I interviewed Guy Sanschagrin who discussed What is Transfer Pricing and What are its Impacts on Supply Chains?
My name is Guy Sanschagrin. I began my career in supply chain through Northeastern University’s industrial engineering program. I worked as an industrial engineer for about five years, performing dozens of projects to increase the efficiency of processes, streamline workflows, and lay out facilities. After obtaining an M.B.A. in finance and international business from the University of Chicago, I was recruited by Ernst & Young to join its transfer-pricing practice.
At the time, EY was recruiting people with supply chain backgrounds, like me, because they saw opportunities to bridge tax and transfer-pricing opportunities with company supply chain initiatives. I now, have about 15 years’ experience in transfer pricing, including three years spent on international assignment as the national leader of EY’s Belgium transfer-pricing practice…
Transfer pricing involves pricing intercompany transactions, which are transactions that take place between related parties, typically within a company, such as transactions between a company’s divisions or entities. The main types of intercompany transactions involve: 1) the sale of goods; 2) the provision of services such as a central IT group providing global IT support services; 3) intangibles such as the sale or license of technology across borders; and 4) intercompany financing, which includes loans such as one entity loaning to another entity.
Transfer pricing is a huge international tax issue, as it impacts where companies recognize profits when the intercompany transactions cross country borders. As a result, most countries have transfer-pricing rules in place that provide them with tools to claim their fair share of income tax. One of the fundamental pillars of transfer pricing is the arm’s-length standard. To meet the arm’s-length standard, companies must be able to demonstrate that the transfer pricing associated with their internal transactions are consistent with the results that would’ve been realized if independent companies had engaged in the same transaction under the same circumstances.
Companies get into trouble when they don’t take tax and transfer pricing into account when restructuring their supply chains. A multi-country supply chain initiative can subject the company to a high global effective tax rate when locating important functions in high-tax jurisdictions. Also, some companies are engaging in tax planning that is not well-aligned with their supply chains. These often result in tax structures that are not sustainable, as tax authorities can challenge a tax structure that lacks the business purpose of a supply chain initiative or substance such as important functions that can demonstrate the ability of an entity to manage important supply chain risks.
Companies can create sustainable tax-efficient structures by layering transfer pricing and tax planning with their supply chain initiatives. As companies expand or streamline their supply chains, they can make tax-smart decisions about where to locate the value drivers and the important functions within their supply chains.
For instance, if it makes sense to create a regional headquarters or centralized services such as a strategic sourcing group, companies can consider the tax rates that their cash flows will be subjected to in the various jurisdictions. Companies should keep in mind that there are significant differences in the tax rates levied by the countries they are operating in, and as they decide on locations of important supply chain functions, they should perform their cost-benefit analyses on an after-tax basis.
Many companies make decisions above the line on a pretax basis as they restructure their supply chains. As a result, they may not be maximizing shareholder value. I recommend that companies make their decisions on the after-tax free cash flows their initiatives are expected to generate. They should consider tax cost and tax-planning opportunities as the company expands or changes its supply chain.
Global intangibles and the high-value functions that go with them are important elements to consider. Companies should make certain they identify the important intangible assets contained within their supply chains. These intangibles can include know-how, technology, patents, and supplier relationships.
Companies should consider how these will change in value over time. They should think about locating intangibles and the people that go along with them in favorable tax jurisdictions. This approach will help companies maximize the value that their supply chain initiatives generate for their shareholders.
About Guy Sanschagrin
Managing Director at WTP Advisors