Transfer Pricing Framework and SAP Scenarios

Advisory
Transfer Pricing
Framework and SAP Scenarios
20 March 2014
Transfer Pricing
Transfer pricing is becoming ever more important as
even numerous mid sized companies have producing
and sales entities across several countries.
The legal requirements for determining transfer prices
are as crucial as is the transparency of profitability for
all steps of the value chain.
In addition to legal transfer prices, management
transfer prices are used to set objectives.
Transfer Pricing Framework and SAP Scenarios

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20 March 2014
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What we will Cover in this Session

Outline the legal requirements, the related processes
and risks and how to deal with them.
Learn in detail how SAP allows to you to track the
profitability for all steps of the value chain for both
legal and management transfer prices based on an
example for manufactured goods using the crosscompany/cross-plant costing solution.
Compare the features of the solution with the material
ledger solution.

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Agenda
1
2
3
3.1
3.2
4
5
6
6.1
6.2
6.3
6.4
Basic Principles
Legal Framework
Processes
Business Models
Price Determination
Functional Analysis
Risks
SAP Scenarios for Profit and Cost Reporting
Legal vs Management Aspects of Transfer Pricing
Scenario for Cross Plant/Cross Company Costing
Transfer Pricing Using the Material Ledger
Comparison of Methods

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20 March 2014
Section 1
Basic Principles

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Section 1 Basic Principles
What is Transfer Pricing all About?

Transactions between Affiliated Companies
Only Cross-border transactions between affiliated companies are relevant for
transfer pricing
Difficulty: Transfer of tax relevant profits
The preponderant part of worldwide transactions does not take place with third parties
but within the group
Affiliated companies
Company A
CH
IC transactions
Tax relevant profits

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Company B
Abroad
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Basic Principles
Facts (1/3)
Not all transactions between companies of a group are relevant for transfer
pricing, only tax relevant cross-border transactions.
For determining transfer prices, local law is decisive. Statements and guidelines
of supra-national organisations (e.g. OECD, EU JTPF*) also play a central role.
The number and complexity of transfer pricing regulations has significantly
increased during the last years.
Companies have to be characterised based on their function from a transfer
pricing point of view. In addition to the function, particularly the risks born and
the commodities used are relevant.
The correct application transfer pricing methods is not sufficient in order to
satisfy the needs of the arms length principle. The determined transfer price has
to meet the standards of comparison with transactions with third parties.
* EU Joint Transfer Pricing Forum)

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Basic Principles
Facts (2/3)
A comprehensive transfer pricing concept does not only cover cross-border flows
of merchandise, but also has to take into account services, immaterial
commodities and financing.
An optimised transfer pricing concepts does not lead to the fact that all the local
profits can be attributed to a principal, but only the transferable part. A basic
profit has to remain with the de-central companies.
In order to guarantee the fulfilment of the arm`s length principle, not only
external transactions between third parties have to be taken into account but also
internal transactions between the tax payer and third parties.
In Switzerland, a transfer pricing documentation only has to be submitted to the
tax authorities on demand.

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Basic Principles
Facts (3/3)
Depending on the individual case, there is the possibility to negotiate a deal on
the acceptance of transfer prices with one or several tax authorities (Advance
Pricing Agreements).
Aggravation of regulatory rules and tax audits due to the economic crisis.
Increasing pressure on transfer prices and more restrictive requirements
regarding the application and proof of the arms length principle.
Potential increase of so called uncertain tax positions due to the above
described tendencies.

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9
Section 2
Legal Framework

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Section 2 Legal Framework
OECD Guidelines versus Local Law

These 2 Frameworks are Relevant for Transfer Pricing
OECD Guidelines
Local regulations
Arms length principle

Transfer pricing methods
Disputes
Burden of proof/
Documentation
Special topics: Intangible
assets, group services etc.
Country specific
regulations
Rules for the
documentation of
functional analyses and
benchmarking

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The Arms Length Principle

OECD Guidelines
OECD Transfer Pricing Guidelines, paragraph 1.33:
Application of the arms length principle is generally based on a comparison
of the conditions in a controlled transaction with the conditions in
transactions between independent enterprises.
Economically relevant characteristics of a comparable situation

must be sufficiently comparable
Target: Application and proof of the arms length principle
Comparable means
that there is no discrepancy significantly influencing the
relevant parameters (e.g. price or margin)
that appropriate measures have been taken in order to balance
existing discrepancies

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The Arms Length Principle

Overview Influence Factors
Land A
Land B
Transactions
Real assets
Intangible assets
Services
Financing
Market price?
Price?
Company Y
Company Z
Company A
Characteristics
Functional analysis
Contractual conditions
Economic situation
Business strategies
Company A1

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13
The Arm`s Length Principle

Questions to be Answered
Transactions between legal units (or operating site) of the group?
What is the volume and the type of the transactions?
Does the actual determination of transfer prices lead to a profit allocation
according to the arms length principles?
Which financial data are relevant to judge the transfer prices?

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14
Section 3
Processes

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Section 3 Processes
Processes
Recurring Processes on a Yearly Basis
Definition Business
Model
Price Determination
Management
Operating Units
Value drivers/risks
Budget
Monitoring/Controlling
Price adaptations
Price Determination
Core/local documentation
Defence of contracts, etc.

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16
Section 3.1
Business Models

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Section 3.1 Business Models
Processes
Business Models (1/2)
Two parties (third or affiliated) are basically free to determine their
way of collaboration within the limits of legal requirements
Possible exchange of merchandise:
Scenario 1
Entrepreneur
Distribution
partner
Buys as much merchandise

as is needed or as can be sold
with a positive margin
Wholesale
dealer/importer
Importer searches for a

commodity, buys lot sizes
from the provider and bears
the sales risk himself
Scenario 2
Provider

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Section 3.1 Business Models
Processes
Business Models (2/2)
There are as many business models as there are companies and relationships
between companies.
In order to fully understand the business relationship and the value chain, a
Functional Analysis has to be established.

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Section 3.2
Price Determination

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Section 3.2 Price Determination
Overview of Methods Defined by the OECD

Based on Turnover, Gross Margin and EBIT
Turnover
(COGS)
Gross Margin
(OPEX)
Comparable Uncontrolled Price Method
Resale Price
Method
Cost Plus Method

Profit Split
Method
EBIT
Comparable Profits Method

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Comparable Uncontrolled Price Method (CUP)

Preferential Use in Case Comparison Prices Exist
Comparison with the price of a similar product for a relation between internal
partners (P1) for third parties.
TP: Transfer price
P1: Internal
comparison price
P2: External
comparison price
AA
TP: 800
P1: 850
P2: 900
AB
Client
Client

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But:
Quantity
Market
Point in time
must be comparable!
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Resale Price Method RPM

Applied for Sales Companies if there is no CUP
Sufficient third party financial information must be available for comparison.
AA
Comparison gross margin of AB

(1000800 = 200) on products from AA
with the gross margin on products
comparable in the widest sense
(e.g. same industry)
XXX
TP: 800
or
AB
between independent third parties

(value 1value 2) and also functional
and risk profile comparable with AB.
YYY
SP: 1000
Client
Purchasing price from a third party
Client
Client
Client
Sales price to a third party

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Cost Plus Method

Primarily Used for Services
Service used in the context of production, R&D and management fees.
Basis: full costs of the company
Appropriate percentage surcharge on effective costs for the margin
The transfer price equals the total of full costs plus profit margin
The percentage surcharge must be in line with the Arms

Length principle depending on functions, risks and used
resources

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Comparable Profits Method

In Case Primary Methods are not Useful or Reliable
Alternatively used to support findings brought up by a different transfer pricing method.
AA
Turnover
600000.
EBIT
Profit margin
XXX
Profit margin of
comparable companies
TP: 800
24000.
4%
AB
YYY
Client
Client
Client
Client
Band with e.g.

Lower Quartile
Median
Upper Quartile
3%
6%
12 %
Possible reference figures for the EBIT (depending situation): Turnover, OPEX, assets, equity
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Transaction Based Profit Method

Similar to Comparable Profits Method
This method is based on the comparison of divisions within a company.
Turnover
600000.
EBIT
Profit margin
AA 1
AA 2
TP: 800
TP: 500
AB 1
AB 2
Client
Client
XXX
Profit margin of
comparable companies
24000.
4%

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YYY
Band with e.g.

Lower Quartile
Median
Upper Quartile
3%
6%
12 %
Client
Client
Client
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Profit Split Method

Profit is Split Based on Defined Rules
Split of the total profit of the value chain
or
of the residual profit (the profit remaining after attributing the routine profit)
of the companies involved in a transaction.
The profit of the involved group companies that has been achieved due to intercompany prices is compared to the profit that would have been made if
the total profit was split to each participating individual company
based on the individual contribution of the company, using a
functional and risk analysis.

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Section 4
Functional Analysis

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Section 4 Functional Analysis
Definition of the Functional and Risk Analysis

Criteria for High Quality
A functional and risk analysis of high quality
Contains the description of transactions to be documented and of the involved
parties
Is supported by facts (e.g. interviews), contracts and financial data
An analysis of economically relevant facts for all transactions examined:

Functions
Risks
Assets (material and immaterial)
The functional and risk analysis is the basis in order to determine the appropriate
(at arms length) price for a transaction

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Contents of a Functional and Risk Analysis

Overview of Relevant Elements
Risks
Transactions
Functions
Activities
Companies
Contracts/
Conditions
Elements
Products
Markets/
Competitions
Financial results
Organisation/
Persons
Business Processes
Forecast/ Business
Plans
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Results of a Functional and Risk Analysis

Results
Business
Understanding
Internal ly
Comparable Values
Basis for Benchmark

Studies
Identification of tax
potentials/ risks
Results
Basis Transfer
Pricing Doc.
Planning Options
Characterising
Group Companies
Transfer Pricing
Methods

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Section 5
Risks

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Section 5 Risks
Risks
Minimising by Application of Correct Charges
Charge without effective transaction
Effective transaction without charge
Significant risk of correction

by the tax authorities
Effective transaction with charge as

usually NOT applied to third parties
Weakened position against

tax authorities
Penalties
Effective transaction with charge as

usually applied to third parties without
documentation (burden of proof)

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Section 6
SAP Scenarios for Profit and Cost
Reporting

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Section 6.1
Legal vs Management Aspects of
Transfer Pricing

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Section 6.1 Legal vs Management Aspects of Transfer Pricing
Legal vs Management Aspect of Transfer Pricing

Different Price According to Reporting Targets
Transfer prices determine the allocation of margins, and thus profits, along the value
chain of an enterprise and across production and sales plants and legal entities
Legal aspect
Management aspect
Externally oriented view authorities

The aim of legal transfer prices is to
allocate profits between legal entities in
order to minimise taxes on a national
and/or international level.
Internally oriented view management

Incentive setting for various entities of an
enterprise, legal or non legal, in order to
get decisions that maximise the benefit of
the entire organisation.
The legal aspect is only relevant when selling across legal entities. The
management aspect is also relevant when transferring goods within a legal
entity, e.g., across production plants.

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Management Aspects of Transfer Pricing

Decision Support from a Business Point of View
In order to support decision making in an efficient way:
Cost transparency needs to be given on all steps of the value chain within an
enterprise
The structure of the costs (material, personal, overhead, freight, etc.) and the
internal profit must be available for reporting for all production/delivery plants
and legal entities
Example decision making: Set lower internal transfer prices in order to fully use
the capacity of a production plant of a group when the buying entity also has the
right to purchase the same product/service from a third party

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Handling of Transfer Prices in SAP

Possible SAP Scenarios
SAP offers the possibility to handle and report both legal- and management-oriented transfer
prices and related margins
The legal view and the management view are available in Product Costing (CO-PC) and
Profitability Analysis (CO-PA)
In the FI leading ledger, only the legal view is available.
All company codes and plants must be assigned to the same controlling area!
There are two technical options to handle transfer prices to show the margin across all
entities of a group:
Cross-company code/cross-plant
costing (without using the material
ledger)
Valuation in the material ledger
Supports management and legal view from a

group perspective
and
a local perspective
Supports the legal view from a

group perspective
and
a local perspective

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Section 6.2
Scenario for Cross Plant/Cross
Company Costing

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Section 6.2 Scenario for Cross Plant/Cross Company Costing
Scenario for Cross-Plant/Cross-Company Costing

Required Settings in SAP
The cross-plant costing/cross-company code without using the material ledger will be
shown in the following scenario using legal transfer price only:
A material is produced in plant CH01 of a legal entity, and transferred to plant
CH02 of a different legal entity where it is used to manufacture another material
that will be sold to a third legal entity within the same group
Intercompany profit will be generated in both transfer steps

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The Scenario will be Shown Based on an Example
The cross-plant costing/cross-company code without using the material ledger will
be shown in the following scenario using legal transfer price only:
A material is produced in plant CH01 of a legal entity, and transferred to plant
CH02 of a different legal entity where it is used to manufacture another material
that will be sold to a third legal entity within the same group
Intercompany profit will be generated in both transfer steps

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Graphical Overview of the Scenario
Producing
Legal Entity 1
Producing
Legal Entity 2
Selling
Legal Entity 1
Plant CH01
Plant CH02
Plant CH03
Production of
material 7
Production of material
11, using material 7
Sells material 11 to
3rd party
Material 11
Material 7
= intercompany sale with profit
Material 11
Material 7
= sale to 3rd party

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Step 1 Transfer Between Producing Legal Entities
Producing Legal Entity 1
Plant CH01
Plant CH02
Material 11
1.750.
Material
Labour
Overhead
1.200.
200.
350.
Material
Labour
Overhead
Freight
IC-Profit
500.
500.
550.
100.
100.
Assembly
Material 7
1.000.
Material 7
1.200.
Material
Labour
Overhead
500.
300.
200.
Material
Labour
Overhead
Freight
IC-Profit
500.
300.
200.
Revenue 1.100.
COGS
1.000.
IC-Profit
100.
100.
100.
Freight = 100.
IC-Profit = 100.
Revenue
COGS
IC-Profit
Cost element
view
Cost
component
view
1.925.
1.750.
175.
Legal entity 1 sells for 1.100,- to legal entity 2. Freight costs of 100. paid by legal entity 2.
Legal entity 2 uses 1 PC of material 7 to build 1 PC of material 11. Labour costs of 200 ., overhead of 350 .

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Base Material 7, Sending Plant CH01, Cost Element View
Transaction CK11N:
Cost element
view

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Base Material 7, Sending Plant CH01, Cost Component View
Transaction CK11N:
Cost component
view

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Material 7 in Receiving Plant CH02, Cost Element View
Cost estimate transferred from plant CH01 Cost element view including additive costs
for freight and profit Transaction CK11N:
Cost element
view

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Material 7 in Receiving Plant CH02, Cost Component View
Cost estimate transferred from plant CH01 Cost component view including additive
costs for freight and profit Transaction CK11N:
Cost component
view

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Material 11 in Plant CH02, Cost Element View
Assembled using material 7 Transaction CK11N:
Cost element
view

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Material 11 in Plant CH02, Cost Component View
Assembled using material 7 Transaction CK11N:
Cost component
view

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Procurement Key, Freight and Profit
The cost estimate of material 7 is transferred from Plant CH01 to Plant CH02
In order to do this, the special procurement key in the material master of
material 7 in the receiving plant needs to indicate that the cost estimate should
be transferred from plant CH01
Plant CH01 and plant CH02 belong to different legal entities
The freight and profit will be added to the transferred cost estimate as additive cost
elements
In order to have this automated, the dependencies and rules of the freight
calculation need to be defined in customer-specific tables, and an add-on
program needs to be created reading these tables and updating the additive costs

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Costing Views and Stock Values
The cost component view and the cost element view are identical for material 7.
They are related to a costing variant.
In plant CH02, material 7 is used to manufacture material 11
Stock value
Plant CH01: Material 7 1.000.
Plant CH02: Material 7 1.200.
Material 11

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Step 2: Transfer Between Plants of Different Legal Entities, with
Profit
Selling Legal Entity
Plant CH02
Plant CH03
Material 11
1.750.
Material 11
1.975.
Cost element
view
Material
Labour
Overhead
1.200.
200.
350.
Material
Freight
IC-Profit
1.750.
50.
175.
Cost
component
view
Material
Labour
Overhead
Freight
IC-Profit
500.
500.
550.
100.
100.
Revenue
COGS
IC-Profit
Material
Labour
Overhead
Freight
IC-Profit
1.925.
1.750.
175.
500.
500.
550.
150.
275.
Freight = 50.
IC-Profit = 175.
Cost element
view
Cost
component
view
Revenue 2.200.
COGS
1.750.
Legal entity 2 uses 1 PC of material 7 to build 1 PC of material 11. Labour costs of 200,-, overhead of 350,-

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Material 11 in Plant CH03, Cost Estimate Transferred from Plant
CH02, Cost Element View
Including additive costs for freight and profit -Transaction CK11N:
Cost element
view

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Material 11 in Plant CH03, Cost Estimate Transferred from Plant
CH02, Cost Component View
Including additive costs for freight and profit Transaction CK11N:
Cost component
view

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Procurement Key, Freight and Profit
The cost estimate of material 11 is transferred from
Plant CH02 to plant CH03
In order to do this, the special procurement key in the material master of
material 11 in the receiving plant needs to indicate that the cost estimate should
be transferred from plant CH02
Plant CH02 and plant CH03 belong to different legal entities
The freight and profit will be added to the transferred cost estimate as an additive
cost elements
In order to have this automated, the dependencies and rules of the freight
calculation need to be defined in customer-specific tables, and an add-on
program needs to be created reading these tables and updating the additive costs

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Costing Views and Stock Values
In this case, the cost component view and the cost element view for material 11 are
different, as the cost element view treats all components of material 7 as material
costs
They are related to a costing variant
Stock value
Plant CH01:
Plant CH03:
Material 11
Material 11
1.750.
1.975.

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Mixed Costing
If there are procurement alternatives for a material, such as multiple vendors or
deliveries from multiple production plants, a mixed cost estimate can be created
For this purpose, the mixing ratio has to be defined
The cost estimate based on this information will be transferred to the standard price of
the product in the material master
Example: 100 PC of 11 costed, based on 50:50 PC procurement ratio from plant X and Y
Plant X
Material 11
Standard cost = 80.
Plant Z
Standard cost = 75.
(80. x 50 PC) + (70. x 50 PC)
Plant Y
Material 11
100
Standard cost = 70.

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Margin Reporting
The components of the cost component split can be assigned to different value fields in CO-PA
Thus, reporting from the perspective of the plant/company code is possible as well as from a
group view
Material 11 in Plant CH02
Cost. Comp.
view
Material
Labour
Overhead
Freight
IC-Profit
Value
fields
500.
500.
550.
100.
100.
Material
Labour
Overhead
Freight
IC-Profit
COGS
Cost. Comp.
view
500.
500.
550.
100.
100.
Material
Labour
Overhead
Freight
IC-Profit
1.750.
Value
fields
500.
500.
550.
150.
275.
Material
Labour
Overhead
Freight
IC-Profit
500.
500.
550.
150.
275.
COGS
1975.
From a group view, the overall COGS are 1.650. in plant CH02 / 1.700. in plant CH03.
From a legal entity point of view, the COGS are 1.750. in plant CH02 / 1.975 . in plant CH03.
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Authorisation for Different Views
In addition to the basic costing variant allowing cross-plant/cross-company code transfers, an
additional costing variant can be created on the level of a plant or legal entity, showing only the
total cost of the material purchased within the group*
Group costing
variant
Material
Labour
Overhead
Freight
IC-Profit
500.
500.
550.
100.
100.
Local costing
variant
Material
Labour
Overhead
Group costing
variant
1.200.
200.
350.
Material
Labour
Overhead
Freight
IC-Profit
500.
500.
550.
150.
275.
Local costing
variant
Material
1.975.
Via access control, group controllers can, e.g., see both costing variants; local controllers can
only see the additional costing variant
* Freight costs could be shown separately if desired.
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Group View and Local View
Cost component views (cost element views same as in group costing)

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Overview of Functionalities
The cost component view enables the reporting of intercompany margins for all steps of the
value chain, i.e., for every plant and every legal entity within the group
In the example, the profit for the legal view is shown
It is also possible to show IC profit based on management- determined transfer prices in
addition to the legal view
This can be done by using an additional cost component for management IC profit
In the reporting for CO-PA, the cost components can be selected to calculate margins from
a local point of view as well as from a group view, based on legal or management margins
In case the single plant or single legal entity should not have the transparency on the
intercompany margin and the detailed cost structure of the sending plant, an additional
costing variant can be created, showing only the total purchasing value in cost estimates
In case of a more complex account determination setup, an alternative cost component split
might be needed, using the primary cost component split.

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Section 6.3
Transfer Pricing Using the Material
Ledger

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Section 6.3 Transfer Pricing Using the Material Ledger

Standard Costs and Actual Costs
Using the material ledger, transfer prices can be calculated using either the legal
valuation view or the group valuation view, based on either standard costs or
actual costs
Both scenarios are based on a cross-company code stock transfer, using valuated
stock in transit and require the activation of business function LOG_MM_SIT

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Legal Valuation and Group Valuation
Overview of the approach using the legal and the group valuation
Legal valuation
Group valuation
Difference between the valuation price

of the sender and the procurement price
(purchase order price) is shown as
intercompany profit in the cost
component view of the actual cost
component split
No additional group validation needed.
Separate valuation and currency profile

in addition to the legal valuation,
showing the inter-company profit
Electronic Data Interchange (EDI)
scenario between the sender and receiver
company code for sending invoices
The calculation is based on the actual price of the sender using Business Add-In (BadI)
Control of Cross-Company Code Transfers (CKML_CROSS_COMPANY), the usage of the
actual price can be suppressed and the standard price can be used instead.
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Prerequisites for Using the Material Ledger
Legal
valuation
Group
valuation
Activate actual costing with actual cost component

split
A new cost component needs to be created for the cost

component structure in use to store the delta profit
for group costing
Electronic Data Interchange (EDI) scenario between

the sender and receiver company code for sending
invoices
Separate valuation and currency profile

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Features of the Material Ledger
Legal
valuation
Group
valuation
Take into account freight costs for intercompany

profit
Actual cost component split passed to receiving legal

entity
Roll-up of multi-level valuation differences from the

sender to the receiver
Reporting of variances according to responsibility of

each legal entity

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Enhancements of the Material Ledger
Business Add-In (BadI) Control of Cross-Company Code Transfers
(CKML_CROSS_COMPANY) offers several enhancement options to adapt the SAP
standard functionality
The most important features relevant for intercompany profit calculation and
reporting:
Cost component split can also be transferred in the legal view
Intercompany profit is based on standard costs of the sender instead of actual
costs
Define intercompany profit calculation based on a customer-specific algorithm

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Profit Center View
The material ledger also offers the possibility of a third valuation view, the profit
center view
In the profit center valuation view, cross-company code transfer processes are not
mapped multilevel
This means for cross-company code profit centers that no price differences are
rolled up and no cost component split is passed on
Moreover, with cross-profit center transactions, no intercompany profit ever
appears in the profit center valuation view

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Summary
Material ledger offers the option to show intercompany profits both from a legal
and a management perspective
However, for each of the views, a separate valuation view and costing variant are
necessary
The configuration is more complex than the cost component- based solution,
which can deal with both views using a single costing variant
The material ledger should be the preferred solution when actual costs are relevant
and when the company code currency and the controlling area currency are not
sufficient

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Section 6.4

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Cross-Plant/Cross-Company Costing versus Material Ledger
Cross-company/crossplant costing
Material ledger
Legal view
Lower implementation
effort
Easy config and handling
Full transparency on
margins legal and
management oriented
Plant and legal entity
Actual costs possible as well as standard costs

BAdI for adaptations available
Enhancement needed for

IC profit and freight
Freight costs are not integrated, enhancement

Config and handling of high complexity
Profit only when transferring between legal entities, not
between plants of the same legal entity
No management oriented view
Only legal oriented
No third currency, only

company code and
controlling area currency
Material ledger
Group view
Variance roll-up possible

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Section 6.4 Comparison of Methods
Decision on Choice of Method
The choice of the appropriate method to calculate and report transfer prices
using the material ledger legal and/or group view or not using the material ledger
depends on how the responsibility is divided within a group and which decision
authorization is granted to the plants and/or legal entities
Furthermore, it depends on whether standard costs should be used to determine
the intercompany/inter-plant profit, or actual costs, which currencies are relevant
and only if legal or internal transfer prices should be used
Hence, a decision on the detailed setup for an enterprise depends on legal
requirements as well as on the business requirements of the group and the single
entities

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Section 6.4 Comparison of Methods
Questions and Contact
How to contact me:
Questions?
Robert Kremlacsek
robert.kremlacsek@ch.pwc.com

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Transfer Pricing Framework and SAP Scenarios

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