UN Manual on Transfer Pricing (2017)

A.4. Managing the Transfer Pricing Function in a Multinational Enterprise

A.4. Managing the Transfer Pricing Function in a Multinational Enterprise

A.4.1.           MNEs face challenges in managing their transfer pricing function. While transfer pricing may be used in some MNEs for management control, MNEs nevertheless are required to comply with the transfer pricing rules for tax purposes in the countries in which they operate. The determination of the transfer price affects the allocation of taxable income among the associated enterprises of an MNE group.

A.4.2.           Entities in an MNE group conduct global business that gives rise to opportunities to optimize the value chain of goods or services and therefore look for synergies. A challenge facing an MNE conducting a global business with associated enterprises is whether the transfer pricing method used for internal transactions is acceptable to the tax authorities in the countries in which the MNE operates. The transfer pricing challenge becomes even greater when the MNE has multiple global businesses with different business models and multiple cost centres. The size of the MNE adds to the complexity.

A.4.3.          Financial reporting for MNEs is informed by two decision trees. On the one hand, corporate and tax law require an associated enterprise to determine its taxable income derived from a specific jurisdiction. On the other hand, an MNE will usually need to determine for management purposes the income and costs of its businesses lines, which, as the previous discussion shows, can operate across several jurisdictions. In other words, while tax authorities focus on an associated enterprise’s taxable income, an MNE’s managers focus on income from their business lines. MNEs, particularly those where the parent is listed on a stock exchange, are more likely to aim to meet their tax obligations in the countries in which they operate provided that they are not subject to double taxation. Consequently, MNEs should develop and publicize within the enterprise a global transfer pricing policy to help minimize the risk of transfer pricing adjustments which may result in double taxation.

A.4.4.           The following is an illustrative example of the two different decision trees within an MNE:

Figure A.2:

Multinational Enterprise Decision Trees

A.4.5.           The allocation of profits and costs to the various legal structures is based on the functions performed, risks assumed and assets employed. Since MNEs consist of numerous associated enterprises it is very difficult to allocate the profits and costs to all the separate legal entities due to the absence of market forces. It is a complex exercise to come up with a consistent global policy for allocating results to the legal structures.

A.4.6.           The arm’s length principle allows national tax authorities to make an adjustment to the profits of one enterprise where the terms of transactions between associated enterprises differ from terms that would be agreed between unrelated enterprises in similar circumstances. A tax authority should only disregard a controlled transaction in exceptional circumstances. If the terms of a transaction between associated enterprises differ from those between unrelated parties and comparisons are difficult to make, an MNE bears the risk of transfer pricing adjustments. If the income of an associated enterprise within Country A is increased as a result of a transfer pricing adjustment, it would be reasonable to expect that there would be a corresponding transfer pricing adjustment resulting in a proportionate reduction in the income of the other associated enterprise in Country B, provided a consistent transfer pricing method is used by both countries.

A.4.7.           But Country B may use different transfer pricing methods. Consequently, if transfer prices are adjusted by a tax authority in one country, double taxation will occur if the tax authority in the other country does not use the same transfer pricing method and allows a corresponding transfer pricing adjustment. It is the task of the transfer pricing function within an MNE to limit the risk of transfer pricing adjustments and the risk of double taxation. See the illustration of double taxation below in Figure A.3.

A.4.8.           In principle, designing, implementing and documenting an appropriate transfer pricing policy should not be viewed solely as a compliance issue for MNEs. The main goal should be to develop a consistent global policy which cannot be altered to exploit tax laws. A well-developed and consistently applied transfer pricing policy should reduce an MNE’s risk of transfer pricing adjustments and the potential for double taxation, thereby increasing profitability by minimizing transfer pricing costs. Moreover, a global transfer pricing policy may be used as evidence in negotiations with tax authorities when transfer pricing disputes occur.

A.4.9.           An MNE’s transfer pricing policy should ideally reduce the risk of transfer pricing adjustments and the risks of double taxation of cross-border transactions. A comprehensive transfer pricing policy should cover four key areas as shown in Figure A.4.

Ø Advisory;

Ø Reporting;

Ø Documentation; and

Ø Audit support/Dispute resolution.

Figure A.3:

Global Effect of Transfer Pricing Adjustments (before adjustment)



Global Business 2


Global Business 1


Global Business 3






Figure A.4:

Aspects of Transfer Pricing Policy

A.4.10.          Advising requires a thorough knowledge of an MNE’s business operations. It is a misconception that the tax department makes the key business decisions within an MNE. In practice, the business units of an MNE will identify business opportunities and a decision may be taken to exploit the opportunity if it fits into the MNE’s global business strategy. Advice can be provided to minimize the risk of transfer pricing adjustments and therefore optimize the business opportunity if the tax department is involved in an MNE’s decision-making.

A.4.11.          In today’s environment there is an increasing level of detail required to meet each country’s transfer pricing documentation requirements. Most MNEs therefore prepare global and regional documentation (master files) of the various global businesses. Subsequently, global and regional reports are prepared for local purposes based on the identified risks for each country in which the MNE operates.

A.4.12.          Tax authorities around the world are increasingly focused on transfer pricing and on expanding their transfer pricing capabilities. MNEs have to find a way to deal with the increasingly detailed, complex and often conflicting domestic transfer pricing legislation in the countries where they operate. Some countries follow guidance from international bodies, others only implement part of the guidance while some develop transfer pricing rules independently.

A.4.13.          Tax authorities should not start from the assumption that MNEs are manipulating their results in order to obtain tax benefits. Many MNEs and certainly those with shares quoted on a stock exchange (listed MNEs) have published codes of conduct or a set of business principles or both. These codes or principles require that an MNE must comply with the tax rules of the countries in which they operate. Violations of these codes may result in severe consequences for a listed MNE.

A.4.14.          As transfer pricing is often referred to as “an art, not a science”, the resulting uncertainty creates the potential for transfer pricing disputes with tax authorities, even if the MNE is seeking to comply with domestic transfer pricing rules. Despite the efforts MNEs invest in setting the appropriate transfer prices and preparing comprehensive documentation, there is always the risk that tax authorities disagree with the approach taken and there is thus the risk of a transfer pricing adjustment. This creates uncertainty for MNEs including the potential associated costs of preparing additional documentation, managing tax audits and conducting litigation. Notwithstanding this, there are cases where transfer prices are manipulated to shift prof its from one jurisdiction to another to gain tax benefits including low-taxation or no-taxation.

A.4.15.          Transfer pricing rules are considered very useful by MNEs if they are able to achieve a globally consistent approach and eliminate the risk of transfer pricing disputes. If in one country an MNE’s transfer prices are adjusted, resulting in a higher taxable income, the associated enterprise in the other country should in principle receive a “corresponding adjustment”, reducing its taxable income. If there is no corresponding adjustment, the MNE will suffer double taxation. In this situation, the dispute is between two tax authorities with the MNE seeking to have consistent transfer prices accepted by both countries.

A.4.16.          Countries should try to avoid such double taxation, though in some cases there may be legitimate reasons why a corresponding adjustment is not given, or is less than the original adjustment. In such a case, it is important that the two countries enter into discussions to resolve the double taxation issue under the mutual agreement procedure mechanism in a tax treaty.

A.4.17.          The following diagram illustrates a transfer pricing adjustment to relieve double taxation:






Figure A.5:

Global Effects of Transfer Pricing Adjustments (after adjustment)




Global Business 2

Global Business 1 Global Business 3
A     A
  P P