automotive industry focus: transfer pricing risk...

Automotive Industry Focus: Transfer Pricing Risk Management

TAX

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

Contents

Introduction 3

Transfer Pricing Overview 4

The Automotive Value Chain 5

Transfer Pricing Challenges in the Automotive Industry 7

Transfer Pricing Risk Management 9

Concluding Thoughts 12

Contacts 12

The automotive industry is in a period of unprecedented disruption, with nearly all companies

in this sector restructuring their operations to some degree through acquisitions, divestitures,

globalization of operations, and other activities.

In the United States, GM, Ford, and Chrysler (the “Detroit Three”) continue to lose U.S. mar-

ket share to Asia-headquartered competitors. Competitive product alternatives from foreign

manufacturers, along with high legacy and structural costs, have severely impacted profitabil-

ity and resulted in a great deal of restructuring, including sizable head-count reductions at

Ford and GM and the sale of the Chrysler group by DaimlerChrysler to a private equity firm.

Foreign automakers (called “transplants”) continue to invest in the United States to support

their increasing domestic sales of high-profit-margin vehicles and the associated local pro-

duction needs. Given the increasing presence of non-U.S. automakers, intense competition

will likely continue in the U.S. automotive market for the foreseeable future, regardless of

economic conditions.

At the same time, the Detroit Three and foreign automakers are making significant progress

in building production, sales, and sourcing capabilities in high-growth, low-cost countries.

Low-cost-country sourcing and sales strategies are expected to continue, driven by high mar-

ket growth and access to inexpensive labor and materials in emerging markets such as China,

India, Russia, and certain Eastern European countries.

This dynamic supply chain environment creates significant challenges for corporate tax

directors and professional tax advisers serving the automotive industry. An international tax

area receiving particular risk management attention in recent years is transfer pricing.

Transfer pricing is an economic discipline used to determine the prices of transactions

between subsidiaries of a multinational enterprise. For many multinational companies, trans-

fer pricing decisions play a significant role in determining taxable income reported in each

jurisdiction. Understandably, tax authorities around the world have issued specific laws and

regulations governing transfer pricing between related parties, and comprehensive transfer

pricing audits are increasingly common. The general goal of tax laws and regulations regard-

ing transfer pricing is to establish “arm’s-length” prices for intercompany transactions that will

depend on the functions performed and risks assumed by each party to the transaction.

The purpose of this paper is to highlight emerging issues pertaining to transfer pricing in

the automotive industry and to establish a framework for peer-group discussion. We invite

comments from all stakeholders, including representatives from industry, tax authorities, and

professional services firms. KPMG will endeavor to coordinate these ongoing discussions,

synthesize emerging best practices, and publish updates to this initial paper.

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

Introduction

Tax directors in the automotiveindustry face the challenge of managing international taxexposures in the context of arapidly evolving value chain.

“Once you take on board the fact thatmore than 60 percent of world trade takesplace within multinational enterprises(MNEs), the importance of transfer pricingbecomes clear…Transfer prices are usefulin several ways. They can help an MNEidentify the most and least efficient partsof the enterprise. Furthermore, an MNEcould suffer double taxation on the sameprofits without proper transfer pricing.”

— Organisation for Economic Co-operation and Development, Center for Tax Policy

and Administration

A u t o m o t i v e I n d u s t r y F o c u s : T r a n s f e r P r i c i n g R i s k M a n a g e m e n t 3

Regulatory EnvironmentGlobalization and supply chain management trends have led to increasing cross-border trade

involving related parties, and governments in developing economies more fully recognize the

tax revenue at stake for their treasuries if they do not actively enforce transfer pricing policies

that protect their tax bases. More than 50 countries have issued specific laws and regulations

concerning intercompany transfer pricing. A decade ago, fewer than 15 countries had such laws.

Along with the proliferation of country-specific transfer pricing rules, tax authorities around

the world have significantly expanded their scope of enforcement activities. Transfer pricing

assessments have been the largest single source of tax audit adjustments in the United States

for many years. This is increasingly the case in other jurisdictions around the world. Tax

auditors generally have an expectation that the taxpayer has already prepared supporting

documentation and they will typically request such information with a very short turnaround

time. Taxpayers that have not prepared documentation can be subject to nondeductible penalties

in many jurisdictions, including the United States, Canada, Japan, Australia, and Germany.

In addition to penalties, the operational disruption associated with preparing documentation

on short notice can be severe. In the worst cases, required data cannot be found and person-

nel turnover has effectively erased any institutional memory of the rationale for past transfer

pricing positions.

Given the increasingly harsh regulatory environment, it is not surprising that financial state-

ment auditors are spending more time and attention assessing unrecorded tax exposures

pertaining to transfer pricing. Booking a tax contingency reserve in the financial statements

has the effect of lowering earnings per share, and it can be large enough to have a material

impact on a company’s stock price—particularly if large entries made at year-end were not

anticipated by the market. This increased audit scrutiny and the trend toward more explicit

financial statement disclosures has elevated the level of debate within companies concerning

transfer pricing policy.

The Arm’s-Length PrincipleThe central premise of most nations’ transfer pricing regulations rests on the arm’s-length

principle—the international standard for member countries of the Organisation for Economic

Co-operation and Development (OECD). This principle requires that transfers of tangible

goods, services, and intellectual property between affiliated companies be priced in a manner

consistent with prices that independent parties would have negotiated.

Although this broad objective is clear enough, individual countries have myriad unique rules

for how taxpayers should document that their transfer pricing methods and results meet the

arm’s-length standard. Individual countries also have different definitions of what constitutes

“documentation” within the context of local tax regulations. Finally, case law and bilateral

discussions among tax authorities reveal that reasonable parties can disagree on fundamental

economic principles, and the significant judgmental element in the application of those prin-

ciples leaves more room for disputes, even when the principles are agreed.

The number of countriespassing transfer pricing legis-lation has exploded over thepast decade, and transferpricing audit activity will onlyincrease as these countriesfurther develop enforcementcapabilities.

4 A u t o m o t i v e I n d u s t r y F o c u s : T r a n s f e r P r i c i n g R i s k M a n a g e m e n t ©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

Transfer Pricing Overview


The preceding section painted a picture of the transfer pricing landscape that is common

for multinational companies in a variety of industries. This section presents an overview

of the automotive value chain as context for highlighting related transfer pricing challenges

and opportunities.

Value Chain OverviewHistorically, automotive original equipment manufacturers (OEMs) operated vertically

integrated businesses, including in-sourced design, component manufacturing, assembly,

marketing, and distribution.1 Over time, this highly integrated value chain has disaggregated

in response to increased competition and the need for OEMs to reduce costs and more effec-

tively manage capital investment. Most notably, many OEMs have spun off their component

manufacturing operations, thereby creating an independent network of Tier One and Tier Two

suppliers. Since that time, OEMs have been increasingly relying on suppliers for component

design and engineering expertise, and independent suppliers are accounting for an ever-larger

proportion of total vehicle value.2 Suppliers that have taken on increasing design and engi-

neering responsibilities sometimes find it difficult to recoup the investment through higher

component pricing with their OEM customers. The chart below presents a high-level depic-

tion of the automotive value chain, accounting for these changes.

A second key feature of the automotive value chain is the importance of proximity between

manufacturers and consumers. The high cost of shipping finished vehicles and government

regulations, such as tariffs and import quotas, have encouraged foreign companies to set up

manufacturing (or assembly) and sales operations in large markets and emerging countries

to best serve those markets.3

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

VehicleDesign

ComponentDevelopment

VehicleAssembly

VehicleMarketing and

Distribution

ComponentDesign

Raw MaterialSourcing

ComponentManufacturing

OEMSupplier

Automotive Value Chain

1 www.gm.com2 “Changing Business Dynamics in the Automotive Supply Section,” Center for Automotive Research, October 20053 Id.

The Automotive Value Chain

A more recent feature of the value chain is the shift from a producer-driven to a buyer-driven

system.4 This dynamic can be seen most notably in vehicle design processes and the degree to

which buyers can customize vehicles online and through dealers, and hence influence the

build in the factory. This dynamic suggests that successful OEMs of tomorrow will be adept

at designing products that customers will buy, maintaining supply chain agility to allow more

customization from the factory, and adjusting quickly to changing customer preferences.

Industry DynamicsAutomotive OEMs and suppliers operate in an intensely competitive environment. Asian

OEMs have successfully challenged the supremacy of the Detroit Three in markets through-

out the world, and upstart OEMs in China and India might well add fuel to global competition.

Driven by general globalization trends and increasing demand for vehicles in emerging mar-

kets, OEMs and suppliers are driven to expand their global supply chain capabilities. Because

of the importance of the proximity of the manufacturing facility to the area of highest con-

sumer demand, effective management of a global supply chain continues to be a key competi-

tive advantage for the most successful automotive companies.

At the same time, manufacturing overcapacity and intense market share competition continue

to exert downward pressure on vehicle price to consumers. This pricing pressure is occurring

even as the cost of key inputs, such as metals and plastics, continues to rise. OEMs pressure

suppliers for year-over-year cost reductions, which is particularly difficult for suppliers with

noncompetitive labor structures and rising healthcare costs.5

The unrelenting pressure to reduce costs is driving OEMs and suppliers to consider low-cost-

country sourcing, through either off-shoring or third-party arrangements. OEMs are also

rationalizing vehicle platforms and the number of unique parts and components. These trends

would seem to benefit large-scale suppliers with global capabilities and the capital to invest

alongside OEMs.

Finally, the automotive industry, for suppliers and automakers alike, is sensitive to shifts in

the business cycle and overall economic activity. Specifically, factors such as consumer con-

fidence, interest rates, and disposable personal income growth have far-reaching effects on

consumer demand for vehicles, and hence their parts. With the slow recovery of the economy

after the 2000 slump, the current environment remains challenging to automobile makers and

their suppliers.6

In summary, globalization of consumer demand, market share competition, and the continu-

ing need to drive down vehicle costs all contribute to ongoing efforts to improve supply chain

performance for both OEMs and suppliers. In light of this restructuring, tax directors have

ample opportunity to manage transfer pricing risk and otherwise address tax-planning oppor-

tunities. These considerations are discussed further in this paper.

4 Id.5 Delphi 10-K report, year ending December 31, 20066 Citigroup Equity Research, “Focus on Auto Parts and Equipment,” May 2004

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

6 A u t o m o t i v e I n d u s t r y F o c u s : T r a n s f e r P r i c i n g R i s k M a n a g e m e n t

Automotive Industry

As a result of the industry dynamics summarized in the previous section, transfer pricing

professionals serving this industry must be vigilant in managing potential transfer pricing

risks and in identifying potential planning opportunities. This section addresses transfer

pricing challenges at the intersection of tax authority regulations and the evolving automotive

supply chain.

Allocation of Residual LossesTax authorities are generally easier to satisfy when there is plenty of profit in the value chain.

However, in the case of the North American OEMs and their dependent suppliers, profits are

thin and tax authorities are more likely to downplay functions and risks, which would justify

a share of the residual loss. Residual profit (or loss) is the difference between total profits

and the profits attributed to routine functions. This issue is further muddied by the fact that

in certain jurisdictions non-tax business realities such as legacy labor contracts and general

overcapacity are the primary factors driving actual transfer pricing results below the range

established by benchmark data (and indeed to a loss position). Questions concerning who

should bear such non-transfer-pricing-related costs and what adjustments are necessary to

make relevant comparisons to benchmark data are pivotal for many automotive companies

struggling to support their transfer pricing results. The Canada Revenue Agency (CRA) in

particular has been known to assert that the Canadian subsidiary should be earning a profit,

even when the U.S. parent is showing losses.

Attribution of Profit to Intangible AssetsClosely tied to the low level of profit in the value chain is treatment of the transfer of

intellectual property pertaining to brand and product technology. For many companies, the

“commensurate with income” standard in U.S. transfer pricing regulations would suggest a

very low rate or no royalty charge at all because of the low level of profits earned by the

licensee. However, tax authorities sometimes focus on earning back royalty income to

offset past deductions taken for research and development efforts. If the affiliate using the

intellectual property cannot demonstrate returns above a residual profit, then it will have

a difficult time convincing the tax authorities to allow the royalty expense deduction. The

CRA in particular has a history of challenging the royalties paid by Canadian automotive

businesses to their U.S. parents. The issue is further clouded by the attribution of value to

brand intellectual property. For some automotive groups the brand is centrally managed and

for others the brand is linked with the value inherent in the distribution network, or there

can be a mixture of the two.

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

Selecting transfer pricing approachesthat satisfy every tax authority is partic-ularly challenging in the automotiveindustry due to:

• Thin profit margins in the overall value chain

• Global involvement in the contractpursuit process

• Brand and technology intangibles thatdo not clearly drive premium profits

• Theoretical disagreements among taxauthorities.


Transfer Pricing Challenges in the

Supplier R&D CapabilityFor some time following the spin-off of component parts businesses, the newly formed com-

panies functioned primarily as contract manufacturers for vehicle OEMs. In this state, the

primary risk taken by component suppliers was investments in manufacturing. On this basis,

a transfer pricing approach for cross-border transactions among entities comprising these

now standalone businesses was adopted and refined over time by the tax authorities. Now, as

suppliers are required to take more responsibility for innovation and design as a precondition

for winning contracts, the fundamental risk equation for the suppliers has changed. This com-

bined with thin profits and pressure on royalty payments can make it difficult to get positive

returns in the jurisdiction bearing the innovation risks. The tax authority with jurisdiction

over the risk-taking entity will naturally challenge this result.

Distribution Network ValueThe tax authority of the parent entity is inclined to attribute much of the success to product

development and innovation. The tax authority of the sales entity points to the distribution

network and branding activities as key factors of success. These differences of opinion can

lead to sharply different views of what constitutes an appropriate transfer price. In addition,

arguments from tax authorities tend to change when the issue turns from considering how

profits should be allocated in the value chain to considering how losses should be allocated.

Assumption of RiskOEMs have adopted various business models. For some, a centralized approach is used, with

risk assumed mainly by the assembler/developer/brand owner. For others, the assembler is seen

as simply that, and the entrepreneurial risk is shared with the distributor that may be respon-

sible for a regional or domestic market. It is sometimes difficult to persuade tax administra-

tions that location of significant fixed assets is not the sole determining factor in the location

of the party assuming entrepreneurial risk.

High Stock Keeping Unit (SKU) CountAutomotive companies are known to deal in many different parts that individually do not

account for significant intercompany trade volume. For practical reasons, many companies

set one transfer pricing policy (e.g., cost plus X percentage) for many different parts. Depending

on other economic factors, this single transfer pricing policy can lead to significant profits

for one particular part but losses for other parts. This outcome can lead to challenges from

jurisdictions that take a transaction-level perspective in their reviews.

Treatment of Assembly OperationsAs intensive engineering and manufacturing activities are shifted to third-party integrators,

the OEM production facilities may be most appropriately characterized as “assembly centers.”

There are at least three transfer pricing methods to remunerate an assembler:

• Return on total costs (including cost of goods sold)

• Return on value-add cost, e.g., labor costs

• Return on assets

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6


Which of these methods is most appropriate depends on the particular functions and risks of

the assembly operations, including risks that are allocated under intercompany agreements.

In addition, it is critical to consider the comparables that are used to benchmark an assembly

operation. For example, do the comparables have significant “pass-through” costs that do not

earn a return? Does the comparable have the same asset intensity as the assembler? A trans-

fer pricing analysis that does not carefully align the comparables and the assembler may end

up materially overcompensating the assembler.

Related-Party Transaction ShareTransfer pricing addresses only the prices charged and profits attributable to transactions

between related parties. Certain automotive businesses (such as parts suppliers) may purchase

a majority—even a substantial majority—of their inputs from unrelated parties. Related-party

transactions may account for only a quarter or less of overall cost of goods sold. In such a

case, the local entity’s profit is largely independent of the transfer prices on the related-party

inputs. Despite this fact, tax authorities may seek to adjust the entire entity’s profit to some

external benchmark. Such an adjustment can result in highly distorted transfer pricing or

even sales of tangible goods at a gross margin loss. Although companies facing this type of

adjustment have had success defending against it, tax authorities including the IRS continue

to pursue this line of reasoning.

Periodic Adjusting Entries to Restate Transfer PricingResultsAutomotive companies are large payers of customs and other indirect taxes. Given the vari-

ous factors confounding transfer pricing in the automotive industry, it is likely that a post-

transaction transfer pricing adjustment might be recorded from time to time. Transfer pricing

audit history suggests that tax authorities in some jurisdictions can be highly suspicious of

such adjustments, increasing the likelihood that transfer pricing results are challenged and

adjusted. Additionally, on the indirect tax side, these after-the-fact adjustments could lead

customs officials to assert that the original customs valuation declared at import was under-

stated, resulting in audit challenges, assessments, and penalties.

Transfer Pricing Risk ManagementIntercompanyTransaction InventoryGiven the increasingly challenging transfer pricing environment, automotive financial

executives should take steps to identify and mitigate exposures pertaining to intercompany

transactions. A rigorous evaluation begins with an inventory of all significant related-party

transactions. Establishing whether such an evaluation has been performed is an important

consideration under management’s general responsibility for establishing and maintaining

adequate internal controls over financial reporting.

It is advisable to periodically survey a broad constituency of managers who have decision-

making authority to contract with affiliated companies. The inventory should identify parties

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6


involved, trade volumes, functions and risks undertaken by each party, and the company’s

current transfer pricing approach. It is important to look beyond simple product flows and to

consider intercompany services and the use of intangibles. This information, combined with

an understanding of local-country transfer pricing regimes, will allow financial executives to

prioritize the potential exposures most in need of further investigation. The inventory is also

a great first step in developing support for the company’s tax reserve positions.

Transfer Pricing PoliciesTransfer pricing policies should be developed in writing for each type of material intercom-

pany transaction. Most critically, the policy manual should clearly describe the price-setting

process and the transfer pricing methods selected to demonstrate compliance with applicable

laws and regulations.

In developing transfer pricing policies, it is important to consider tax regulations governing

both sides of the transactions. Additionally, the “story” implied by the company’s transfer

pricing methods must be consistent with demonstrable facts and circumstances and be based

on economic principles that embody the arm’s-length standard.

Based on the transfer pricing policy manual, training should be provided to operators and

finance personnel who will be involved with negotiating intercompany terms of trade, moni-

toring transaction results, financial reporting, and documenting transfer prices at year-end.

Most tax directors find that there is surprisingly little awareness of transfer pricing rules and

the consequences for noncompliance. A policy manual is obviously useless (and possibly

dangerous) if the people involved in the process have little or no awareness.

Transfer Pricing Controls

Tax Department Advice Up FrontProcesses and controls should be established whereby the tax department is notified of new

intercompany transaction flows before trade commences. Ideally, tax departments are

included early in the process of adjusting supply chain flows so that issues can be raised and

addressed early on. Such early involvement will allow companies to consider alternative

arrangements that are neutral from an operating standpoint but cash-flow positive due to

tax-related savings.

Intercompany ContractsThe terms of trade for intercompany transactions should be set forth in formal contracts at

the time the relationship commences. The contract should embody the principles described in

the transfer pricing manual. This sort of contemporaneous record of the company’s beliefs

and intentions can be a powerful defense against a tax authority challenge based on hindsight.

Transfer Pricing Risk Warning Signs

The following “red flags” might indicatea transfer pricing risk area:

• High trade volume between specificaffiliates

• Lack of transfer pricing documentation

• Decentralized approach to settingterms of intercompany transactions

• Consistent losses in one jurisdiction oranother

• Management fees without sufficientexplanation or support

• Transactions with affiliates in low-taxjurisdictions

• Significant royalty transactions

• Year-end adjustments to intercompanytransaction results

• Pure risk transfers to locations lackingphysical substance

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6


Monitoring Compliance A current inventory of intercompany transactions should be maintained centrally and peri-

odically updated throughout the year. Such an approach will reinforce the company’s trans-

fer pricing policies and the importance of involving tax specialists in the process of setting

prices. Processes and tools also should be developed to provide visibility into the actual

performance results achieved by each party to the intercompany transaction. Since year-end

adjustments to “fix” transfer pricing results significantly increase tax audit risk in the juris-

diction on the losing end of the adjustment, it is highly desirable to make mid-year adjust-

ments to transaction-level pricing to bring the system into compliance over time.

Global Documentation ProgramCompanies should prioritize their intercompany transactions based on assessment of audit

risk and prepare formal documentation for those transactions that are higher-risk to fully

present the underlying economic rationale and demonstrate compliance with local-country

transfer pricing regulations. Successful documentation programs are driven by carefully con-

sidered organizational approaches. Decisions on whether to approach documentation on a

global, regional, or local level will have a strong bearing on the success of the program. Each

approach has pros and cons, and the best choice for an individual company will be influenced

by the specifics of the transfer pricing structure and risks, company organization, and com-

pany culture.

A primary goal for global documentation should be to achieve global consistency in the

characterization of parties to intercompany transactions and the companies’ economic approach

to demonstrating compliance with the international arm’s-length principle. Some companies

choose to collaborate across their affiliates to develop a common fact base, which becomes

the foundation-level “story” used consistently, no matter the jurisdiction. More informally,

other companies encourage local affiliate finance personnel to compare notes regarding

transaction characterization and economic approach directly with their counterparts overseas.

Advance Pricing AgreementsA company desiring a degree of certainty in its transfer pricing results should consider an

advance pricing agreement (APA). An APA is an agreement between the taxpayer and one

or more tax authorities that sets forth the methods and results acceptable to the tax authori-

ties over some defined period of time. As long as annual compliance with the terms of

the APA is shown, taxpayers are fairly well insulated against transfer pricing adjustments

imposed by tax authorities.

The decision to pursue an APA depends largely on the materiality of the potential exposures,

a company’s risk tolerance profile, and the likely positions of the tax jurisdiction(s) involved.

Some taxpayers find the time and resources to pursue an APA to be worthwhile. Other taxpayers

find they can achieve their transfer pricing risk management objectives through detailed

economic analysis of intercompany transactions and carefully prepared transfer pricing docu-

mentation.

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6

Transfer Pricing Control Risk

The primary areas of control risk forwhich processes should be developedare as follows:

• Transfer pricing policies are updatedand communicated to stakeholders ona regular basis.

• All intercompany transactions are iden-tified, and transfer pricing policies areupdated on a timely basis to reflectthe impact of new intercompany trans-actions and changes in the business.

• Terms of intercompany agreementsare consistent with stated transferpricing policies.

• Financial results of intercompanytransactions are consistent with trans-fer pricing policies and applicable taxregulations.

• Financial statement adjustments per-taining to transfer pricing are made inaccordance with company policies.

• Transfer pricing documentation is pre-pared as required under applicable taxregulations.

• Potential tax exposures pertaining totransfer pricing are appropriatelyreflected in financial statements, inaccordance with applicable accountingstandards.


Concluding Thoughts

Transfer pricing is one of the most significant tax risk areas faced by multinational compa-

nies today. Enforcement efforts are on the rise throughout the world, and tax authorities are

reluctant to accept a loss in their jurisdiction even when profits are very thin in the overall

value chain. In addition, the application of economic principles can be subjective in practice.

This mix of factors creates an unpredictable environment in which economic principles are

rigorously debated, and multinational companies face the very real threat that the same

income can be subjected to double taxation, interest, and nondeductible penalties.

As summarized in this paper, there are specific risk management steps financial executives

should take to mitigate the risk of transfer pricing adjustments. Additionally, it is hoped that

a continuing dialogue among taxpayers, their advisers, and tax regulators will result in com-

mon industry practices for acceptable transfer pricing methods.

Contacts

This paper was prepared by Sean F. Foley and Jerry A. Klopfer, who are members of

KPMG’s Global Transfer Pricing Services group. If you have comments or questions on

this paper or the topics discussed within it, please contact your KPMG adviser or any

of the individuals listed below.

Sean F. Foley

U.S. Principal in Charge, Transfer Pricing Services

202-533-5588

[email protected]

Jerry A. Klopfer

Managing Director, Economic and Valuation Services

312-665-2096

[email protected]

Hans F. W. Flick

Partner, Automotive Tax Sector Leader

313-230-3470

[email protected]

©20

07K

PM

GLL

P,a

U.S

.lim

ited

liabi

lity

part

ners

hip

and

am

embe

rfir

mof

the

KP

MG

netw

ork

ofin

depe

nden

tm

embe

rfir

ms

affil

iate

dw

ithK

PM

GIn

tern

atio

nal,

aSw

iss

coop

erat

ive.

All

right

sre

serv

ed.0

7081

6


The information contained herein is general in nature and based on authorities that are subject to change.Applicability to specific situations is to be determined through consultation with your tax adviser.

ANY TAX ADVICE IN THIS COMMUNICATION IS NOT INTENDED OR WRITTEN BY KPMG TO BE USED AND CANNOT BE USED BY A CLIENT OR OTHER PERSON OR ENTITY FOR THE PURPOSE OF (i) AVOIDING PENALTIES THAT MAY BE IMPOSED ON ANY TAXPAYER OR (ii) PROMOTING, MARKETING, OR RECOMMENDING TO ANOTHER PARTY ANY MATTERS ADDRESSED HEREIN.

© 2007 KPMG LLP, a U.S. limited liability partnership and a member firm of the KPMG network of independent member firms affiliated with KPMG International, a Swiss cooperative. All rights reserved. KPMG and the KPMG logo are registeredtrademarks of KPMG International. 070816

automotive industry focus: transfer pricing risk...

Documents