Read nearly any business publication in the last two years and a common theme keeps appearing—supply chains have been disrupted on a historic level. In this environment, decision makers at multinational enterprises (MNE) have had to react quickly, often with few choices or little information regarding the best course of action. And yet, while today’s supply chain disruptions have had a profound, generational impact, supply chain disruptions are not a new phenomenon. The U.S.-China trade war beginning in 2018 and the 2009 financial crisis are recent shocks that also caused disruptions to supply chains, albeit on a lesser scale. While today’s disruptions may be larger in scale, other recent supply chain disruptions can give MNE decision makers some guidance on the best way forward.
One area where this guidance is most pertinent is transfer pricing. Most supply chains consist of intercompany entities and outsourced vendors. However, based on some estimates, intercompany trade accounts for between 60% to 80% of all global trade,1 and the pricing of that trade is governed by transfer pricing principles. So, having a tax-efficient and defendable transfer pricing structure that is aligned with the value creation of an MNE supply chain is a must—the two go hand in hand. This is especially true in the face of market disruptions that require realignment of supply chains, turning value creation upside down. This realignment opens the door to tax authority scrutiny of an MNE’s transfer pricing structure. As such, a sound, malleable transfer pricing structure helps provide confidence in the alignment of income allocation and value creation in the face of supply chain disruptions.
For example, supply chain disruptions caused by COVID-19 lockdowns left MNE decision makers scrambling to ensure the continued flow of goods. In many cases, ad-hoc movement of operations to a related party in another jurisdiction with no lockdowns was required. As a result, the transfer pricing structure had to adjust to ensure proper income allocation to the entity assuming more operations as a result of the lockdown in its related party’s country.
Supply chain disruptions are not only limited to physical impacts. Consider the intellectual property (IP) of an MNE being developed by multiple related parties across different countries. A rise in geopolitical tensions between some of these countries could pave the way for sanctions, distorting the supply chain development of the IP. Without a clearly defined transfer pricing structure delineating the functions, risks, and assets employed in the development of the IP, disagreements between tax authorities over IP ownership could give rise to unforeseen income allocations or even the IP being stranded in a market that an MNE may be looking to exit.
Having a sound transfer pricing structure can alleviate exposures by providing greater flexibility for decision makers to react to these and other types of supply chain disruptions. Supply chain disruptions are nothing new and MNE decision makers should expect them even after the current supply chain disruptions subside. Having a sound transfer pricing structure in line with your supply chain would help align income allocation to value creation during calm periods and can provide enough flexibility to reduce distortions during times of disruption.
At FORVIS, our transfer pricing team is ready to assist your business as it meets these challenges head on. To learn more, reach out to a professional at FORVIS or fill out our Contact Us form below.