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Industry 4.0: Digitalisation and the operational transfer pricing framework

Industry 4.0 requires organisations to rethink the way they structure and design their business processes. Tax, as a domain, now has to innovate

Updated: Jan 21, 2020 02:27:27 PM UTC

Bhupendra Kothari is Senior Director and Urvi Jagirdar is Manager, Deloitte Haskins and Sells LLP.

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Image: David Ryder/Getty Images

Digitisation is the one constant that has changed the world. If the idea of Industry 4.0 is to be realised, digital transformation will be needed in all aspects of business, be it supply chain structures or operating models, making them more flexible and agile compared to what they were under the traditional information technology (IT) based processes.

The retail sector is one of many businesses that witnessed an early digital disruption. In fact, Investopedia termed the year 2018 as “the year of retail bankruptcies”.

Even as we speak, big-box retailers are competing in a landscape dominated by online giants such as Amazon.com, who envisioned the trend early and used digital transformation as an opportunity to evolve, focusing on bringing innovative ways to deliver value to customers. In a recent study, Home Depot found that more than 50 percent of online orders are picked up in physical stores. Learning quickly, Amazon realised the need to have physical presence for increasing its offline strength resulting in an altered supply chain.

In contrast, a giant like Walmart was reactive enough to adapt change in consumer buying preferences, in the backdrop of digitisation. Through a modified supply chain, Walmart today has a strong online presence added by acquisition of Indian e-commerce giant, Flipkart.com, even though they started as a classical brick-and-mortar player.  Many other companies such as Thomas Cook were not adaptive and caught unawares, triggering survival issues.

Such rapid variations in business models and supply chains would require a flexible and agile IT infrastructure to support and accumulate accurate real-time data, which is critical for change management. Also, such data would be required by the internal finance and tax teams for various tax and regulatory compliances. One practical issue multinational corporations (MNCs) face is that there are often hundreds of applications running globally, assisting various parts of supply chain processes; such divergent processes and IT applications lead to inconsistent and or redundant data at the corporate level.

Further, many organisations continue to rely on outmoded transfer pricing systems that often overlook such critical changes in business models. Such changes can alter the value chain swiftly and affect profit drivers of global businesses.

Regulators and policy makers around the world have also been proactive in proposing new policies/ tax reforms to align with values created in the backdrop of digitisation and are desirous to get a 'fair' share of taxes from underlying economic activities and business values. The widely adopted OECD response to Action 13 of the Base Erosion and Profit Shifting (BEPS) initiative requires significant real-time information of a qualitative (master file and local files) and quantitative (country-by-country reporting) nature, requiring detailed description of business models adopted by MNCs along with profit driver analyses.

Taxpayers not prepared to provide consistent explanations where taxable profits are not aligned with values created, face significant consequences, including tax additions, penalties, and even double taxation. However, with foresight and careful planning, companies can effectively deal with transfer pricing issues arising out of increased digitisation of business models. By understanding and improving processes, controls, and technologies, to more effectively implement transfer pricing policies, companies may reduce compliance costs, facilitate transparency in transfer pricing results, and mitigate financial restatement and tax audit risks.

Thus, proactive organisations are employing the Operational Transfer Pricing (OTP) framework to respond to the changing regulatory landscape as this framework bridges the gap between business operations, finance, IT and tax, due to its ability to provide real time data—the current ask of tax authorities.

OTP framework is a comprehensive process comprising of framing a consistent global inter-company transfer pricing policy for inter-company transactions, establishing automation in governance models, and implementing analytics and monitoring process for enhancing operational efficiencies within MNEs.

Often, data is scattered across the globe in different formats by various business functions; collating and harmonising such data is time intensive, difficult to update and offers no source data visibility. The OTP framework allows to collect seamlessly, validate and standardise the data in a centralised system, irrespective of source of data or location. For example, various procurement teams could be negotiating with different suppliers (third parties and group companies) across jurisdictions for similar products. Seamless collection, validation and standardisation of this information in real time, will aid business teams acquire visibility on negotiated price and credit periods and in turn, obtain the optimum price and terms for an MNC. From a taxation perspective, it would help MNCs undertake comparability analysis of prices available for similar products, assist in determining transfer pricing and avoid any tax adjustments.

Thus a comprehensive OTP framework would not only aid C-Suites to acquire real time information for smart decisions, but would also bring tax and regulatory teams on par with business changes in order to meet compliances and plan ahead for any tax risk.

Industry 4.0 requires organisations to rethink the way they structure and design their business processes. Tax, as a domain, cannot remain aloof; it has to innovate. Process automation is a key element to achieving an efficient, scalable and well-controlled OTP framework. Such automation may also be facilitated by application of cutting edge technological tools under blockchain to help create an agile yet robust process which will service the change.

Bhupendra Kothari is Senior Director and Urvi Jagirdar is Manager at Deloitte Haskins and Sells LLP.

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