Enlarge This ImageAn important part of international corporate tax strategy is calibrating assets, profits and losses at just the right levels across regional subsidiaries-a goal accomplished extensively through transfer pricing.
But experts warn that the accounting strategies for transfer pricing are about to become significantly more complex for global banks, due to new regulations like the Volcker rule, derivatives provisions in the Dodd-Frank Act and incoming Basel III capital standards.
"The burden is on institutions to modify and figure out how they are going to respond to the regulatory regime," says Bob Clair, a managing director at KPMG who has been following the issue. "And that now has more international tax ramifications than it has in the past."
Transfer pricing involves shifting cash between units, in part by establishing how much one unit can charge another for providing funding or internal services.
Depending on how prices are set in those in-house agreements, companies can use them to lower effective tax rates in countries where they do business, provided they meet an "arms length" standard similar to what unrelated parties would charge in the open market.
But with all the legislative changes afoot, banks will have to consider the effect of transfer pricing on the enterprise, such as how such those accounting decisions will impact remediation plans, institutional living wills and capital risk factors (both home and abroad) that must satisfy the increased scrutiny of regulators and tax authorities.
In a June poll by KPMG, 75 percent of bankers indicated that Dodd-Frank and Basel III would have "some" or "significant" impact on how they set transfer pricing policies at their institutions. And 29 percent claimed it would be "extremely" or "very" difficult to address all the implications of the regulations on transfer pricing, due in part at the time to uncertainty as to how final regulations from bodies like the U.S. Commodity Futures Trading Commission would shape up. (For instance, which derivatives are to be considered swaps that must go through clearinghouses?)
With new restrictions in place like the Volcker rule, which bans proprietary trading at regulated banks, institutions may not be able to shift the booking of trades as before. (Previously, banks could assign portfolio trades to offices in other countries to lower their domestic regulatory capital requirements.)
"With the derivatives rule and Volcker rule," says John Bush, global banking tax managing director for KPMG LLP in New York, "the basic question becomes, what entities should do what business in what jurisdiction? Where are you going to trade derivatives? A lot of them can no longer be traded in the banks. They have to be traded in another legal vehicle."
Bush says the changes that regulations are bringing to transfer pricing ultimately will impact key business-line decisions, not just the P&L allocation across units. For instance, under Dodd-Frank, banks will be required to push out over-the-counter derivatives to new, independently capitalized entities, so that swaps operations are removed from insured entities and trading losses cannot be shifted to the public. That regulation kicks in next year.
Assets transferred to a foreign office may need to have third-party validation of its arm's length nature as well.
"There's the serious question of how many entities do you want to trade these instruments going forward because of regulatory constraints on how you trade them," says Bush. "The Volcker rule is getting [banks] out of certain lines of businesses. Anytime you change how you do business and in particular moving businesses from one jurisdiction to another ... that's a major transfer-pricing question caused by the legislation."
