Optimizing Transfer Pricing Through Effective Documentation

To stay compliant with the OECD Transfer Pricing [‘TP’] Guidelines 2022, multinational companies involved in cross-border transactions between related entities must document their adherence to the arm’s length principle. This ensures that the prices charged between related parties align with what independent companies would agree upon in comparable circumstances.

But TP documentation isn’t just a compliance exercise—it’s a valuable tool if used effectively. By leveraging the information within these reports, companies can refine their intercompany pricing strategies, enhance profitability, and reduce tax risks without disrupting core business operations.

In this article, we delve into the key requirements of TP documentation and define how it can contribute to TP strategy optimization.

1. Understanding the Arm’s Length Principle

The arm’s length principle [codified in Dutch tax law as Article 8b of the Dutch CIT Act, with a direct reference to the OECD’s Transfer Pricing Guidelines] ensures that the valuation of intercompany transactions reflects the price that would be agreed upon between unrelated companies [the transfer price]. It’s mission? To prevent group companies from cooking up conditions that only serve tax purposes.

The example below illustrates the importance of the arm’s length principle in combating profit shifting to low-tax jurisdiction. Picture this: the group decides to set the transfer price artificially high at 90. What happens next? Well, the high-taxed company sees a dip in profits, while the low-taxed company inflates its profits. As a result, the group’s overall tax bill is lower [4] than it would be in situations where the companies would be dealing with an unrelated party [7]. This is where the arm’s length principle comes in, which states that the group ‘transfer price’ should be (roughly) equal to the external and fair market price of 80. A well-documented TP strategy ensures regulatory compliance with the at arm’s length principle.

2. The Three-Tier TP Documentation Approach

Most jurisdictions follow a three-tier approach to TP documentation:

1. TP substantiation files [general documentation]
2. Master and Local Files
3. Country-by-Country Reporting (CbCR)

While these are mandatory for multinational companies exceeding certain financial thresholds, they also serve as a strategic opportunity to assess and optimize pricing structures. Let’s break them down.

2.1 TP Substantiation File [general documentation]

In the Netherlands, this report isn’t technically required, but it’s highly recommended from a compliance perspective anyways. Keeping a well-documented TP substantiation file ensures you’re ready if the tax authorities come knocking. The format is flexible, but the content should in any case align with the OECD TP Guidelines 2022.

2.2 Master File & Local File

Think of the Master File as a high-level overview of your global operations. It provides tax authorities with information on:

• Corporate structure – legal entities, ownership structure, and operational framework.
• Business activities – core revenue-generating activities and business models employed by the group.
• Intangible assets – intellectual property, patents, trademarks, and their role in value creation.
• Financial transactions – intercompany loans, financing arrangements, and risk management strategies.
• Tax positions – key tax policies, TP strategies and risk assessments.

A solid Master File helps you proactively address any potential tax/ TP risks and ensure compliance with tax regulations across multiple jurisdictions.

The Local File zooms in on transactions between a specific entity and its related foreign counterparts. It includes as least:

• Transaction details – documentation of sales, purchases, royalties, service fees, and financing arrangements between related parties.
• Comparability analysis – an evaluation of whether intercompany pricing aligns with the arm’s length principle.
• Chosen TP methodology – a description of the TP method(s) used and supporting data.

2.3 Country-by-Country Reporting (CbCR)

For multinational companies exceeding a €750 million revenue threshold, CbCR is mandatory. It requires submitting an annual report outlining financial data for each jurisdiction, including:

• Revenue generated in each jurisdiction
• Profit before taks to assess tax allocation
• Taxes paid and accrued to determine the effective tax rate
• Number of employees to guage economic activity
• Tax residency status of each entity to evaluate potential international tax mismatches

CbCR enhances tax transparency and helps tax authorities assess whether profit allocation aligns with economic activity. Consistency across all TP documentation [that is, consistency between the Local and Master Files and CbCR] is crucial to avoid audit-triggering discrepancies.

3. When Does a Company Need to Prepare TP Documentation?

This depends on the jurisdiction. In the Netherlands, companies must meet specific financial criteria:

• Master & Local File: Required if the company engages in intercompany transactions and has a consolidated group turnover exceeding € 50 million in the previous financial year.
• CbCR: Required for groups with consolidated revenue over € 750 million. The ultimate parent entity or a designated Dutch taxpayer must file this report.

Deadlines in the Netherlands:

• The Master and Local File should be available when filing the Corporate Income Tax return.
• CbCR must be proactively filed within 12 months after the reporting year.

4. Beyond Compliance: How TP Documentation Can Benefit Your Business

While TP documentation may seem like a regulatory need-to-have, it offers strategic advantages [nice-to-have]:

• Tax efficiency – identifying and implementing more tax-efficient structures.
• Risk mitigation – reducing exposure to tax audits, disputes, and penalties.
• Financial performance – aligning pricing strategies with business objectives to boost profitability.
• Transparency & trust – strengthening relationships with tax authorities and stakeholders.

The truth is, TP documentation is both a necessity and a strategic asset. A well-documented TP strategy ensures compliance while also providing insights to optimize tax positions and operational efficiency. Given increasing scrutiny from tax authorities, companies should proactively approach TP documentation rather than treating it as a mandatory compliance task.

5. Want Advance Certainty? Consider a Tax Ruling or Advance Pricing Agreement (APA)

If you want to be sure that your TP policy is acceptable, and/or whether you are fulfilling your reporting obligations, the Dutch tax authorities have dedicated teams available to grant advance certainty.

Advance certainty can be a valuable part of cooperative tax compliance, which is a trending approach to tax compliance under which the Taxpayer implements a ‘Tax Control Framework’ in return for quicker certainty and decreased audits and scrutiny from the tax authorities.

6. Let’s Talk!

Need help optimizing your TP strategy? Book a Calendly meeting; it’s on the house! Whether you need compliance guidance or want to explore strategic tax benefits, I’m happy to discuss.