Key Takeaways
- Intragroup transactions must be priced as if the parties were independent; tax authorities benchmark this using the arm's length principle.
- EU groups with cross-border intercompany sales exceeding EUR 50M typically face mandatory TP documentation under local rules and the OECD's master file / local file framework.
- A TP adjustment by one tax authority creates a double-taxation exposure unless the other jurisdiction grants a corresponding adjustment.
- Auditors assess the impact on deferred tax, uncertain tax positions, the effective tax rate reconciliation, and IAS 24 disclosures under IAS 12 .
What is transfer pricing?
On about half the mid-market group engagements we review, the TP analysis amounts to ticking and bashing last year's benchmarking study without asking whether the comparables still fit. That shortcut works until a tax authority opens a file and finds the tested party sitting outside the interquartile range.
Transfer pricing (TP) is the setting of prices for transactions between related entities within the same multinational group across tax jurisdictions. The OECD Transfer Pricing Guidelines (Chapter I, Section D) require the price to match what unrelated parties would agree under comparable conditions. Tax authorities test this by selecting a TP method (comparable uncontrolled price, resale price, cost plus, transactional net margin, or profit split) and comparing the entity's results against a benchmark range of comparable companies.
For the auditor, TP sits at the intersection of uncertain tax positions and deferred tax. IAS 12.46 requires the entity to measure current and deferred tax using the rates and laws enacted or substantively enacted at the reporting date, which includes TP rules. When the entity's intercompany pricing deviates from arm's length, the risk is a tax authority adjustment that increases taxable income in one jurisdiction without a corresponding decrease in the other. IFRIC 23 (now incorporated into IAS 12 ) requires the entity to assess whether it is probable that the tax authority will accept the TP position. If not, the entity recognises the tax effect of the most likely outcome or the expected value, whichever better predicts the resolution.
Worked example: Fernandez Distribucion S.L.
Client: Spanish wholesale distribution company, FY2025, revenue EUR 34M, IFRS reporter. Fernandez is a subsidiary of a German parent (Schafer Elektrotechnik AG). Fernandez purchases electronic components from Schafer at an intercompany price and resells them to independent Spanish retailers. Intercompany purchases in FY2025 total EUR 22M.
Step 1 — Identify the controlled transaction
Fernandez buys components from Schafer at a transfer price that produces a gross margin of 18%. Revenue is EUR 34M, cost of goods sold is EUR 27.9M (of which EUR 22M is intercompany purchases from Schafer), and gross profit is EUR 6.1M.
Documentation note: record the intercompany transaction type (purchase of goods), the counterparty (Schafer Elektrotechnik AG, Germany), the total value (EUR 22M), and the resulting gross margin (18%). Cross-reference to the intercompany agreement and IAS 24.18 disclosure requirements.
Step 2 — Select the TP method and benchmark
Fernandez's tax adviser applies the transactional net margin method (TNMM), using Fernandez as the tested party. From a database search, the adviser identifies 14 comparable European distributors and calculates an interquartile range of operating margins from 2.1% to 4.8%, with a median of 3.3%. Fernandez reports an operating margin of 3.5%, which falls within the interquartile range.
Documentation note: record the method selected, the reason for choosing TNMM over CUP (no reliable comparable uncontrolled prices available), the search criteria, the number of comparables accepted and rejected, and the interquartile range. Reference OECD Guidelines Chapter II, paragraphs 2.64–2.72.
Step 3 — Assess the tax risk under IFRIC 23
Because the operating margin sits within the benchmark range, the entity concludes it is probable that the Agencia Tributaria will accept the position. No uncertain tax provision is required. The comparables search is two years old, though. If the benchmarking study is not refreshed before the next filing, the probability assessment may change.
Documentation note: record the IFRIC 23 analysis, the conclusion on probability, the basis for accepting the arm's length outcome, and the planned refresh date for the benchmarking study. Flag any open tax audits or advance pricing agreements.
Step 4 — Evaluate the deferred tax and disclosure impact
Because the position is accepted as arm's length, no adjustment to current tax or deferred tax is required beyond the standard computation. IAS 24.18 requires disclosure of the intercompany purchases (EUR 22M) in the notes, covering the nature of the relationship, the type and volume of transactions, outstanding balances, and settlement terms. ISA 550.25 requires the auditor to evaluate whether these related party disclosures are complete.
Documentation note: confirm that the IAS 24.18 disclosure includes the total intercompany purchase amount, the outstanding payable at year-end, the terms of the agreement, and whether the terms are equivalent to arm's length. Cross-reference to the related party disclosure checklist and ISA 550.25 .
Conclusion: Fernandez's TP position is defensible. The operating margin falls within the interquartile range of comparable distributors, the IFRIC 23 probability assessment supports no provision, and the IAS 24 disclosures capture the full intercompany relationship. No further work required on this transaction category.
Why it matters in practice
Teams frequently treat TP as a pure tax compliance matter and skip the IFRIC 23 assessment entirely. Nobody enjoys revisiting the tax provision workbook at the end of a long close, but skipping it is how files get flagged. When an entity's intercompany pricing is under audit by a tax authority or sits outside the interquartile range, the auditor must evaluate whether an uncertain tax provision is required. IAS 12 (incorporating IFRIC 23) requires recognition of the tax effect unless it is probable the authority will accept the position. Missing this assessment means the uncertain tax position balance and the effective tax rate reconciliation are both understated.
We've seen engagement teams rely on outdated benchmarking studies (three or more years old) without reassessing whether the comparables remain valid. The OECD Guidelines (Chapter III, paragraph 3.80) expect the benchmarking analysis to reflect current economic conditions. A stale study weakens the entity's defence if the tax authority challenges the transfer price, and it undermines the auditor's basis for concluding that the IFRIC 23 probability threshold is met. Refreshing takes effort. Ignoring it creates real exposure.
Transfer pricing vs. intercompany elimination
| Dimension | Transfer pricing | Intercompany elimination |
|---|---|---|
| Purpose | Sets the price at which group entities transact, driven by tax law and the arm's length principle | Removes the intragroup transaction from the consolidated financial statements so the group appears as a single entity |
| Governing framework | OECD Transfer Pricing Guidelines, local tax legislation, IFRIC 23 | IFRS 10 .B86 (consolidation) |
| Where it matters | Individual entity financial statements and tax returns | Consolidated financial statements only |
| Audit focus | Whether the price is arm's length, whether an uncertain tax provision is needed, whether IAS 24 disclosures are complete | Whether all intragroup balances, revenue, expenses, and unrealised profits have been eliminated |
| Risk if wrong | Double taxation, penalties, adjustments to current and deferred tax in one or both jurisdictions | Overstatement of consolidated revenue, assets, or profit |
Both concepts address the same underlying transaction from opposite directions. TP determines the price at which Entity A sells to Entity B. Intercompany elimination removes that sale entirely on consolidation. An error in the transfer price affects the tax position of both entities individually; an error in the elimination affects the consolidated FS.
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Frequently asked questions
How do I audit transfer pricing on a mid-market group engagement?
Obtain the entity's transfer pricing documentation (master file, local file, and benchmarking study). Confirm that the intercompany transactions match the invoices, the method selection is reasonable, and the tested party's results fall within the benchmark range. ISA 620.9 permits the auditor to use the work of a tax specialist if the transfer pricing analysis requires expertise beyond the audit team's competence. Evaluate the IFRIC 23 probability assessment for each material jurisdiction.
Does transfer pricing apply to intercompany services as well as goods?
Yes. The OECD Guidelines (Chapter VII) cover intragroup services, including management fees, shared service centre charges, and cost contribution arrangements. The arm's length principle applies identically: the service must be one that an independent party would be willing to pay for, and the charge must reflect what an independent provider would charge. Low-value-adding services qualify for a simplified approach (cost plus a 5% mark-up) under the OECD's 2015 guidance.
What happens if the tax authority rejects the transfer price after the financial statements are issued?
The adjustment is typically an adjusting or non-adjusting event under IAS 10, depending on whether the tax authority's action provides evidence of conditions that existed at the reporting date. If the entity had already recognised an uncertain tax provision under IFRIC 23, the actual assessment replaces the estimate. If no provision was recognised, the additional tax liability appears in the period the authority issues its assessment, and the entity may seek relief through the mutual agreement procedure under the applicable double taxation treaty.