Enhancing Effective Transfer Pricing Audits, UN Releases the Toolkit

Transfer pricing has garnered significant attention from stakeholders worldwide, with several international organizations identifying it as a key issue due to its impact on the global economy.  A prominent organization in this regard is the United Nations (UN), which released the '"Transfer Pricing Compliance Assurance – An End-to-End Toolkit' in June 2024."

The intense focus by policymakers and influential organizations stems from the fact that transfer pricing (TP) is often used by multinational companies as a means to reduce their tax liabilities, thereby diminishing the potential tax revenues that should be collected by jurisdictions or countries worldwide.

In the document released, the UN revealed that this Toolkit is not merely a technical guide, but also provides practical strategies to ensure that transactions between multinational companies comply with regulations and remain efficient. Generally, there are two main pillars discussed in the Toolkit: the transfer pricing risk assessment roadmap and the transfer pricing audit roadmap.

This article will focus on discussing the transfer pricing audit roadmap as part of a series related to the 'Transfer Pricing Compliance Assurance – An End-to-End Toolkit' and a continuation of the previous article titled 'UN's Comprehensive Solution to Improve Transfer Pricing Compliance. 

Stages of the TP Audit Process

The TP audit is designed to ensure that every transaction complies with the arm's length principle, considering the facts and economic circumstances of the audited transaction. However, conducting a TP audit comes with its challenges.

The TP audit process requires significant resource allocation from both tax authorities and taxpayers. In short, audits are only conducted when risk assessment indicates the need for a deeper investigation.

For this reason, we present this article as a guide to best practices for planning, conducting and completing TP audits, starting with the preparation stage to the follow-up stage after the audit is completed.

1. Audit Preparation Stage

The first step in a TP audit is forming an audit team composed of experts with diverse backgrounds, such as economists, accountants, lawyers, and IT specialists.

This diversity of expertise is crucial to ensure that the audit approach is applied consistently across the company’s operational regions. Additionally, a manager responsible for coordinating audits across various locations is needed to ensure uniform audit results.

Before beginning the audit process, the team must review risk assessment results and findings from previous audits to identify which transactions should be the focus. This process also involves creating a clear audit plan, with milestone schedules and deadlines set to ensure the audit proceeds smoothly and on time.

2. Audit Implementation Stage 

The implementation stage of the UN-recommended TP audit includes several activities, such as collecting information, analyzing the information collected, conducting field visits and interviews, the evaluation stage, and opening communication with taxpayers.

• Information Gathering

Information gathering is the main activity in conducting an audit. The information collected should be contextual to the taxpayer's industry. This includes the level of competition, regulatory factors, and other elements that affect the business environment. 

While some information is publicly available, specific data related to related party transactions usually requires a formal information request. Therefore, it is important to submit document requests as early as possible to make the audit process more efficient. 

• Analyzing Information

Next, the audit team needs to analyze the function and economic characteristics of related party transactions. This includes an assessment of the contractual terms, a functional analysis of the controlled transactions, the nature of the goods or services exchanged, the economic circumstances, and the business strategies of each party involved. 

This analysis is important to determine which transactions are the most economically significant and the roles and risks each entity takes in those transactions. In addition, the audit team should also evaluate intercompany agreements to understand the structure of the transaction and ensure conformity between written agreements and actual practices. 

• Site Visits and Interviews

At this stage, it is also important to conduct site visits to business locations and interviews with key managers. This allows the audit team to gain insight into the functional role of each entity in related party transactions, as well as evaluate whether the information presented in the TP Doc matches the reality. 

• Methodology Evaluation

Related to this, the audit team also needs to evaluate the TP methodology applied by the taxpayer, ensuring that the methodology is consistent with the functional profile identified, as well as reviewing whether the TP method is aligned with applicable standards. To assess the feasibility and accuracy of the analysis, the audit team may review the comparable data used.

• Open Communication with Taxpayers

Lastly, during an audit, open communication with taxpayers is essential. This is because discussing the audit findings before the final report is completed can help find solutions that both parties can agree upon and ensure a more transparent audit.

3. Audit Closing Stage

A TP audit ends with the preparation of a report that summarises the entire audit process and the results of the analysis. This report should include important elements such as an executive summary, transaction background, functional analysis, and the TP methodology used. It is also important to showcase the proposed TP adjustments as well as the agreements reached.

4. Follow-up Stage

Once the audit is completed, the process does not end there. Several follow-up steps must be taken, such as evaluating the impact of the audit on the next tax year. For recurring transactions, the audit may need to be extended to subsequent years, especially if the company does not make changes to the intercompany transactions.

Companies may also want to seek future tax certainty with an Advance Pricing Agreement (APA). However, the results of previous audits should be considered in the evaluation of these APA applications. On the other hand, TP audits often result in double taxation, which must be resolved through the Mutual Agreement Procedure (MAP) between the countries involved.

The evaluation of audit results is also important to ascertain whether previously identified risks were evident in the audit and led to significant TP adjustments. This step helps to improve the risk assessment process in the future. In addition, the transfer pricing database should be continuously updated with the latest audit results to keep the taxpayer risk profile accurate and up-to-date.

Evaluating the audit results is also essential to determine whether the risks previously identified were confirmed during the audit and led to significant TP adjustments. This step helps improve future risk assessments. Furthermore, the transfer pricing database must be continuously updated with the latest audit results to keep the taxpayer’s risk profile accurate and up-to-date.

Conclusion

An effective TP audit requires thorough preparation, comprehensive execution, and targeted follow-up. By using this toolkit, both multinational companies and tax authorities can ensure that the audit proceeds smoothly, fairly, and in line with the arm's length principle.

This toolkit not only helps to reduce the potential for tax offenses and tax disputes but also enhances transparency and trust in the tax system, ultimately fostering a more stable and sustainable investment climate.