Transfer Pricing Policy: How to Create and Document Your TP Framework

Quick Answer: What is a Transfer Pricing Policy?

A transfer pricing policy is a formal document that establishes how your multinational enterprise will set prices and terms for intercompany transactions. It provides the framework for consistent, arm's length pricing across all controlled transactions and serves as the foundation for your transfer pricing documentation.

---

What is a Transfer Pricing Policy?

A transfer pricing policy is your organization's playbook for pricing intercompany transactions. It answers fundamental questions:

• What methods will we use to price each type of transaction?
• How will prices be set and adjusted?
• Who is responsible for transfer pricing decisions?
• When will prices be reviewed and updated?
• What documentation will we maintain?

Unlike transaction-specific documentation, a transfer pricing policy establishes the overall framework that guides how all controlled transactions should be priced across the MNE group.

Why Have a Formal Policy?

---

Policy vs Documentation vs Agreements

Transfer pricing involves multiple layers of documentation. Here's how they relate:

How They Connect

1. Policy sets the methodology for each transaction type
2. Intercompany agreements implement policy for specific transactions
3. Benchmarking studies validate that policy produces arm's length results
4. Local Files document how policy is applied in each jurisdiction
5. Master File describes the overall TP policy framework

---

Essential Transfer Pricing Policy Elements

A comprehensive transfer pricing policy should address six key areas:

1. Transaction Coverage

Identify all intercompany transaction types within the MNE and specify which are covered by the policy:

For each category, specify:

• Transaction types included
• Materiality thresholds (if any)
• Special treatment for certain transactions

2. Method Selection

Document the transfer pricing method(s) to be used for each transaction type:

3. Pricing Mechanisms

Specify how prices will actually be set:

Price-setting approaches:

• Target margin — Prices set to achieve target PLI from benchmarking
• Cost-based — Mark-up applied to actual or budgeted costs
• Market-based — Prices derived from comparable transactions
• Formula-based — Prices calculated using agreed formula

Adjustment mechanisms:

• When and how prices are adjusted
• Year-end true-up procedures
• Treatment of budget vs. actual variances
• Currency fluctuation handling

4. Benchmarking and Update Process

Document how arm's length ranges are established and maintained:

• Benchmarking frequency — How often studies are refreshed (typically every 3 years)
• Database sources — Which databases will be used (Orbis, Amadeus, etc.)
• Search criteria — Standard screening parameters
• Update triggers — What changes require mid-cycle updates

5. Documentation Requirements

Specify documentation standards:

6. Governance and Oversight

Establish clear accountability:

• Policy owner — Who maintains and updates the policy
• Approval authority — Who approves pricing decisions and changes
• Review cadence — Annual policy review process
• Escalation procedures — How to handle disputes or unusual transactions
• Training — How staff are educated on policy requirements

---

Transfer Pricing Policy Template Structure

A well-structured policy document typically includes these sections:

Section 1: Introduction and Purpose

• Policy objectives
• Scope and applicability
• Definitions
• Regulatory framework (OECD Guidelines, local law references)

Section 2: Organizational Overview

• Group structure summary
• Business model description
• Key intercompany flows (refer to Master File)

Section 3: Transaction Categories

For each category (goods, services, intangibles, financial):

• Transaction types covered
• Functional profiles of typical parties
• Pricing method(s) to be applied
• PLI or margin targets
• Pricing mechanism (how prices are set)

Section 4: Pricing Procedures

• Annual budgeting/forecasting process
• Price adjustment mechanisms
• Year-end true-up procedures
• Currency handling

Section 5: Documentation Standards

• Master File and Local File requirements
• Benchmarking study requirements
• Intercompany agreement standards
• Record retention

Section 6: Governance

• Roles and responsibilities
• Review and approval processes
• Policy update procedures
• Training requirements

Section 7: Appendices

• Intercompany agreement templates
• Standard pricing schedules
• Benchmarking study summaries
• Compliance checklists

---

Creating Your Policy: Step-by-Step

Step 1: Inventory Intercompany Transactions

Before writing policy, understand what you're pricing:

• List all intercompany transaction types
• Identify transaction values by type and entity
• Map transaction flows
• Identify materiality thresholds

Step 2: Perform Functional Analysis

For each transaction type, document:

• Functions performed by each party
• Assets employed
• Risks assumed
• Characterization of each party (routine vs. entrepreneur)

Step 3: Select Transfer Pricing Methods

For each transaction type:

• Identify applicable methods
• Select most appropriate method with justification
• Document why alternatives were not selected
• Align with existing benchmarking studies

Step 4: Establish Pricing Mechanisms

Determine how prices will be set in practice:

• Target margins from benchmarking
• Cost allocation methodologies
• Adjustment and true-up procedures
• Currency conventions

Step 5: Draft Policy Document

Write the policy following the template structure:

• Keep language clear and practical
• Include specific procedures, not just principles
• Reference OECD Guidelines where appropriate
• Ensure consistency with existing documentation

Step 6: Implement and Train

Roll out the policy:

• Communicate to affected functions (finance, tax, operations)
• Train staff on key requirements
• Update intercompany agreements to align
• Establish compliance monitoring

---

Common Transfer Pricing Policy Mistakes

Policy vs. Practice Disconnect

The most common and serious issue is when policy documentation doesn't reflect actual business practice:

Example: Policy states management fees are charged at cost plus 5%, but actual charges vary based on local tax considerations.

Risk: Tax authorities may disregard the policy entirely if it's demonstrably not followed, undermining all your documentation.

Solution: Ensure policy accurately reflects what you actually do. If practice varies for valid reasons, document those variations in the policy.

---

Policy Implementation and Monitoring

Implementation Timeline

Compliance Monitoring

Ongoing monitoring ensures policy is followed:

• Quarterly reviews: Compare actual pricing to policy targets
• Year-end true-ups: Adjust prices if results fall outside range
• Exception reporting: Track transactions that deviate from policy
• Audit readiness: Maintain documentation contemporaneously

---

Annual Policy Review Process

Transfer pricing policies should be reviewed annually. Key activities:

What to Review

• Business changes: New products, markets, entities, restructurings
• Regulatory changes: New guidelines, country-specific rules
• Audit developments: Findings from completed audits
• Benchmarking updates: New studies, range changes
• Process improvements: What worked, what didn't

Update Triggers

Update your policy when:

• Significant business restructuring occurs
• New transaction types are introduced
• Tax authorities challenge current approach
• OECD Guidelines are updated
• Benchmarking shows material changes in ranges
• Intercompany agreements are renegotiated

---

Related Topics

• Transfer Pricing Policy Glossary — Definition and key concepts
• Transfer Pricing Documentation Guide — Master File, Local File, CbCR
• Intercompany Agreements Documentation — Contract requirements
• Benchmarking Study Guide — Establishing arm's length ranges

OECD Guidelines References

• Chapter V: Documentation — Documentation requirements
• Chapter II: Methods — Method selection guidance
• Chapter I: Arm's Length Principle — Foundation principles

---

Frequently Asked Questions

What should a transfer pricing policy include?

A comprehensive transfer pricing policy should include: (1) scope and transaction coverage, (2) method selection for each transaction type, (3) pricing mechanisms and adjustment procedures, (4) documentation requirements, (5) governance structure, and (6) review and update processes. The goal is to provide clear guidance on how intercompany transactions should be priced consistently with arm's length standards.

How often should transfer pricing policies be updated?

Policies should be reviewed at least annually and updated when material changes occur. Common triggers include: business restructurings, new transaction types, regulatory changes, audit findings, or material changes in benchmarking results. A policy that isn't current creates audit risk.

Is a transfer pricing policy required by law?

While few jurisdictions explicitly require a written policy, most require documentation that includes the methodology used for pricing controlled transactions. A formal policy demonstrates systematic arm's length compliance and is viewed favorably by tax authorities. OECD Guidelines recommend documentation of pricing methodology.

Who should own the transfer pricing policy?

Typically, the Group Tax function or Head of Transfer Pricing owns the policy, with input from Finance, Legal, and business operations. The policy should have executive sponsorship (CFO or Tax Director) and clear accountability for maintenance and compliance.

How detailed should a transfer pricing policy be?

Detailed enough to guide actual pricing decisions, but not so rigid that it can't accommodate business realities. Include specific methods and target ranges, but allow for documented exceptions. Staff should be able to use the policy to price transactions without escalating every decision.

What's the difference between policy and intercompany agreements?

The policy establishes the framework and methodology for pricing. Intercompany agreements are legal contracts that implement the policy for specific transactions between specific entities. Policy is internal guidance; agreements are binding contracts. Both should align—discrepancies create audit risk.

---