The BEPS project resulted in a 15-point action plan, which includes initiatives specifically designed to address transfer pricing. For instance, BEPS Actions 8-10 focus on aligning transfer pricing outcomes with value creation, emphasizing the need for transactions to reflect economic reality. This approach marks a shift from a purely legalistic interpretation of transfer pricing rules to a more substance-based view, considering the location of functions companies perform, assets they use and risks they assume in their global value chains.
 
Another significant development is the move towards greater transparency. This is embodied in the Action 13 report of the OECD’s BEPS project, which introduces a three-tiered standardized approach to transfer pricing documentation, which includes the country-by-country report (CbCR), the master file and the local file.
 
The U.S. CbCR rules require U.S.-based multinational companies with revenues greater than $850 million to report annually, for each tax jurisdiction in which they operate, the amount of revenue, profit before income tax, income tax paid and accrued, total employment, capital, retained earnings, and tangible assets via Form 8975.[3]
 
This level of reporting is designed to give tax authorities a clearer view of how multinational companies structure their operations and allocate their income among their global affiliates.

The impact of the digital economy

The digital economy presents new challenges for transfer pricing. Digitalization has enabled companies — especially tech giants — to earn substantial profits in low-tax jurisdictions, complicating traditional transfer pricing models based on material goods and services.
 
In response, the OECD’s BEPS Action 1[4] addresses the tax challenges of the digital economy. This includes proposals for new nexus and profit allocation rules that go beyond the traditional physical presence requirement, aiming to ensure that company profits are taxed where they perform essential activities and create value.
 
More recently, the OECD introduced a two-pillar solution to address BEPS and “challenges arising from the digitalization of the economy.”[5]
 
Pillar 1 introduced Amount A, which allocates the routine profit above 10% among tax jurisdictions using a formula. This allocation formula includes jurisdictions without a physical presence. Amount A applies to multinational companies with revenues exceeding EUR 20 billion and profit margins of 10% or more. Amount B provides standard returns for certain types of functions, such as routine marketing or distribution activities. There is no threshold for Amount B.
 
Pillar 2 applies to multinational companies with revenues exceeding EUR 750 million. Pillar 2 is sometimes referred to as the “top-up tax” and focuses on entities taxed below 15% to ensure a minimum global effective tax rate.[6] The following table summarizes the thresholds specified by the above OECD initiatives.
 

OECD Initiative	Thresholds
CbCR	Revenue of EUR 750 million / $850 million (U.S.)
Pillar 1	Revenue of EUR 20 billion / 10% margin
Pillar 2	Revenue of EUR 750 million

Regional and country-specific developments

Different regions and countries have responded to these global trends with their own regulations. For instance, the European Union has been actively incorporating BEPS actions into its member states’ local laws and exploring additional measures like a digital services tax. Countries in Latin America, Asia and Africa are also updating their transfer pricing regulations to align with global standards. This includes adopting CbCR requirements and revising local transfer pricing guidelines to reflect the focus on substance over form and the importance of intangibles and digital services. Every country has its own culture, and there may be differences in how they evaluate arm’s length behavior versus results and flexibility to view transactions as a bundle, such as the United States, or a strong preference to examine individual transactions, such as Italy. Thus, it is important to understand each country's regulations and how local authorities implement them.

How should companies prepare for the future?

Companies should proactively manage their transfer pricing by developing a clear global transfer pricing policy, maintaining documentation, and accessing transfer pricing know-how either by developing internal transfer pricing teams or strong working relationships with trusted consultants.
 
Companies need to tap into experience to understand how local tax authorities enforce their transfer pricing rules and be prepared to respond to tax authority challenges and proposed adjustments.
 
Smaller companies may believe they are under the radar of transfer pricing scrutiny. However, in most countries, there is no materiality threshold.
 
We have seen a tax authority impose million-dollar adjustments on relatively small $50 million revenue companies with the threat of imposing nondeductible transfer pricing penalties and interest. It is important for all companies to develop clear and coherent global transfer pricing policies based on the arm’s length standard with support from intercompany agreements, benchmarking studies and documentation.
 
Middle-market companies with global revenues approaching or exceeding EUR 750 million should prepare a CbCR. Those who are operating in a dozen or more jurisdictions should consider running a transfer pricing risk assessment to evaluate risks by jurisdiction and transaction types.
 
It will be necessary for these companies to map their value chain flows, understand their intangible assets and the entities that own them, and identify DEMPE functions — the activities that involve the development, enhancement, maintenance, protection and exploitation of intangible assets.
 
Companies should develop a documentation plan and maintain robust documentation based on the direction provided by the transfer pricing risk assessment output.
 
In addition, these companies should model the potential impact of Pillar 2 and develop plans to minimize the impact of the 15% top-off tax. They should consider using technology, such as the TransPortal Global Transfer Pricing Management Platform[7], which helps companies organize documentation and legal entity information, manage processes, and automate data collection and analysis.
 
Companies approaching or exceeding EUR 20 billion revenue and the 10% margin thresholds should take additional measures to address Pillar 1.
 
Since Pillar 1 will require these large companies to allocate some of the residual profit[8] among routine entities and countries where the companies have a digital presence without a physical presence, these companies should consider running the residual profit split method as an approach to identify and allocate residual profit across their value chains. Many companies and specialists have traditionally avoided the profit split method to their peril, as many high-profile transfer pricing cases involve some application of the profit split method[9].
 

Looking ahead: Future of transfer pricing

Transfer pricing will continue to evolve further, especially as the global economy grapples with the implications of digitalization. The ongoing discussions about the digital economy under the OECD’s BEPS project will shape future transfer pricing rules. Moreover, the COVID-19 pandemic’s economic impact has brought additional complexities to transfer pricing arrangements, with many companies restructuring their operations and supply chains.
 
Tax authorities worldwide will scrutinize these changes to reflect the arm’s length principle and their regulations.
 
Transfer pricing is undergoing significant changes, driven by global efforts to ensure fair taxation practices, the challenges posed by digitalization, and the need for increased transparency. Multinational companies must stay abreast of these developments and adapt their transfer pricing policies accordingly.
 
Meanwhile, tax authorities must balance the need for strict enforcement with the reality of an ever-evolving global business landscape.
 
Guy Sanschagrin leads WTP Advisors’ transfer pricing and valuation practice and is CEO of TransPortal, a global transfer pricing management platform. You may reach him at 866-298-7829 ext. 702 or guy.sanschagrin@wtpadvisors.com.