From calculating transfer prices to managing intra-Group flows

After the drafting of a first article on the issue of transfer pricing, Baptiste Beauchamps, Senior Consultant & Jean-Luc Faure, VISEO Finance Consulting Director, discuss the calculation of transfer prices as well as the management of intra-Group flows:

Cost calculation and performance measurement

Whatever the types of services offered internally (IT, HR, Marketing, etc.), it is necessary for an entity to know all the constituent costs of this service. In order to achieve this, the construction of a cost model is a simple and reliable way for each entity to correctly calculate the cost of each service provided, but also to monitor and measure its performance.

The implementation of a cost model allows an entity to take into consideration all costs related directly or indirectly to the production of services, to manage their use through activities, and to be able to justify their price.

In addition, the definition of appropriate billing units also provides justification for the amounts invoiced to the recipient entities.

A good transfer pricing calculation is the assurance of a good performance measurement for an entity that sells or buys services from an entity belonging to the same Group as itself.

Benchmarks between internal and external services

The definition of transfer prices allows both beneficiary and issuing entities to compare the price charged internally with those charged externally through regular benchmarks. This allows the beneficiary entity to ensure that the service it receives is at a price comparable to market prices, and the issuing entity to ensure that, from a Group perspective, the service provided represents an overall cost in line with that of its competitors.

This comparability thus allows the Group to answer the "Make or buy" question on a particular service/activity, even if in the case of outsourcing it will be important to take into consideration criteria other than financial, such as:

• The quality of the service provided,
• The criticality of the service provided (research, marketing, HR, holding)
• The development and good control of internal skills.

The tax justification

In addition to performance management issues, transfer pricing justification is first and foremost necessary for tax justification. Indeed, since the OECD introduced the arm's length principle, an international Group must be able to justify the amounts invoiced internally for services rendered or fees.

The absence of intra-Group invoicing for a service rendered, or invoicing that is not consistent with the service provided, may be interpreted by the tax authorities as an attempt to conceal profits or, on the contrary, to create artificial profits. As tax rules vary widely from one country to another, a Group may wish to minimize its profit by overbilling in high-tax countries and maximize it in low-tax countries. The problems of increasing VAT are also to be taken into account here.

This tax justification therefore requires both:

• The correct construction and understanding of the transfer price, through the implementation of cost models to justify the cost bases and inducers used
• A transparent and homogeneous mark-up policy
• End-to-end monitoring of intra-Group flows to justify cost bases composed of previous intra-Group invoicing (cascading invoicing).

Intra-Group flow management tool

In order to ensure proper traceability of flows and to provide a relevant audit trail, it is necessary for a Group to manage all these intra-Group flows. This must often be accompanied by the implementation of tools, centralizing all these flows. These tools will make it possible to both justify and archive intra-Group flows, but also to calculate the transfer price linked to each of these flows.

Through these tools, each entity will be able to monitor the intra-Group invoicing it has received, the construction of its own transfer prices, as well as all the invoicing it has issued to other Group entities. From a Group point of view, it will be possible to control all intra-Group flows from end to end, and to justify each of the invoicing and the profits generated.

The implementation of such a tool could also allow the budgetary construction of all these flows, but also the simulation of new services, thus making it possible to arbitrate their launch.