Understanding Risk in the Enterprise: The Key to Transfer Pricing for Today's Business Models

06 November 2014
By Pim Fris, Sébastien Gonnet, and Ralph Meghames

Transfer pricing involves a number of stakeholders, each potentially having a different perception with respect to risk: multinational enterprise (MNE) top management, tax authorities, operational management, personnel, shareholders, suppliers, customers, and the public. These different views can be divergent and can lead to misinterpretation when it comes to understanding the risks at stake inside an MNE and, consequently, comprehending correctly the allocation of risks among related parties involved in transactions.
In this article from International Transfer Pricing Journal, NERA Affiliated Consultant Pim Fris, Vice President Sébastien Gonnet, and Consultant Ralph Meghames present an analytical framework for understanding risk in the context of applying the arm's length principle that takes into consideration value creation, roles and responsibilities, and bargaining positions.

This article is published while the OECD, under the BEPS (Base Erosion Profit Shifting) initiatives, is currently working on the notion of risks in the transfer pricing context, and has recently published a "discussion draft on revisions to Chapter I of the Transfer Pricing Guidelines (including Risk, Recharacterisation and Special Measures)" on 19 December 2014.

The process described by the authors in the article starts with the definition of risk. Once risk in its broad sense is defined, a framework is developed for mapping the responsibilities of the individual parties for the different risk categories concerned.  Having identified the responsibility of parties for the risks involved in the relationship, the respective contributions by these parties to the joint value creation can be assessed and the relative bargaining position of each of them derived. The information on the bargaining power of the entities involved is essential for concluding whether or not, in the complex reality of the MNE, third parties would enter or would have entered into the transactions at the prevailing terms and conditions. Only if that conclusion is justified can the prices for intercompany transactions be deemed to be "at arm's length."