Reasons to monitor your TP model

The business model of a scale-up company must evolve to sustain its new size and continue its dynamic growth. As fast-growing companies, they may need to develop their business strategy continuously. However, they will also most likely need to amend their end-to-end processes and optimize its business operations, including changes in critical activities, hiring new skillful staff in different locations, and assigning new responsibilities to employees.

In addition to the above, scale-up companies must deal with increasing tax compliance, legal requirements, and multiple other obligations once they expand to foreign markets. As part of the global expansion, taxes and transfer pricing play a crucial role of this journey.

In terms of transfer pricing, countries that largely adopted the OECD Transfer Pricing Guidelines[2] (including the Netherlands) use the business model as a starting point for designing a transfer pricing model, resulting in arm’s length prices for (new) intragroup transactions.

In a nutshell, the transfer pricing model is generally identified depending on the degree of control and management exercised by the entities in a multinational group, where the most common models are:

• Centralized: One entity exercises most control over the entities in the multinational group.
• Decentralized: Each entity has complete autonomy over its operations.
• Hybrid business model: Combines certain features or has different activities that engage the centralized and decentralized business models.

The transfer pricing model is not set in stone, as it is tied to the business model, and therefore, it can change from one moment to another based on the group’s needs as reflected in the applied business model.

For example, gaining more flexibility and autonomy to exercise independent decisions according to the know-how and special skills gained in the local markets are some of the reasons that can create the need to transform a centralized business model into a decentralized one.

Red flags that indicate you should revise your transfer pricing model

Losses: As mentioned by the OECD Guidelines, a multinational group can assume losses in the context of its economic operations, strategy, and other factors. The need to take initial losses can be a common trait for scale-up companies, as they are managing the balance of their growth and profitability and, therefore, might register losses for different reasons (e.g., high investments in innovation and pricing strategies). However, negative financial results can set an attention point for tax authorities to review the validity of such losses and confirm that profits/losses are recorded where they should be.

Team growth: Expanding the team in the foreign market and hiring personnel to engage in additional functions may imply new activities and responsibilities undertaken locally. A transformation in the foreign team functions can influence the transfer pricing policy and, therefore, must be taken into consideration.

Team independence: There are several reasons why a company may start to operate independently, such as skills gained by the personnel, the need to provide a swifter response to clients and the need to adapt to evolving markets quickly. If a team operates more autonomously than before, this might lead to changes in the transfer pricing model.

Innovative functions by different entities of the group:  Innovation is at the core of many scale-up companies. Innovation can refer to products and processes, but it can also be marketing, business relations with clients or unique customizations performed locally. The transfer pricing model might be altered when any such innovation is led and created by different entities in the group.

Mitigation procedures and follow-up steps

Avoid non-compliance: A scale-up company should prepare an appropriate transfer pricing policy once it expands internationally. It is also advisable to periodically review such policy to ensure that it is still aligned with the facts of the business operation.

Adjust the TP Policy: Where additional transactions or changes to existent transactions are identified through the periodic review of the transfer pricing policy, processes to implement the changes in the transfer pricing policy and monitoring such transactions are of key importance. Furthermore, monitoring mechanisms become more relevant; for instance, the company may need to segment the financial information linked to that transaction to apply and enforce the correct methodology.

In case you are triggered by the above and want to explore the impact of transfer pricing in your (scale-up) organization, RED is happy to schedule an introduction meeting to discuss the importance of transfer pricing tailored to your situation. Please feel free to contact rocio.martel@red.tax.

[1] OECD (2022), Financing Growth and Turning Data into Business: Helping SMEs Scale Up, OECD Studies on SMEs and Entrepreneurship, OECD Publishing Paris, https://doi.org/10.1787/81c738f0-en

[2] OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations issued in January 2022.