Digital Revolution and Transfer Pricing

The following are popular technologies used by businesses as part of their digital transformation: 

• Big data analytics help businesses to understand customer preferences. Instead of undertaking a market study the data gives details as to what is working in the market and what is not.  
• Artificial Intelligence (AI) is another tool used by businesses to improve their digital marketing. Some of them use it as a backend to forecast demand for products and services and also to develop customer profiles. Some businesses use AI to improve customer experience and thereby strengthen their brand recall rate.   
• Chatbots are used by many businesses on their websites. Chatbots do either auditory or textual conversations. Apart from gathering data on prospective customers, Chatbots can even move customers to a sales channel.  
• Cloud Computing has become quite popular for businesses in the small and medium size segment. Businesses can now use remote computers and data centers for storage, computing and networking.  
• Internet of things (IOT) makes it possible for physical devices to get connected to the internet to share data in real time, thereby connecting the physical world to the digital world.  
• Virtual and Augmented Reality enables the perception of a new version of the actual physical world, using digital elements, sound and other sensory stimuli, with the result that it produces intelligent data that can be implemented in mobile applications.

Businesses who adopt digital transformation models will enjoy the benefits of automation, cost reduction and increased security levels.  

Meanwhile tax regulators are also concerned that the tax systems in many countries do not properly capture profits derived from the digitalization of businesses. Many businesses derive income from users in jurisdictions where they do not have any physical presence and therefore escape payment of taxes. The OECD has now come out with the Pillar 1 proposal which will require multinational businesses to pay taxes in jurisdictions where they do business and earn income. Many countries in Europe, Asia, Latin America and Africa have already implemented digital service tax (DST), which is a tax on the top line revenue. It is expected that with the implementation of the Pillar 1 initiative the DST will be withdrawn in a phased manner by many countries.  

As companies in a variety of industries undertake digital transformation, some important transfer pricing related questions that they should be considering include: 

• Which entity owns or shares ownership of any valuable intangibles created because of digitalisation? 
• How has digital transformation affected the group’s value chain? 
• Are the current transfer pricing positions established by the multinational group still supportable and properly documented? 

With these questions in mind, some examples of digitalisation and how they may have transfer pricing impacts on multinational groups are discussed below. 

As more people are using smartphones in today’s economy, more companies are developing smartphone apps as a necessary tool to remain competitive within their industry. Often these smartphone apps can represent valuable intangible property and the profits earned through these apps needs to be considered within the scope of the intercompany transactions established within the multinational group as they can be attributed to generating profits in multiple tax jurisdictions.

Since the COVID-19 pandemic, there has been an accelerated move towards technology advances for remote workers. As more employees are working remotely for multinational groups, these companies need to take careful consideration of how these remote workers contribute to the groups profits such as services rendered, or sales executed by these remote workers located in multiple tax jurisdictions.

Digital storefronts are becoming more common for retailers, replacing traditional brick-and-mortar businesses and addressing a significant increase in consumer demand. More companies are moving towards having centralised warehouses that serve sales in multiple countries from a single location. As multinational retailers move towards this supply chain model, they should be re-examining the intercompany arrangements they have in place and whether these need to be amended.

IOT has allowed companies, particularly manufacturers, to connect and coordinate their manufacturing equipment to significantly improve manufacturing efficiencies. In addition, from a retail perspective, more companies are integrating IOT within their product lines which in-turn results in the creation of data. This data can then be used by the multinational group to create highly valued IP. Multinational groups need to consider keeping track of how these technologies are being developed internally and how they are shared amongst their business and supply chain.

In addition to improving marketing analytics, multinational companies are leveraging big data analytics and AI to spot and improve quality control issues and reduce inefficiencies in their manufacturing processes. Multinational companies should document these innovations and advancements to keep track of how they have contributed to the multinational group’s profits. Information such as how and where the multinational group generated the data as well as how and where the multinational group used this data to develop technological advancements are key items that multinational companies need to consider for transfer pricing in the digitalised economy.

Cloud computing allows companies to accelerate internal processes when it comes to sharing and accessing of data (particularly when used in the context of rendering services to third party customers). In addition, cloud computing accelerates the development of other digitalisation processes such as smartphone app development, remote working, and IOT. As cloud computing allows multiple users across the globe to access data, companies should be thinking about how they are keeping track of this potential intangible property value and how it is being shared and utilized amongst the multinational group for transfer pricing purposes.

The digital revolution is affecting all areas of our business lives and transfer pricing is one of them. How businesses respond to these new considerations remains to be seen but multinational entities should apprise themselves of the key transfer pricing pitfalls now if they are to futureproof their tax affairs.