Transfer prices are part of the agenda of almost every medium-sized and large company. If the company is subject to audit, its audit committee should also be involved. Because of the implications that incorrectly-set transfer prices can have for the organisation, audit committee members need to have detailed information about the group’s transfer pricing status. But how is it in practice?
Areas of responsibility of audit committees in relation to transfer pricing
Audit committees have many responsibilities within a corporate group, ranging from the oversight of external reporting (in particular financial reporting), internal control systems and their functioning, and external compliance among others.
Although it may not seem so at first, transfer pricing can have implications for the responsibilities of the audit committee, as they may affect:
- external reporting, e.g., in the context of income tax provision, deferred tax, provision for tax risks
- internal control system, considering the size of potential risks in transfer pricing, both in monetary terms (reassessment of transfer prices by the tax authorities with a consequential increase in taxes due) and reputational terms (the image of a company could be damaged by potential claims of tax avoidance)
- compliance: in many countries, the preparation of transfer pricing documentation is obligatory.
What does the current situation look like?
Audit committees are not very interested in transfer pricing because it is perceived as a very specific topic with numerous details and often as a mere compliance obligation that needs to be dealt with in a routine manner. This perception completely overlooks the far-reaching implications that transfer pricing may have for a group — not only regarding compliance and reporting, but also from a reputational perspective.
In the past years, numerous multinational entities have suffered reputational damage from transfer pricing-related topics. Their transfer pricing policies and structures have been scrutinised by tax authorities or by the European Commission (in the context of possible state aid), but especially by the public. The implications of reports of tax avoidance in the media may affect consumers and possibly may result in lower revenue for these groups.
Topics such as a global minimum tax rate and ESG are also likely to affect a group’s transfer pricing policy and could contribute to increase the group’s transfer pricing-related risks. A higher level of involvement from the audit committee is therefore important.
What could the audit committee’s involvement look like conceptually?
Given its main responsibilities, the audit committee should be informed about:
- the main characteristics of the group’s transfer pricing system setup, including an evaluation of the main risks connected with it; this is necessary so that the audit committee can evaluate whether the risks connected with the current transfer pricing system are in line with the organisation’s risk appetite
- the compliance status in terms of transfer pricing documentation as well as other compliance obligations
- significant ongoing tax inspections in which transfer pricing plays a major role: such tax inspections may also lead to broader implications such as reputational issues and need to be on the audit committee’s radar.
Based on this information, the audit committee may then require further information on individual topics that are identified as specific risk areas requiring more detailed attention.