Transfer pricing in a globalised manufacturing landscape

The top 10 manufacturing countries globally are China, USA, Japan, Germany, India, South Korea, Italy, UK, France and Brazil. Per Top Manufacturing Countries in 2024: Global Insights. Global manufacturing is diverse and has witnessed significant transformation in technology, value and supply chains and demand, as well as challenges from a relatively unstable socio-economic and political global environment.

This summary discusses transfer pricing (TP) in a globalised manufacturing landscape, as seen in our entrepreneurial client base.

Entrepreneurial manufacturers

Our multi-national manufacturing clients are mainly:

• UK head quartered multi-national enterprise (MNE) groups,
• UK manufacturers of MNEs headquartered overseas, often original entrepreneurial manufacturing entities acquired for technology/products, and
• Inbound sales/distribution entities of MNE.

Startup entrepreneurial manufacturers are generally run by the founder and their management team and:

• Design and develop the products,
• Conduct R&D,
• Develop/deliver strategy,
• Manage supply/value chains,
• Market/sell, and
• Undertakes all operational and back-office support functions.

This makes them a “one-stop shop” for driving value throughout the supply chain.

The centralisation of these key functions creates the need for sound Transfer Pricing advice on international expansion, which necessitates disseminating some of these functions globally.

Successful manufacturers are entrepreneurial, fast growing and evolve to face market trends and demand. Transfer Pricing advice needs to therefore evolve and develop with them.

Transfer Pricing specialists work closely with local international direct and indirect tax teams in the relevant jurisdictions to provide a holistic and joined-up approach to advice.

Transfer pricing and the global manufacturer’s life cycle

Below, we focus on the entrepreneurial manufacturing group holistically as transfer pricing affects these groups throughout their growth evolution and is not focused entirely on the manufacturing function.

Transfer pricing tips and advice for entrepreneurial manufacturing MNEs:

• Plan for exit:
  • Transfer pricing follows the entrepreneurial global manufacturer’s life cycle of growth and often ends in an exit, being a sale to a competitor, a larger MNE or to private equity backed investors.
  • Ensuring transfer pricing outcomes follow value creation and policies are documented under local tax legislation, ensures local compliance, and can reduce findings in future due diligence exercises on exit, also smoothing integration.
• Transfer price and document cross border transactions from the perspective of each counter party territory to the transaction:
  • This reduces the risk of adjustment and penalty under future enquiry and reduces management time in costly enquiries.

Some tax authorities are more vigilant than others under enquiry or raise enquiries more often.

International expansion

A typical entrepreneurial manufacturer, benefiting from successful development and marketing of innovative products, which sells into overseas markets, will look to set up a local sales entity there. Transfer pricing advice provided at this stage might be:

• Involvement in designing the international trading structure. These enterprises are resource constrained and the transfer pricing structure needs to fit local resource and substance,
• Designing the transfer pricing policies, based on the accurate delineation of the controlled transactions between the relevant enterprises eg sale of goods to an overseas distributor, and
• Pricing the sale of goods, documenting and running appropriate benchmarks.

Examples of manufacturing international expansion relevant to transfer pricing

• Overseas business visitors, engaged in initial business development (BD) functions. Ensure appropriate direct and employment tax advice is provided in respect to personnel visiting the territory and to reduce local permanent establishment (PE) risk.
• Incorporating a local subsidiary (or branch) to undertake marketing services for the overseas manufacturer (entrepreneur). This may be remunerated on with a cost-plus profit level indicator (PLI), or on a sales-based commission basis, subject to an analysis of the local functions undertaken. PE risk should also be managed.
• The next evolution of the manufacturer might be setting up a local distribution network.

Important transfer pricing considerations

• The characterisation of the overseas operations or transaction drives the transfer price and is driven by local people functions eg will local marketing teams be concluding contracts or not?
• Indirect tax implications of the product imports into the overseas location – VAT and customs duty must be advised on. For the USA, it’s important that any sales function is reviewed for sales and local taxes.
• Analyse how sales are made. Often, various channels are implemented eg direct sales contracted locally, sales by the overseas principal, external sales agents, or online marketplaces. Selling B2B and/or B2C affects the pricing of the transactions.
• Consider the support functions undertaken overseas and factor this into the transfer pricing policies.
• Losses and startup strategies – transfer pricing policies can be designed to cover startup losses, depending on the fact pattern and to fund market penetration strategies.
• Product intangibles – setting the transfer price for a product is dependent on the characterisation or type of manufacturer within the global group. Remuneration for product intangibles may form part of this.
• Marketing intangibles – as the group expands internationally, transfer pricing strategies can include the restructure or sale of marketing rights to another local territory to exploit via licence or an absolute sale arrangement.
• A thorough analysis of IP within the group is essential to ensure transfer pricing policies align with the business’ strategy and commercial objectives. This will focus on the DEMPE functions; development/acquisition, enhancement, maintenance, protection and exploitation of each IP asset.
• Outsourcing manufacturing benefits from skillsets and resources in other territories within the group or to third parties. Where third parties are concerned, the group may set up a local group entity as a quality control/liaison function.

Manufacturing operations

Transfer pricing policies for manufacturers depend on its functions, risks borne, and assets used. Common terms used for manufacturing operations are:

• Fully fledged manufacturers undertake an entrepreneurial function, the development of manufacturing intangibles, know-how and processes. This entity might also be the group principal and entrepreneur. It assumes significant risk and requires the funding to provide the financial capacity to bear them.
• Licensed manufacturers produce goods under a relatively long-term licence agreement and assume significant risk. They pay a royalty to use manufacturing intangibles owned by the licensor such as knowhow, patents or designs. It may own manufacturing intangibles used in the production process. It buys raw materials and semi-processed/assembled products and bears inventory risks. It also bears sales risks of the products manufactured and invests in skilled labour, plant and machinery.
• Contract manufacturers own production plants, employ skilled labour and make products for their sole customer (the principal), which guarantees to buy the goods, subject to agreed terms. It assumes no sales risks. It buys raw materials/semi-finished products and assumes their stock risks. It may hold title to finished goods until they are purchased by the principal.
• Toll manufacturer: the principal retains title to the goods throughout the manufacturing process and purchases raw materials and semi-assembled goods required by the toll. They bear all the inventory and selling risk.

Global mobility and the knock-on effect to transfer pricing

Expansion into international markets is generally driven by the mobility of existing employees or directors relocating overseas and setting up operational functions.

Transfer pricing is key in the following instances:

• Location of staff and directors in determining the characterisation of the controlled transactions, which drives the transfer pricing policies.
• Global mobility can lead to a global management team with C suite directors, personnel undertaking key entrepreneurial risk-taking functions within the value chain based across various jurisdictions, leading to complex transfer pricing policies for strategic management and operations.
• Isolate shareholder functions of such individuals and identify the enterprise which should bear these costs.
• Directors of overseas companies may also be those of the principal. Consider this for corporate residency risks. This may have knock on PE risk.
• Moving key R&D, Technical Officer etc can complicate policies around the ownership of IP economically. When designing such policies ensure that intellectual property is not diluted across a number of jurisdictions, unless this is a strategic aim.

Moving key functions and assets overseas requires holistic approach to tax planning across direct and indirect taxes.

Funding

Manufacturing requires significant capital investment before generating revenues, through shareholder funds, internal or external debt. Evaluation of the corporation tax and transfer pricing implications of funding requires up front analysis and planning.

How we can help

Our transfer pricing team have a wealth of experience in these matters and regularly work together with other Nexia members on multi-territory projects.

To discuss any of the areas discussed, please get in touch with Dawn Ross.