different stakeholders involved in transfer pricing, including tax teams, finance departments, and business units. Centralized platforms enable easy sharing of information, supporting effective decision-making and alignment of transfer pricing policies. Transfer pricing software can assist in monitoring and tracking compliance with transfer pricing policies, regulations, and deadlines.

For developing countries, this creates challenges for resource mobilization and economic expansion. A thorough literature review is increasingly required to summarize the existing research in this area. Due to the possible loss of tax revenue and the detrimental effects on economic development, the topic of transfer pricing practices and their effect on tax collections in developing nations has garnered much attention. An increasing worry is the eroding of tax bases and declines in tax collections in developing countries due to claims that multinational businesses engage in tax-motivated profit shifting (IMF Working Paper, 2019).

Owing to the difficulties in supplying comparable information, auditors often fail to stand their ground and at times tax authorities can lose court cases or where they have won the cases, appeals can be successful and court resolutions overturned (Tørsløv et al., 2020). In Table 2 all ZIMRA officers, 92% of TCs and 60% of MINOFs agreed on the fact that the subjective nature of the arm’s length computations was a constraint to effective audits and dispute resolution. Participants submitted that the arm’s length principle is subjective and that tax administrators and tax auditors often find it difficult to enforce compliance and to evaluate compliance respectively. Interviewee ZIMRA4 in acknowledgement also pointed out to the fact that though CUP is normally the best method, “it is not always applicable due to the shortage of comparable data hence we end up considering other methods which are rather persuasive than objective”. The officer further explained that the consideration of comparability issues such as the contractual conditions of the agreements, functions being operated, features of the property, goods or services, economic conditions and strategies, was on its own a subjective assessment. From the ZIMRA TP manual, the outline of what is considered made the subjectivity apparent, for example, strategies include risk appetite, the scope of diversification, and an assessment of political risk, innovation and development of new products.

In normal times, the manufacturer benchmarks the profitability of its foreign subsidiaries against data with comparable unrelated entities with which it has contracts and other data from similar market players. The rules that these businesses follow to determine where and how much they owe in taxes are complex even in normal times. The crisis has revealed challenging questions, especially when it comes to the significant losses that many businesses are currently facing. Deloitte refers to one or more of Deloitte Touche Tohmatsu Limited (“DTTL”), its global network of member firms, and their related entities (collectively, the “Deloitte organization”). DTTL (also referred to as “Deloitte Global”) and each of its member firms and related entities are legally separate and independent entities, which cannot obligate or bind each other in respect of third parties. DTTL and each DTTL member firm and related entity is liable only for its own acts and omissions, and not those of each other.

  1. The effects of intangible assets, debt covenants, bonus programs, and tax penalties on the transfer pricing choices made by Indonesian manufacturing enterprises were examined by Pramono Sari et al. in 2022.
  2. All the TCs concurred that the lack of appropriate expertise and skills, as well as experience amongst TP auditors, revenue officers in general and tax officials, crippled the effectiveness of audits and dispute resolution.
  3. Kabala and Ndulo (2018) allude to the fact that the understanding of TP legislation is rudimentary among tax officers and auditors in developing countries.
  4. GTIL is a nonpracticing umbrella entity organized as a private company limited by guarantee incorporated in England and Wales.
  5. Similar situations arise in manufacturing, when one
    division ships parts or unfinished products for final assembly at
    another location in a different jurisdiction.

It’s our goal to design economically-sound strategies that your company can also easily administer. With the help of one of our seasoned experts, you can maximize company profits and minimize audit risk. Let’s talk about your unique transfer pricing challenges and how Valentiam can help solve them—schedule a free discovery call today. While these problems of transfer pricing are less technical than most others, they still require careful consideration because they can have a significant impact on both taxes and profits. As such, companies should keep them in mind when designing, implementing, or revising transfer pricing strategies. Companies that operate in multiple countries face a number of issues never encountered by those with operations based exclusively in one country.

Financial and tax reporting

Sari et al. (2022), Amidu et al. (2019), Park et al. (2016), Büttner and Thiemann (2017) and Richardson and Taylor (2015), Look at the connection between profit shifting or tax avoidance and transfer pricing. The results highlight tax-motivated transfer pricing, the influence of intangible assets, positive correlations between indices of profit-shifting and greater tax avoidance inclination among MNCs. All the choices that the U.S. company in the example faces in adjusting its transfer pricing and profit attribution to subsidiaries will impact the taxes that it pays and where it pays them.

Challenges Of Transfer Pricing To Consider

Transfer pricing is defined as the price at which goods and services are sold or exchanged between intra-group firms and their affiliates (Beebbejaun, 2019; Bhat, 2009). Transfer pricing is not in itself bad or illegal, but, since it occurs among related parties, the challenge is when it becomes aggressive, challenges of transfer pricing unethical and manipulative (transfer mispricing) (Beebeejaun, 2019; Bhat, 2009; Klassen, Lisowsky, & Mescall, 2017). The transfer price applied by MNEs has a bearing on the profits reported by MNEs and their affiliates in the various countries they operate in and ultimately the taxes they pay.

If the terms of the contract with the Italian distributor result in a profit margin of 2.5 percent for that distributor, then under the arm’s length principle the Danish subsidiary should be attributed a taxable profit of 2.5 percent (all other things being equal). When more data becomes available, the U.S. company plans to adjust the royalty payment and taxable profit margin in France based on that data. The nature of the current economic situation means that some sectors and businesses will face greater challenges with their transfer pricing than others. Some companies will survive the crisis without adjusting transfer pricing because relationships with suppliers, distributors, and customers will be maintained.

The Problems of Transfer Pricing

Even though most taxpayers know their duties well, only 25% of them successfully collect tax payments, with Asia–Pacific countries performing worse (Carnahan, 2015). Tax evasion is more likely to occur in multinational corporations that have expanded internationally by establishing offshore subsidiaries (Park et al., 2016). Pricing to market and tax evasion are two scenarios where multinational corporations may depart from arm’s length prices. Once the factors determining market pricing are under control, the sensitivity of intra-firm prices to foreign taxes is strengthened (Davies et al., 2017).

The German government’s commitment to providing superior infrastructure and educational institutions also creates a national competitive advantage for the car industry. The insights and quality services we deliver help build trust and confidence in the capital markets and in economies the world over. In so doing, we play a critical role in building a better working world for our people, for our clients and for our communities. This means that, under OECD rules, the Danish distribution unit will get a steady and small return because it is in a lower-risk portion of the U.S. manufacturer’s value chain.

For the transfer pricing system to be defensible, it must be treated
consistently throughout the company. So, for example, if credit risk
is considered in one situation, it must be considered in others, too. Beta produces a variety of molded plastic parts, including the
hard-plastic exteriors or shells of telephones, using raw plastic
purchased in bulk. Excluding shells, much of Betas output is shipped
to Gamma, where it is combined with purchased parts to create
telephone subassemblies.

Suppose Example faces effective income tax ratesstate, local and
federal combinedof 52% in the Alpha location, 39.6% in Beta and 50% in
Gamma. If Example successfully establishes an $80,000 transfer price
for marketing and administration services, compared with using the
actual costs of $100,000 incurred by Alpha to provide those services,
it will save $1,440. The transfer pricing literature as it is currently written is succinctly summarized in this study. This review sheds light on the top researchers, approaches, conclusions, theoretical and empirical gaps, and upcoming issues of transfer pricing research over the previous nine years through a methodical analysis of 29 research publications from the Scopus database (2014–2022).

A transfer price impacts the allocation of total profits across entities in different tax jurisdictions and is therefore an important determinant of the total taxes paid by the MNC. From a global perspective, the world economy is becoming more integrated, and MNCs account for an increasing proportion of the global economy. Intercompany transactions represent a growing factor of cross-border trade, and, according to the Organization for Economic Co-operation and Development (OECD), approximately 60% of world trade takes place within multinational enterprises. These studies offer insightful information about transfer pricing rules and how they affect multinational corporations and the economy. However, further investigation is required to fully understand these problems and create sensible legislative responses to MNC tax avoidance. The research on the impact of multinational firms’ use of transfer pricing on tax revenues and base erosion is summarized in Table 1.

State and Local Sales Tax Rates, 2024

Interviewee ZIMRA9 argued that the lack of cooperation is not only on the international angle but on the domestic angle as well as MNEs are generally stingy with their information, they do not easily avail information on their transactions and at times give it in bits and pieces making audits difficult. Interviewee TC6 on a different view on the uncooperativeness argued that the badly damaged relations between taxpayers and ZIMRA account for the situation. He expressed that “ZIMRA auditors tend to be aggressive, intimidating and somewhat accusatory causing MNEs and other taxpayers to be defensive and conceal some issues”. Over the past decade, EY’s global transfer pricing surveys have recognized that tax authorities worldwide are identifying transfer pricing noncompliance as fertile ground for raising tax revenues. Since EY’s last transfer pricing survey, the pace of globalization and integration of economies has accelerated, and businesses have increased their focus on managing transfer pricing issues across the supply chain. Approximately 61% of oil and gas survey respondents in the 2013 GTPS identified tax risk management as their highest priority for transfer pricing, an increase of 27% and 22% over surveys conducted in 2010 and 2007, respectively.

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