Beyond Size: The True Scope of Transfer Pricing

Transfer pricing is often misunderstood as a “large multinational” issue. In reality, it is a structural requirement that applies to any group with controlled transactions regardless of size.

If your business operates through multiple legal entities and those entities transact, you are expected to apply the arm’s length principle as defined by the OECD Transfer Pricing Guidelines and local regulations.

At its core, transfer pricing is about aligning profit allocation with value creation.

Here’s a more technical perspective on what that actually involves:

Controlled transactions require arm’s length pricing

Intercompany transactions whether for tangible goods, services, financing, or intangibles must be priced as if they were conducted between independent parties under comparable circumstances.

Functional analysis (FAR) is foundational

A defensible transfer pricing policy starts with a detailed analysis of each entity’s Functions performed, Assets employed, and Risks assumed (FAR). This determines the appropriate profit level and pricing method.

Method selection must be justified

Choosing the “most appropriate method” is not arbitrary. Common approaches include:

• Comparable Uncontrolled Price (CUP)
• Resale Price Method (RPM)
• Cost Plus Method
• Transactional Net Margin Method (TNMM)
• Profit Split Method

Each method requires supporting comparability analysis and benchmarking.

Benchmarking anchors outcomes

External comparable data is typically used to establish an arm’s length range (e.g., interquartile range), margin outside this range may require adjustments or further justification.

Intercompany agreements must reflect substance

Legal contracts should align with the actual conduct of the parties. Misalignment between contractual terms and operational reality is a common audit trigger.

Intangibles and DEMPE functions are high-risk areas

Where intellectual property is involved, tax authorities focus on Development, Enhancement, Maintenance, Protection, and Exploitation (DEMPE) functions to determine where returns should be allocated.

Intra-group financing is under increased scrutiny

Loans, guarantees, and cash pooling arrangements must reflect arm’s length interest rates, credit risk, and commercial rationale.

Documentation is a compliance requirement

Many jurisdictions require  documentation aligned with OECD Action 13, including:

• Master File
• Local File
• Country-by-Country Reporting (where thresholds are met)

Transfer pricing is not isolated from other tax domains

It directly interacts with customs valuation, indirect taxes (e.g., VAT), and permanent establishment risk. Inconsistencies across these areas can create compounded exposure.

Audit risk is no longer limited to large taxpayers

Tax authorities are increasingly data-driven and risk-focused, applying transfer pricing reviews to mid-sized and fast-growing groups, particularly in cross-border contexts.

Let’s further understand this with an example

Informal Intercompany Charges Leading to Tax Exposure

A mid-sized family-owned business operates through two related companies in different countries. One entity handles procurement and supplier negotiations, while the other manages local sales and customer relationships. To simplify operations, the owners periodically transfer funds between the companies and record them as “management support” or “shared expenses” without formal agreements, benchmarking, or supporting calculations.

For several years, the arrangement receives little attention internally because the group is relatively small and privately held. The owners assume transfer pricing rules mainly target large multinational corporations.

During a routine tax review, however, the tax authority questions the nature and pricing of the intercompany charges. The business is unable to demonstrate:

• how the charges were calculated, 
• whether the services were actually provided, 
• why the pricing was commercially reasonable, or 
• whether independent parties would have agreed to similar terms. 

As a result, the authority adjusts the taxable profits of one entity, disallows portions of the deductions claimed, and imposes penalties and interest for non-compliance. The group also incurs significant professional costs to reconstruct documentation and defend the arrangement retrospectively.

What began as an informal internal practice ultimately created a material financial and compliance exposure illustrating that transfer pricing obligations are driven by related-party transactions, not by the size or profile of the business.

The key takeaway:

Transfer pricing is not a compliance “add-on” it is a framework for allocating income in line with economic activity.

For growing businesses, the priority should be to implement a proportionate but technically sound approach:

• Conduct a baseline FAR analysis
• Select and document an appropriate method
• Support pricing with benchmarking where feasible
• Align legal agreements with operational reality
• Maintain robust documentation

The complexity can scale with the business but the obligation starts much earlier than most expect.

Transfer pricing is not determined by the size of a business, but by the existence of related-party transactions. Any group structure with controlled dealings must ensure its arrangements are commercially justifiable, appropriately documented, and consistent with arm’s length standards. Overlooking these requirements can expose even smaller businesses to significant tax and compliance risks.