Transfer Pricing Seminar for Medium-sized corporations in Japan

(This is the final article of this seminar series composed of 11 articles)

(Part 11) Transfer Pricing Policy and Transfer Pricing Documentations

Although the term “transfer pricing policy” has been widely used in the practice of transfer pricing, it seems that both its meaning and its role have slightly changed with the evolution of transfer pricing documentation.

1. “Transfer pricing policy” prior to the introduction of transfer pricing documentation

“Transfer pricing policy” originally meant the pricing policy and/or operational rules to set the arm’s-length price as the transaction price in controlled transactions within a multinational corporation.

However, prior to the introduction of transfer pricing documentation, there were many cases in which corporate groups with only a few foreign affiliates, too small to be called multinational corporate groups, prepared documents similar to what we now call “local files” for certain controlled transactions with taxation risk. These documents were considered to be the company’s “transfer pricing policy.”

In other words, certain corporate groups took steps to reduce transfer pricing taxation risks potentially caused by certain controlled transactions. They voluntarily developed their own transfer pricing documentation that over time became similar to the local files of today.

2. “Transfer pricing documents” and “Transfer pricing policy” after the introduction of transfer pricing documentation

In transfer pricing documentation, “transfer pricing documents,” means the local files, CbCR, and a master file, although it more generally means all the documents necessary to show that the company’s transfer pricing has been calculated properly.
The introduction of the documentation rule did not make the “transfer pricing policy” redundant. It is still necessary to have a company policy in its original meaning. The necessity of a good policy increased as the preparation and submission of transfer pricing documentation was made obligatory. Even transactions by businesses smaller than the mandatory standard may have to submit documents upon the request of an examiner during a tax audit.

Having one consistent transfer pricing risk management system for the entire corporate group, after all, can be achieved by segregating the controlled transactions conducted by the company according to the transaction type (e.g. inventory transactions, service transactions, intangible assets transactions, intra-group service transactions, and financial transactions), and then by analyzing functions by transaction type, selecting the calculation method for the arm’s-length price, formulating a pricing policy and its operational rules, and developing all these into a full “transfer pricing policy.”

One approach might be to select comparable transactions in the process of establishing the transfer pricing policy and to calculate the range of appropriate transfer prices in advance of the actual individual controlled transactions. However, we advise sticking to the function analysis and the calculation of the arm’s-length price. We recommend waiting to select the comparable transactions and calculate the appropriate range of transfer pricing until preparing local files on individually controlled transactions.
The master file required of corporate groups that have a consolidated revenue of a hundred billion yen or more can be prepared by adding information such as the business overview to this transfer pricing policy.

Moreover, implementing a transfer pricing policy can also be beneficial to companies required to prepare a local file, since it allows them to manage the risks of potentially unrecognized controlled transactions (e.g. IGS) as well as future risks.

In light of these various requirements, we advise medium-sized companies that conduct controlled transactions, even if they have only a few foreign affiliates, to protect themselves against transfer pricing taxation risks by establishing a transfer pricing policy, not only for currently recognized controlled transactions but also for potential and future risks. The policy should be shared through the entire company, including both the sections currently doing controlled transactions and those that might be doing so in the future.

This is the final article of our “Transfer Pricing Seminar Series for Medium-sized Corporations in Japan.”

Please remember that, for various reasons, price setting and the preparation of local files sometimes require adjustments when dealing with certain kinds of controlled transactions. At HLS Japan, we prepare transfer pricing documents and provide precise advice to meet our clients’ individual needs. Please contact us if you have questions or requests concerning transfer pricing.

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