The importance of establishing a robust transfer pricing policy

In today's globalized business landscape, groups of all sizes face the challenge of managing crossborder transactions effectively. Establishing a robust transfer pricing (‘TP’) policy is important to ensure transparency, compliance, and optimized tax efficiencies.

TP aims in determining the appropriate prices for goods, services, or intellectual property transferred between related companies (e.g., group companies). The purpose of TP documentation is to support that the pricing of related party transactions is aligned with market prices and reflects the contribution and economic substance of each transaction. This is also referred as arm's length pricing.

In 2022, Cyprus became one of the last EU Member States to adopt TP rules and documentation requirements in accordance with recommendations of the Organisation for Economic Co-operation and Development on Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (‘OECD TP Guidelines’).

In accordance with the TP rules, Cypriot entities engaged into domestic or cross-border transactions with related parties, should support the arm’s length pricing of such transactions. This aims to tackle profit shifting and ensure that income is taxed in the same place where economic value is created.

According to the 2023 EY Tax Risk and Controversy Survey of EY Global, businesses anticipate tax audits to double in the next two years following a distinct pause in tax audits and disputes during the pandemic. Among the 2,127 tax and finance executives in 47 jurisdictions who responded to the survey, 84% of the participants acknowledged that implementing or enhancing an effective policy would add “some or significant” value to their business with regards to tax risks and controversy management.

In light of the above, the significance of implementing a comprehensive and proactive TP policy it is becoming increasingly relevant, considering the key benefits that can be achieved. A TP policy shall be designed based on the business objectives of the group ensuring operating model efficiencies. A well-designed and effective TP policy enables groups to strategically allocate profits and expenses amongst their entities, by aligning prices with the economic substance of each transaction.

Such TP policy establishes consistent guidelines for pricing, agreements, and transactions. This clarity promotes informed decision-making and enhances collaboration across group companies and jurisdictions in order to allow for better allocation of resources and capital as well as enhance the overall group profitability.

Furthermore, implementing a robust TP policy enhances the compliance with local tax regulations globally, considering that related transactions are priced at arm’s length. Moreover, by maintaining thorough documentation may substantially lower the risk of tax-related issues and act as a strong defence against tax audits, penalties, and disputes. At the end of the day, based on practical experiences an effectively structured TP policy empowers groups to optimize their global tax position, by aligning pricing strategies with local market conditions and tax regulations. Finally, it is crucial for groups to strategically approach the design of a robust TP policy. Undeniably, a proactive TP policy may allow for enhanced compliance, optimized tax planning, and improved operational efficiency, while groups may consider seeking expert guidance when implementing a TP policy to achieve tax efficiencies and safeguard the group's financial stability.