Adhering to the different requirements of multiple tax regulation among various nations is a complicated process. National tax authorities enforce detailed documentation requirements, transaction transparency, audit/inspection activity, and strict punishments. To meet the requirements of U.S transfer—pricing regulations, a taxpayer must annually prepare, prior to the filing of the U.S tax return, all of the transfer—pricing documentation. Corporations that utilize transfer pricing must satisfactorily document their adherence to the arm’s length approach.
There are two main motivations for compliance. The first is to reduce the risk of an audit and potential dispute with tax authorities. The second is to maintain transparency with investors and tax authorities. Transparency with stockholders and potential investors enhances consumer confidence which potentially adds value to the corporation. Over 50 countries, including the United States, are beginning to ask their MNEs to report contemporaneous transfer—pricing documentation.
Transfer—pricing documentation must show each significant process used by the corporation regarding transfer pricing and the arm’s length methodology applied. When an MNE fails to disclose information concerning transfer pricing, the company faces significant penalties from the country’s tax authorities. For example, in Australia, when an MNE provides inadequate or incomplete information, the country’s transfer—pricing laws permit the taxing authority to assign the transfer price. A second example of the importance of documentation is Mexican’s transfer—pricing rules, in which penalties include denial of deductions for the transfer payments to foreign related parties.