Transfer pricing trends in the retail and consumer sector

What's in Store?

Business insights for the retail and consumer sector

A high-profile masterclass run by PricewaterhouseCoopers (PwC) has provided an invaluable update on Transfer pricing trends in the retail and consumer sector.

"Procurement can make a significant contribution to the bottom line - cutting purchase costs by as little as 5% can result in a 50% increase in profit margin."

Despite Icelandic volcanic eruption disruptions, a PwC masterclass, led by Sue Rissbrook (Global head of the retail and consumer transfer pricing  network), on transfer pricing issues for the retail and consumer sector attracted people from a wide and varied group of international businesses, including Diageo, Burberry, Cadbury’s and Unilever.  There were presentations on procurement, documentation, and resolving disputes, as well as a detailed working session on the challenge of establishing robust comparables.  Here are some of the highlights.

Possibilities in procurement

A number of major organisations have been looking again at this whole area over the last few months. In some cases it’s the result of expansion into new markets, in some it’s been prompted by the continuing recession and the need to keep costs down, and in others there’s been a one-off window of opportunity after a big merger or acquisition. There are also a number of trends affecting retail and consumer businesses in particular, ranging from the increased risk of supplier failure during a recession, to changes in consumer behaviour (some of which are also being driven by the downturn), to sustainability, and the increasing emergence of global supply chains. These developments are leading many international companies to restructure their procurement and supply relationships, whether by pursuing low-cost country sourcing opportunities (with all their attendant political and currency risks), or building green considerations into their procurement at an earlier stage.

As Steve Hasson, (Transfer pricing partner) said, “procurement can make a significant contribution to the bottom line - cutting purchase costs by as little as 5% can result in a 50% increase in profit margin. To achieve that same impact by other means would either require sales to rise by 50%, or drastic cuts in staff numbers.” A full review of procurement arrangements should help identify these savings, then capture those savings through new or revised supplier contracts, and finally make the savings sustainable through rigorous purchase-to-pay procedures. A full review can also be the first step towards a more comprehensive change to the overall procurement model.

There’s a whole range of different options here, ranging from a fully local approach, to a centre-led model that takes on the management and negotiation of some key contracts, to a standalone procurement company. The right approach for a particular business will depend on a number of specific factors, including the markets the company operates in, the scope of its activities, and the location of both risks and assets. These can all be flexed to achieve financial, commercial, or tax efficiencies, and can be based on a wide range of transfer pricing principles, from cost plus service fee, to commission.

Where tax is concerned, the key - as always - is that the tax structure should reflect the actual substance of the business, and the level of transfer pricing is a key consideration here. And again - as always - the more radical the model, the more substantial the operational and tax benefits can be, though this may be counterbalanced by the practical upheavals required to achieve them, and what can be a higher degree of risk, not least in reputational terms, if things go wrong. As Steve said, “if you’re thinking of changing your procurement model you need to take into account a number of significant costs, including IT, potential relocation of staff, and potential tax leakage. As with so many other similar business issues, you need sure-footed planning and execution to turn theoretical benefits into actual gains.”

The value of good documentation

This session was led by Daniel Alter (Transfer pricing senior manager), who’s one of the key members of the PwC team working on ‘global co-ordinated documentation’. Getting decent documentation in place for transfer pricing is clearly a major and time-consuming undertaking, but one where getting it right repays the time and money invested in it. As Daniel said, “A lot more countries are bringing in transfer pricing regulations, or new rules for documenting them, and the penalties for non-compliance can be significant. Likewise, many tax authorities are now working together and comparing notes, so it’s absolutely vital to get your approach and your message consistent across the piece.”

Consistency is only one obvious advantage of managing transfer pricing documentation on a centralised basis; another significant factor is the clarity it gives on the company’s global tax risks and opportunities.

Turning to practicalities, the documentation process should usually start by defining the scope of the project. You need to look at the relevant local transfer pricing rules and documentation requirements, and what you have in place already. You should also look at issues like the type and value of your related party transactions, your tolerance of risk, and how responsibility for different aspects of the process will be allocated. Communication is key here, as is rigorous management of the timetable, as this is an area where significant slippage is a common problem. And remember that you don’t have to have an all-singing all-dancing approach to every single market: some countries may indeed require a traditional transfer pricing study, but others could be dealt with just as effectively with a slide deck analysis, or a brief executive summary.

Daniel Alter summed it up like this: “The key to a successful global documentation approach is a combination of committed resource, detailed project design and planning, and a methodology based on good communication and flexibility.”

Sector updates

Food
Key trends

• Globalisation: the food retail sector is highly concentrated in comparison to other retail sectors - the top ten retailers in Germany, Sweden, France, Belgium, and Switzerland have a cumulative market share of more than 90%.
• Competition: getting more intense all the time, as retailers struggle to differentiate themselves from their rivals
• Private labels: now competing significantly in the premium, mid, and budget price levels
• Customer loyalty: more important than ever, and giving rise to a plethora of new initiatives, including the move towards ‘entertainmentisation’, which ranges from event shopping, to in-store samplings, to the marketing of meal solutions rather than mere ingredients.

Key transfer pricing questions

• How do you develop and roll out the own brand concept internationally?
• How do you allocate a cost to central concepts like merchandising, store layout, and logistics?
• What about the use of common IT infrastructures like merchandise management systems, data warehousing, or staff planning?
• If procurement is pooled, how are the benefits allocated back?

Luxury goods
Key trends

• Emerging markets: rapid growth in recent years, especially in Asia, and especially among the young and well-educated.
• The recession: 2009 was a perfect storm, which hit the luxury sector hard and saw up to 20% falls in sales. Both developed and developing markets are still tough, though there are signs of a turnaround, especially in emerging economies.
• Brand: sustaining the promise of the brand, and factoring in sustainability too.

Key transfer pricing questions

• How do you manage transfer pricing issues in regions like Asia or South America, which are the most challenging in tax terms, but also the most promising in terms of sales growth?
• How do you manage the interaction between transfer pricing, customs duties, royalties, and withholding taxes, especially in a sector where duty rates are often high, both in developed and developing markets?
• How can you make local deductions for central costs?
• How do you manage and maintain local profitability, given the significant and ongoing need to invest in the retail network?

FMCG
Key trends

• The recession: generally milder for this sector, given that most FMCG goods are low-margin, high-volume essentials. That said, commodities markets have been volatile and are likely to continue that way
• Health and sustainability: these were becoming key issues before the recession and will probably re-emerge.
• Speed to market: getting more important all the time, because the first to market secures higher margins and prices. Many US businesses are rationalising their European operations for precisely this reason.

Key transfer pricing questions

• How do you manage transfer pricing models and intra-group transfer pricing arrangements after a major acquisition?
• Do you manage transfer pricing documentation locally, regionally or globally?
• How do you deal with multiple audits across a number of different tax jurisdictions, especially in more challenging markets like India and China?
• What’s the best way to make sure customs and transfer pricing documents work equally well for both authorities, including issues like retrospective pricing?

Dealing with disputes
The masterclass ended with a round-up of the current state of play on transfer pricing disputes in some key markets, with a discussion led by Diane Hay, now Special Advisor to PwC on international tax. As she said, the typical international company is now facing a growing range and volume of tax risks across the world, as more countries see transfer pricing as a way of raising revenue, and more start to collaborate together to conduct multiple tax audits, especially within the EU. A higher number of disputes are going into Mutual Agreement Procedures (or MAPs) - according to the OECD these cases increased by 50% in 2006/7 - but as the government resources available to deal with them is not growing at a similar rate, they’re taking longer to resolve. There’s also evidence of a growing interest in Advance Pricing Arrangements (or APAs), by both tax authorities and businesses. As Diane says, “in the face of such a complex international picture, companies need to be pragmatic: your transfer pricing defences need to be cost-effective defences - you can’t gold-plate everything.”

Key points from the round-up included the UK authorities’ growing emphasis on Alternative Dispute Resolution (ADR) procedures like arbitration and mediation, with HMRC now running some pilot cases. In the US, the IRS has suffered a number of significant recent setbacks in some key litigation cases, and it’s likely they’ll be enhancing both their litigation capability and their approach to transfer pricing audits.

There’s evidence of more transfer pricing audits in Spain, and more aggressive positions being taken during them. Resolving MAP claims is still taking a very long time. However, the Spanish APA programme is getting more effective and working well. Tougher new documentation rules now in place in France, which is also conducting an increasing number of transfer pricing audits. MAP cases are growing, and the UK’s largest number of outstanding international disputes is with France.

Turning to the ‘BRIC’ economies. Brazil is not yet an OECD member, and has a very limited number of full tax treaties that give businesses operating their access to MAP. Neither the US, UK or Germany are covered, for example.  In general, the position is complex, and local knowledge essential. The authorities in Russia have proposed a new law that will introduce APAs for the largest companies. These will probably be for three years, and then renewable for two years.
In India the courts are now showing an increased willingness to apply OECD Guidelines, and 2009 saw the introduction of safe harbours and the establishment of Dispute Resolution panels to tackle a growing mountain of transfer pricing cases. The local tax authorities in China are increasingly asking for documentation of related party transactions - and updating their national databases. There are currently around 50 bilateral APAs and 10 unilateral APAs under discussion; 12 have been concluded, including Japan, the US, Korea, Singapore, and Denmark.

Diane summed up the international situation by stressing the importance of getting the right level of management involved locally: “You need to make sure they’re fully involved in the process, not only where there are language issues, but also because they can help you navigate the niceties of the relevant operating and tax regime. As in so much else, never underestimate the value of local knowledge.”