In today’s interconnected world, companies face the challenge of navigating both State and Local Tax (SALT) and international tax regulations, particularly when dealing with transfer pricing and nexus. The complexities that arise from cross-border business operations demand a proactive approach to tax strategy. As multinationals expand their footprint, they must be prepared to address evolving tax obligations on both domestic and international fronts.

What is transfer pricing, and why does it matter?

Transfer pricing principles/guidelines refer to the rules and methods used by tax authorities to evaluate the arm’s length nature of profit allocation between jurisdictions for multinational companies. These rules are becoming more critical as governments have increased transparency with activities and profits earned outside of their own jurisdiction due to new reporting requirements (e.g., country-by-country reporting, master files, etc.) seek additional revenue sources through audits and requests for voluntary adjustments.

Taxing authorities are requesting increasingly complex data and reporting, often in formats that existing company’s ERP systems are not designed to handle, requiring detailed and time-consuming rework and analysis. A common example of this is often seen when tax authorities request segmented P&L data on an activity basis, whereas ERP systems only contain consolidated legal entity P&L data. Multinational companies must allocate more time and resources to respond to these requests. Without proper planning, the burden of compliance continues to grow, especially as tax authorities share more data across jurisdictions.

SALT’s impact on transfer pricing and Nexus

At the state and local level, SALT considerations introduce their own set of challenges, especially with the rise of remote workforces. A key issue is the creation of nexus, or a sufficient connection to a jurisdiction, which triggers a company’s obligation to collect and remit taxes.

• Physical presence: Traditionally, nexus was established when a company had employees or property in a state. With remote employees, companies may inadvertently create nexus in multiple jurisdictions and tax types including payroll tax, sales and use tax, and income or gross receipts taxes.
• Economic presence: Many states now impose economic nexus standards, where sales alone (without physical presence) can establish a tax obligation. This complicates compliance for companies engaged in remote or digital sales.

With these expanding nexus rules, businesses must constantly reassess their footprint, especially when it comes to hiring remote workers. Ensuring payroll and tax compliance across jurisdictions is essential, as is managing risks such as use tax or personal property taxes when employees utilize company resources remotely.

How do key drivers influence changes in international tax?

Internationally, transfer pricing and tax regulations are also undergoing significant shifts. As companies grow globally, they often outpace their tax departments' ability to keep up with regulatory changes. Cross-border tax planning strategies now require a greater focus on:

• Optimizing effective tax rates (ETR): Multinationals must assess opportunities to minimize their tax burdens, such as tax holidays, reduced withholding taxes, or favorable treaties.
• Entity structure considerations: Whether inbound (non-U.S. entities entering the U.S.) or outbound (U.S. entities expanding abroad), the type of entity formed can have significant tax implications.
• Cross-border financing: Transfer pricing can be used strategically to shift profits to jurisdictions with lower tax rates or move operations to benefit from favorable conditions.

Additionally, tax authorities are shifting their focus towards taxing companies based on economic presence rather than physical presence, especially with the rise of digital economies. This increasing scrutiny and the need for data transparency across borders means companies must proactively manage their global tax positions.

Managing internal and external pressures

Companies face significant pressures in managing their transfer pricing and international tax strategies:

• External pressures include changes to laws such as the Tax Cuts and Jobs Act, global tax reforms, tariffs, and the growing number of audits targeting transfer pricing and cross-border transactions.
• Internal pressures stem from the need to optimize the effective tax rate while ensuring efficient financial closes and meeting operational goals.
  These pressures are compounded by the increasing globalization of supply chains, with many companies offshoring manufacturing and distribution to maintain competitiveness. However, this strategy brings new tax challenges, requiring careful management of intercompany transactions and global supply chains.

The importance of a proactive transfer pricing framework

Here’s where we integrate our framework for more effectively approaching an organization’s transfer pricing environment.

The goal of the CohnReznick transfer pricing framework is to help companies shift from a reactive approach – where transfer pricing is treated as a year-end compliance task – to a proactive, holistic framework.

At CohnReznick, we use a transfer pricing lifecycle approach that mirrors an accounting lifecycle, focusing on six key elements:

1. Planning: Begin by developing a clear intercompany pricing model that aligns with the company’s current and future operations and tax strategy. This involves evaluating how manufacturing entities and distribution affiliates operate relative to the overall company structure. Execution Implementation and monitoring: Many companies struggle with ERP systems that cannot pull segmented data, such as distinguishing between manufacturing and distribution results. By integrating transfer pricing into the ERP system early on, businesses can monitor results in real-time, rather than waiting until the year-end to adjust.
2. ERP integration and data management: A common problem is that ERP systems are often not designed to handle the complexity of segmented financial data for different entities within the company. A proactive framework addresses these gaps by configuring ERP systems to track the required data, reducing manual intervention and improving efficiency.
3. Stakeholder governance: All relevant stakeholders – including tax, treasury, finance, and operations – should be involved in the transfer pricing process.
4. Documentation: Create comprehensive documentation that outlines intercompany agreements and policies. Clear documentation helps tax authorities understand the company’s transfer pricing policies and reduces the risk of costly adjustments.
5. Controversy management: If disputes or audits arise, having a well-documented transfer pricing policy and a clear trail of data helps ensure that companies can defend their positions and avoid significant penalties.

A paradigm shift in transfer pricing management

Historically, transfer pricing was treated as a compliance project at the end of the financial cycle. However, with increasing scrutiny from global tax authorities and the demands of a digital economy, this approach is no longer sufficient.

The new paradigm involves focusing on the beginning of the life cycle – the planning phase. By establishing clear policies and governance models upfront, companies can avoid last-minute disruptions, help ensure compliance, and align transfer pricing strategies with business goals.

Additionally, businesses must view transfer pricing as an ongoing process involving all functional areas, not just the tax department. Whether dealing with state nexus issues due to remote employees or cross-border financing strategies, transfer pricing must be treated as a fundamental part of the company’s overall financial and operational strategy.

Key takeaways for a global tax strategy

1. Proactive planning: Start with a comprehensive intercompany pricing model and ensure that all relevant stakeholders are aligned.
2. SALT and international tax: Nexus challenges at the state and local level must be integrated into broader international tax planning efforts, especially as remote workforces grow.
3. ERP integration: Configure ERP systems to support segmented financial results, reducing the need for manual data manipulation and improving real-time monitoring of transfer pricing compliance.
4. Holistic approach: Treat transfer pricing as an ongoing process, not just a compliance requirement. This reduces the likelihood of significant tax adjustments and enhances operational efficiency.