Transfer Pricing Policy based on Sustainability Norms
The evolving environmental and ESG (Environmental, Social, and Governance) landscape has reshaped global corporate dynamics. Companies are now considering sustainability not only from an operational perspective but also in their financial transactions, including transfer pricing policies. This report delves into the integration of sustainability norms into transfer pricing policies for European businesses.
Europe is at the forefront of ESG regulations. Several European directives such as the Non-Financial Reporting Directive (NFRD) and guidelines from organizations like the European Financial Reporting Advisory Group (EFRAG) lay out requirements and recommendations for businesses in terms of sustainability reporting.
Key Considerations for Transfer Pricing Policy based on Sustainability:
Alignment with ESG Goals: The transfer pricing policy should align with the company’s overall ESG goals. For instance, sourcing raw materials from sustainable suppliers might involve higher costs. This should be reflected in the transfer prices to ensure that entities are not penalized for pursuing sustainable objectives.
Intangible Assets and Sustainability: Value contributions from ESG-related intangibles (like green technologies or sustainable brand reputation) need to be captured in the transfer pricing arrangements. This ensures that subsidiaries which develop or hold these intangibles are appropriately compensated.
Documentation and Disclosure: With increasing emphasis on transparency, companies should maintain robust documentation to demonstrate that their transfer pricing policies consider sustainability aspects. This can include factors that were considered, methodologies applied, and any premium or adjustments made for ESG factors.
Profit Allocation: Companies might benefit from sustainability initiatives in various ways, such as through government incentives, increased customer loyalty, or reduced operational costs. Transfer pricing policies should be structured to ensure that profits arising from such benefits are allocated to the entities bearing the related costs or risks.
Benchmarking Analysis: The traditional comparable uncontrolled price (CUP) method may not always capture the value of ESG factors. Companies may need to look at other methodologies or consider adjustments to comparables to account for sustainability initiatives.
Inter-company Agreements: All inter-company agreements should explicitly mention any ESG-related responsibilities of the parties. This ensures clarity on who bears the costs and reaps the benefits of such initiatives.
Potential Conflicts with Tax Authorities: Tax authorities may not always recognize the premiums or adjustments made for ESG factors. Companies should be prepared to defend their policies and highlight the business rationale behind them.
Monitoring and Review: The ESG landscape is dynamic. Companies should periodically review their transfer pricing policies to ensure they remain aligned with their sustainability objectives and the evolving regulatory environment.
Recommendations:
- Engage in continuous stakeholder dialogue, including with tax authorities, to align on ESG and transfer pricing expectations.
- Invest in robust ESG reporting systems to capture and quantify the impact of sustainability initiatives.
- Consider third-party audits of the transfer pricing policy to ensure compliance with both tax and ESG norms.
- Train and sensitize finance and tax teams about the importance of ESG in the context of transfer pricing.
Incorporating sustainability norms into transfer pricing policies is not just a compliance requirement but an opportunity for companies to demonstrate their commitment to ESG objectives. By adopting a holistic, well-documented, and transparent approach, companies can ensure that their transfer pricing policies are both compliant and value-accretive. It is highly advisable that interested companies connect with the team of specialists at TPA Global to devise a transfer pricing plan that resonates with this evolving landscape.
Author: Ameya Dadhich, Trainee, TPA Global
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