Tuesday, January 18

The complexity of transfer pricing in digitized supply chains


Traditional tax models were based on the physical presence of a company, known as physical companies. The digitization of the global economy has completely reversed the physical presence test, allowing for the fragmentation of business operations and assets, including intangible assets.

The lack of physical presence enabled by digitized technology is a major problem that tax authorities and the Organization for Economic Cooperation and Development (OECD) have been grappling with for nearly a decade.

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Transfer pricing is trying to address other issues as well, including how to value a single intangible asset, such as users’ personal data collected by online organizations.

Transfer pricing refers to the pricing of transactions that take place between connected parties, which can be corroborated with comparable data. There are established methodologies for the valuation of intangible assets, although subjective. But there are no comparables for unique intangible assets.

Taxing the Gains of the Digital Revolution: Many Questions

At the recent 10th Africa Transfer Pricing Summit organized by the South African Institute of Taxation (Sait), an expert panel comprised of Michael Hewson, Director and Founder of Graphene Economics, Jeremy Basckin, CEO and Transformation Manager of the Neways supply chain in the UK, and Philippe Paumier, a founding member of Vector TP in France, discussed the complexities of supply chain management transfer pricing

Hewson said that digital transformation is a key characteristic of most companies. It allows the company to be in the cloud, without borders, without having a physical presence in any country. He posed the question: “How can the income of the digital revolution be taxed?”

He referred to the latest proposed global tax reform spearheaded by the OECD: “While the world has been fascinated by Pillar 1 and Pillar 2, how can the arm’s length price of digital transactions be determined?”

Read: Will Global Tax Reform Lead to a Fairer Tax System?

Technological transformation

According to Hewson, technology has transformed many industries, for example, consumer electronics, automotive electronics, industrial electronics, data processing, communications, electronics, military and civil electronics.

“No industry has missed an opportunity to stay connected.”

Hewson provided the example of the cost contribution of automotive electronics and semiconductor content in a motor vehicle that increased from 18% in 2000 to 40% in 2020, and is expected to reach 45% in 2030.

He explained that a traditional supply chain begins in development and goes through the stage of planning, product sourcing, product manufacturing, delivery, and ongoing support functions. However, a digital supply network has a digital core connected to the various components, the connected customer, a smart factory, digital central planning, digital development, dynamic order fulfillment, and smart sourcing.

Hewson said there are no specific guidelines on the valuation of digital deals.

Seismic change in supply chains in 2020

Basckin explained that supply chains are good at reacting to individual events, such as a transportation problem. But in 2020 there was a multidimensional seismic shift, caused by the Covid-19 pandemic. The blockades caused a change in supply chains; for example, people bought food at different outlets.

Read:

Multinationals: Transfer pricing policies to be analyzed after Covid
Achieving a correct transfer pricing policy is still difficult
Transfer pricing disputes may be on the rise due to Covid-19 outages

He said prices are fluctuating, which has a massive effect on transfer prices. Transport prices have risen and there is a shortage of containers and ships.

Brexit also sparked massive changes: it was, for example, difficult to move goods from the UK to Europe, with ferries going from Europe to Ireland, rather than through the UK.

Basckin said that while large companies could invest in new systems, smaller companies could buy out-of-the-box applications that carry out the functions of traditional IT systems, such as forecasting tools, demand inventory tools and financial tools. .

The transfer pricing perspective

Paumier explained that it is necessary to evaluate each activity in the value chain of a company to understand how value is created. Each function must be valued in order to be quoted.

The most basic difficulty for transfer pricing purposes is keeping track of what is happening.

Not all the various digitization initiatives are of equal value.

Digitization is a facilitator of horizontal fluid transactions. Covid was a catalyst for the fragmentation of things, which can take place remotely.

Paumier said that we now have dispersed teams, working from different locations. There is a data collaboration.

Data is intangible and must be valued. Users must also be valued. But there are active users who provide accurate data and passive users who do not provide accurate or useful data.

Basckin explained that a company can now share upstream and downstream supply chain data through message centers. Hubs are connected to providers and customers. You can react quickly to changes in supply or demand.

He said that collaboration hubs create end-to-end visibility, reducing risk and leading to efficiency, and that technology has allowed all players, including third parties, to come together, which was previously only possible in one multinational company.

He suggested that from a transfer pricing perspective it is advisable to stay within the established framework and look at the less complex entity.

Important conclusions

The panel agreed that the important conclusions are:

  • Identify the areas of the organization in which digitization has been applied;
  • Evaluate the impact on the value chain;
  • Consider contributions from relevant parties;
  • Determine how the parties should be compensated for their contributions;
  • Ensuring proper implementation, for example by contracts; and
  • Document in detail all the steps taken.


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