Exploring the impact of CSRD on transfer pricing (2024)

Why it’s essential to ensure CSRD reporting and transfer pricing are aligned

For reporting periods beginning from 2024 onwards, compliance with the European Union’sCorporate Sustainability Reporting Directive (CSRD)is mandatory for many multinationals active in the EU. In meeting the CSRD’s extensive sustainability reporting requirements, these companies must also be ready to provide specific new disclosures related to tax.

Inthe first release in our Tax and CSRD series, we explored why companies may conclude through the double materiality assessment that tax is a material topic, which therefore requires detailed tax disclosures. In the secondrelease, we explained why tax compliance and governance is a critical component to support CSRD disclosures on EU Taxonomy alignment.

Now, in this third release, we examine the intersection between transfer pricing and CSRD. We explore the interplay between CSRD disclosures and transfer pricing documentation and the steps that transfer pricing teams can take to ensure compliance with the EU Taxonomy minimum safeguard on tax. More broadly, we look at the broader transfer pricing considerations which are likely to arise as a result of transformational change driven by CSRD.

Alignment between CSRD and transfer pricing documentation

The CSRD’s requirements – backed by the European Sustainability Reporting Standards (ESRS) – mean companies will be publicly disclosing more information on their operations than ever before. Many items on which they report will overlap with information contained in transfer pricing documentation, both Master File and Local File.

One example is the stipulation in the ESRS 2 - the General Disclosures standard for the purposes of CSRD reporting - that, to give relevant context to CSRD reporting, companies must provide information on their market position, strategy, business model(s) and value chain. This information can include “key features of value chain entities indicating their relative contribution to the undertaking’s performance and positions and explaining how they contribute to the value creation of the undertaking.”

It is reasonable to expect that tax authorities will be comparing CSRD disclosures with information contained in transfer pricing documentation. It is therefore vital that there is consistency between the disclosures, otherwise it could lead to unnecessary enquiries from tax authorities.

For the first companies in scope, CSRD reporting will cover the reporting year 2024 with disclosures published in 2025. To ensure alignment between CSRD disclosures and transfer pricing documentation, tax departments should proactively engage with internal teams responsible for CSRD reporting. In fact, transfer pricing documentation can provide the CSRD team with a reliable starting point for CSRD disclosures.

Tax minimum safeguard will drive increased governance on transfer pricing compliance

As explored in our release,exploring the intersection of Tax and the EU Taxonomy, companies in scope of CSRD will need to make a disclosure on their alignment with the EU Taxonomy. Taxonomy alignment will require companies to adhere to certain minimum safeguards on tax. The standards for business conduct contained in the OECD Guidelines for Multinational Enterprises define what those safeguards are. Specifically, an organisation must:

1. comply with the letter and spirit of tax law and regulations of the countries in which they operate.

2. treat tax governance and tax compliance as important elements of their oversight and broader risk management systems.

As well as setting out the above expectations, the OECD Guidelines set out explicit guidance on transfer pricing and the ‘arm’s length’ principle, which is the internationally accepted standard for fiscal profit allocation.

These requirements raise several specific considerations for transfer pricing:

Compliance with the letter and spirit of the tax law

There are no commonly accepted standards for assessing compliance with the ‘spirit’ of the law. Instead, from a transfer pricing perspective, objective criteria will need to be applied by a company to ensure compliance.

The ‘letter’ of the law is easier to assess but it is still not without its challenges. While the Base Erosion and Profit Shifting (BEPS) project has done much to introduce standardised frameworks for transfer pricing analysis and documentation, the reality is that many jurisdictions continue to apply a significant number of local transfer pricing regulations that provide varying and specific requirements in relation to the interpretation of the arm’s length principle. The table below outlines areas where applications of the arm’s length principle may vary between different territories.

As a result of these local variations and the complexity of transfer pricing principles more generally, being able to confidently disclose compliance with the letter of the law for transfer pricing will often come with a very high compliance burden for companies. At a minimum, it is imperative that organisations can demonstrate a commitment to be compliant.

Tax governance

To demonstrate a commitment to compliance, the second leg of the minimum safeguard requires that tax governance and compliance are incorporated into a company’s broader risk management systems.

This means that the proper design and implementation of a tax control framework will become increasingly important to substantiate that a company complies with its tax, and more specifically transfer pricing, obligations.

It can be a challenge to comprehensively incorporate transfer pricing within a company’s tax control framework as many sub-processes for transfer pricing sit outside the tax department. Nevertheless, given the requirements of the minimum safeguard, companies should ensure that transfer pricing compliance is adequately governed in the tax control framework through formalised policies, procedures, roles and responsibilities.

As CSRD drives change in the value chain, transfer pricing needs to be considered

The ultimate goal of CSRD is to encourage companies to take action with respect to sustainability-related impacts, risks and opportunities that they identify and disclose. The initial impact, from a transfer pricing perspective, will likely be new activities and associated costs that need to be properly delineated. Over time, these may develop into more substantive activities that create new intangibles, competitive advantage and/or value drivers.

To determine arm's length transfer pricing policies, the potential impact of CSRD should be assessed early on. The impacts of decarbonisation and the circular economy in particular are now front-of-mind for many tax departments. Whether a company operates through a centralised or a decentralised business model, actions in support of both areas will be piloted and managed by new teams (both co-located and dispersed). All will need specific assessment to determine arm’s length policies and implementation.

It’s important to remember that any risks that are material in financial terms should already have been disclosed in a company’s annual financial accounts (and accounted for in the transfer pricing model). So where new sustainability risks are identified through CSRD reporting, they’re unlikely to be economically significant for transfer pricing purposes. This is not to say, however, that the costs of actions associated with managing sustainability risks should not be properly allocated to the legal entities that are expected to benefit from those activities.

What should tax teams do to ensure that transfer pricing is properly considered in the implementation of CSRD?

1. Engage with the CSRD reporting team

It’s crucial that the tax team ensures alignment between CSRD disclosures and transfer pricing documentation by engaging early with the sustainability team. CSRD compliance will mean publicly disclosing information that could overlap with information contained in the transfer pricing documentation. By collaborating and sharing existing transfer pricing documentation, the tax team can ensure accuracy and consistency in information disclosed through the CSRD.

2. Review and update the tax control framework to embed transfer pricing

Organisations should have a formalised Tax Control Framework to ensure that they are executing the core principles in their tax strategy and can evidence compliance with the tax minimum safeguard. Transfer pricing processes and controls should be embedded within the Tax Control Framework including those that sit directly outside the realm of the tax department.

3. Continuously monitor CSRD impacts on supply chain and transfer pricing

The tax team should be ready to assess all impacts, risks and opportunities reported through CSRD disclosure from a transfer pricing perspective. Whether or not these actions develop into more substantive areas such as new intangibles, competitive advantages or new value drivers, it is important to understand how any related costs should be allocated at arm’s length.