In our ongoing series on corporate tax readiness, it is essential to delve into a critical area: related party/connected person transactions. Our previous series provided a comprehensive overview of the new corporate tax landscape, but now we focus on how businesses must adapt their strategies regarding these transactions. The introduction of corporate tax has drastically changed the flexibility in transactions with related parties, emphasizing 'undertaking transactions at arm’s length price', which means transactions should reflect the true market value as if conducted with an unrelated party.
Historically, businesses often managed financial arrangements with flexibility, sometimes centralizing costs without proper allocation among group entities. However, this approach is no longer feasible under the new tax regime. Companies must now understand functional analysis (FAR analysis) and economic analysis before engaging in transfer pricing exercises. These analyses, though sounding complex, are routine exercises in daily business operations.
Functional analysis involves evaluating the functions performed by the organization against its related party, including operational activities and decision-making functions. It also considers the assets used and the risks taken by each entity within the group. In practical terms, preparing a functional organization chart and interviewing personnel to understand processes and decision-making roles is necessary.
Economic analysis focuses on justifying the pricing of intra-group transactions based on the arm’s length principle, known as benchmarking. Both analyses are crucial for establishing and defending transfer pricing policies within multinational corporations. Another significant impact of corporate tax is on the compensation of key managerial personnel, which now requires ensuring salaries reflect true market value.
As companies adapt to these new regulations, strategic planning is crucial. They must reassess internal processes, from cost allocations to managerial compensation structures, integrating FAR analysis and clear documentation practices to ensure compliance and optimize tax positions. Collaboration across departments is essential, fostering a unified approach to financial management involving finance teams, legal advisors, and operational managers.
Adopting a proactive approach rather than reactive is critical, given the limited time to respond during audits or reviews by tax authorities. Embrace these changes, adapt to the new requirements, and ensure your organization is prepared to succeed in the evolving corporate tax landscape.
