Global supply chain disruptions, inflationary pressures, geopolitical tensions, and global elections have emerged as significant challenges in the recent world economy.
Supply chain disruptions caused by restricted trade routes, energy shortages, and sanctions, have led to rising transportation and input costs. Moreover, inflationary pressures fuelled by these crises are pushing prices higher across the globe. As multinational enterprises (MNEs) face this complex landscape, they need to strategically adjust their transfer pricing policies to remain compliant while mitigating the financial impact of these global challenges.
Below we will further explore how the global conflicts, combined with inflation and political shifts, are affecting transfer pricing and offers insights into key strategic considerations for MNEs.
Supply Chain Disruptions in a Nutshell
For MNEs, transfer pricing—used to set prices for transactions between related entities in different jurisdictions—is closely tied to the stability of supply chains. When disruptions occur, MNEs can significantly alter the costs tied to intercompany transactions, impacting profit margins. As a result, businesses must continuously evaluate how these shifts affect their transfer pricing models to maintain compliance with the arm’s length principle and ensure alignment with global tax regulations.
Supply chain disruptions is nothing new, but since the onset of COVID-19, global supply chains have faced unprecedented disruptions, creating long-lasting ripple effects across industries. Lockdowns, factory closures, labour shortages, and restricted transportation routes initially caused severe delays and inventory shortages. As demand surged for certain goods, such as medical supplies and electronics, bottlenecks intensified, particularly in critical nodes like ports and shipping. These disruptions, compounded by subsequent events such as geopolitical conflicts and energy crises, have led to higher shipping costs, increased lead times, and continued material shortages, forcing companies to rethink their supply chain resilience and strategies for sourcing and production.
Inflation’s Role in Transfer Pricing
Inflation has emerged as a significant challenge for multinational enterprises (MNEs), with recent examples from the U.S. and Europe where inflation has been driven by supply chain bottlenecks, energy crises, and surging demand for goods. The cost of raw materials, labour, and transportation has escalated, specifically due to the Russia-Ukraine conflict, further pressuring input costs. This surge in costs affects profitability across industries, requiring MNEs to re-examine their transfer pricing policies to ensure they accurately reflect the rising expenses within intercompany transactions.
For CFOs and transfer pricing managers, inflation distorts the comparability of intercompany transactions with third-party benchmarks, which are a cornerstone of transfer pricing compliance. Rising inflation rates, which vary significantly across jurisdictions—such as double-digit inflation in emerging markets compared to milder inflation in developed economies—complicate the task of maintaining consistency. This necessitates a more dynamic approach to transfer pricing benchmarking, requiring frequent reassessment to ensure that pricing remains within the arm’s length standard, while also managing the increased scrutiny from tax authorities in inflation-impacted regions.
Key impact on MNE’s
- Increased Costs Due to Delays and Shortages: MNEs need to account for rising costs caused by supply chain disruptions and inflation when pricing intercompany transactions. For example, when input costs increase due to delays in receiving raw materials, the additional costs may need to be reflected in the transfer prices charged between related entities.
- Re-evaluating Benchmarking Practices: Traditional benchmarking techniques that rely on historical data may no longer be suitable during periods of inflation or supply chain disruptions. MNEs might need to adjust their benchmarks and look for more contemporaneous data to reflect current market conditions. This may involve revising profit margins or cost-plus methodologies to ensure compliance with the arm’s length standard.
- Managing Risks and Uncertainty: Supply chain disruptions introduce risks and uncertainties that affect MNEs’ operations. Transfer pricing policies must reflect which entity in the corporate group bears these risks. This is crucial in ensuring that the entity responsible for managing supply chain risks is adequately compensated through its transfer pricing arrangements.
Strategic Considerations for MNEs
MNEs facing supply chain disruptions and inflationary pressures should focus on several key strategies:
- Scenario Analysis and Flexibility: Conduct scenario planning to anticipate potential disruptions and model their impact on costs and pricing strategies. This helps MNEs remain flexible and adjust transfer pricing as needed.
- Documentation and Compliance: As supply chain disruptions and inflation evolve, MNEs should maintain thorough documentation to justify any changes to transfer pricing policies. Tax authorities are likely to scrutinize these changes closely to ensure that companies are not using disruptions or inflation as a means to shift profits inappropriately.
- Reviewing Contracts: MNEs should consider revising their intercompany agreements to reflect any changes in the allocation of risks, responsibilities, and rewards arising from disruptions. This includes adjusting pricing mechanisms and payment terms to account for rising costs or longer lead times.
Adapting to a New Reality
Adapting to a new reality of supply chain disruptions and inflation is reshaping the economic landscape, forcing MNEs to rethink their transfer pricing policies. By adopting flexible approaches, conducting regular reviews, and ensuring that intercompany transactions reflect real-time costs, MNEs can maintain compliance while optimizing their global tax positions.
TPGenie from Intra Pricing Solutions can assist MNEs in navigating these challenges by offering automated, data-driven tools for transfer pricing compliance and benchmarking. With TPGenie, companies can streamline the process of adjusting benchmarks, updating pricing models, and documenting changes—ensuring that transfer pricing strategies remain aligned with evolving market conditions. This proactive approach enables MNEs to stay agile in the face of supply chain and inflationary pressures while minimizing risk and maintaining adherence to the arm’s length principle.
Sources used:
https://www.ey.com/en_be/tax/international-tax-and-transfer-pricing-survey
https://www.meijburg.com/news/inflation-and-its-impact-your-transfer-pricing
https://www.linkedin.com/pulse/inflation-supply-chain-labor-disruption-rising-/
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