Documentation of transfer pricing is a key element in multinationals’ tax compliance. This set of technical reports not only meets legal obligations in multiple jurisdictions, but also provides solid evidence to demonstrate that transactions between related entities have been carried out in accordance with the arm’s length principle. This principle requires that intra-group transactions reflect conditions similar to those that would exist between independent parties, thus preventing tax base erosion and profit shifting between countries.
What is transfer pricing documentation?
Transfer pricing documentation is a package of reports and technical supporting documents that justify the determination of prices or margins applied in transactions between associated companies. Its purpose is to explain and substantiate compliance with the arm’s length principle to the tax authorities, avoiding adjustments, penalties, or disputes that may arise during an audit.
The most influential international standards that establish the guidelines for this documentation are the guidelines of the Organization for Economic Cooperation and Development (OECD), particularly those developed within the framework of Action 13 of the Base Erosion and Profit Shifting (BEPS) project. These guidelines recommend a standardized approach to preparing and presenting transfer pricing documentation in multiple jurisdictions. Action 13 seeks to standardize the content and format of this documentation internationally, reducing information asymmetries and avoiding inconsistent requirements between jurisdictions.
Main components of transfer pricing documentation
The OECD guide organizes the documentation into three key components that, together, provide a comprehensive view of the transfer pricing risks and policies adopted by a multinational enterprise:
1. Master File
The Master File provides a global overview of the entire multinational enterprise. Its purpose is to provide tax authorities with a comprehensive description of the business strategy, organizational structure, key intangible assets, transfer pricing policies, and relevant economic activities of the group as a whole.
The information in the Master File allows examiners to understand the group’s global economic context, its global functions, financial policies, and how resources are allocated among its entities.
In accordance with OECD Action 13, the Master File must include, among other elements, a description of the group’s value chain, the main intra-group service and financing agreements, general profit allocation policies, and the geographical location of the main intangible assets.
2. Local File
The Local File focuses on detailed information specific to the local entity or jurisdiction in question. It includes data on relevant intra-group transactions carried out by the entity, comparability analysis, selection and application of the transfer pricing method, and other financial information supporting that the prices or margins used are in line with the arm’s length principle.
Unlike the Master File, which addresses the big picture, the Local File requires direct and detailed evidence of the most significant transactions, including descriptions of functions, risks, assets used, and external comparables.
The OECD emphasizes that the Local File should allow the tax administration to assess, directly and specifically, whether the financial results reported by the local entity are consistent with the functions performed, the risks assumed, and the assets used, thus constituting essential technical support for determining income tax.
3. Country-by-Country Report
This third component is not always part of formal transfer pricing documentation, but it is a complementary requirement in many jurisdictions for multinational groups with consolidated revenues above certain thresholds. The CbC report requires the provision of aggregate data on revenues, profits, taxes paid, and certain economic activity indicators in each country where the group operates.
This report is especially useful for macro-level risk analysis and allows tax authorities to identify potential risk areas or discrepancies in the global distribution of profits.
It is important to note that, according to the OECD, country-by-country reporting should not be used as a basis for automatic transfer pricing adjustments, but exclusively as a tool for risk assessment and case selection for audit.
Obligations and technical criteria
Scope and reporting entities
The obligation to prepare transfer pricing documentation usually applies to companies that are part of multinational groups and that carry out significant intra-group transactions. Many countries adopt materiality criteria, for example, based on revenue, assets, or transaction volume, to define when an entity must prepare formal documentation.
Furthermore, the adoption of OECD standards in most jurisdictions means that even if a country does not have specific Master File or Local File requirements, companies must still maintain sufficient information to demonstrate that their transfer prices comply with local tax rules and the arm’s length principle.
Recommended minimum content
Although local regulations may vary, transfer pricing documentation typically includes:
- Description of the business and group structure.
- Functional and risk analysis.
- Description of intra-group transactions and their economic justification.
- Pricing methods and comparables used.
- Results of the analysis and conclusions regarding compliance with the arm’s length principle.
These sections should be aligned with the guidelines established by the OECD for each component of the Master File and Local File.
Best practices and technical considerations
Regular updating
Transfer pricing documentation should not be considered a static document. In dynamic economic environments, with changes in operations, mergers, acquisitions, or variations in cost structure, it is necessary to review and update documentation files periodically to keep them consistent and effectively support the transactions carried out.
Materiality and proportionality
The OECD guidance recognizes that not all intra-group transactions require exhaustive documentation. It is recommended that tax authorities and taxpayers define materiality thresholds based on the size and complexity of the transactions, so that the documentation effort is proportional to the level of tax risk involved.
Quality over quantity approach
Transfer pricing documentation should focus on providing substantive and consistent evidence, beyond the mere accumulation of documents. This involves applying sound technical judgments when selecting comparables, justifying methods, and explaining business decisions that affect pricing.
Conclusion
Transfer pricing documentation is a tax obligation and an indispensable tax risk management tool for multinational companies. Its structure—comprising the Master File, the Local File, and, in many cases, the country-by-country report—addresses the need to demonstrate to the tax authorities that transactions between related parties have been carried out in accordance with the arm’s length principle.
By properly designing, preparing, and updating this documentation, companies not only comply with the international standards recommended by the OECD, but also strengthen their position during tax reviews, reduce their exposure to adjustments, and improve their transparency with tax authorities.
Specialized technical support in transfer pricing
In an increasingly demanding regulatory environment, having the support of a company specializing in transfer pricing is key to ensuring regulatory compliance and adequate tax risk management. At TPC Group, we provide comprehensive technical advice on transfer pricing documentation, functional analysis, method selection, and audit support, aligning each study with OECD guidelines and applicable local requirements.
Source: OECD