Transfer Pricing Adjustments Under OECD Pillar Two Rules

Transfer pricing has become a key issue in international taxation, particularly as multinational enterprises increasingly conduct transactions between related entities located in different jurisdictions. Under the Arm’s Length Principle, these transactions should be conducted on terms and at prices that independent parties would have agreed upon under comparable circumstances. At the same time, the OECD/G20 Pillar Two framework was introduced to ensure that qualifying multinational enterprise groups are subject to a 15% global minimum effective tax rate under the GloBE Rules. Accordingly, the relationship between transfer pricing and Pillar Two has become increasingly important because transfer pricing adjustments may directly affect the income and taxes recognized in each jurisdiction and, consequently, the group’s potential Top-up Tax liability.

Transfer Pricing Adjustments

A transfer pricing adjustment occurs when a tax authority determines that a transaction between related parties does not comply with the Arm’s Length Principle. The authority may then adjust the reported income or expenses to reflect the outcome that would have been expected between independent parties. For example, if a subsidiary pays an excessive amount to a related company for goods or services, the tax authority may reduce the deductible expense and increase the subsidiary’s taxable income, resulting in additional corporate income tax.

Pillar Two and the Global Minimum Tax

Pillar Two aims to establish a minimum level of taxation for large multinational enterprise groups. Under the GloBE Rules, the effective tax rate is generally calculated on a jurisdiction-by-jurisdiction basis and compared with the 15% minimum rate. If the effective tax rate in a jurisdiction is below 15%, a Top-up Tax may arise to bring the tax level up to the required minimum, subject to the detailed rules and applicable exclusions. Therefore, any change in income or taxes resulting from a transfer pricing adjustment may have a direct impact on the Pillar Two calculations.

Impact of Transfer Pricing Adjustments on the Effective Tax Rate

Transfer pricing adjustments may increase or decrease the GloBE effective tax rate. If an adjustment increases taxable income and results in a corresponding increase in covered taxes, the effective tax rate may increase, potentially reducing or eliminating the Top-up Tax liability. Conversely, if an adjustment increases GloBE income without a proportionate increase in covered taxes, the effective tax rate may decrease, potentially creating or increasing a Top-up Tax liability. Transfer pricing adjustments should therefore be evaluated not only from a local tax perspective but also in terms of their impact on the group’s overall Pillar Two position.

Double Taxation

Double taxation is one of the most significant risks associated with transfer pricing adjustments. When one jurisdiction makes a primary adjustment that increases taxable income, the other jurisdiction may need to provide a corresponding adjustment to prevent the same economic income from being taxed twice. If a corresponding adjustment is not granted, the multinational group may face additional taxation in both jurisdictions. This situation can also complicate the calculation of the GloBE effective tax rate, particularly where the two jurisdictions apply different tax treatments.

Timing and Data Considerations

The timing of a transfer pricing adjustment is an important consideration under Pillar Two because an adjustment may be made after the relevant financial statements or tax returns have been prepared, with its tax effects arising in a different period. Multinational enterprises therefore need effective systems to record and monitor transfer pricing adjustments and ensure that their consequences are properly reflected in the GloBE calculations. Accurate and consistent financial and tax data are also essential, particularly where transfer pricing information must be reconciled with accounting and tax information.

Impact on Multinational Enterprises

Pillar Two has changed the way multinational enterprises should manage their transfer pricing policies. It is no longer sufficient to ensure that transfer pricing complies with local rules and the Arm’s Length Principle. Companies must also assess how their transfer pricing policies affect the group’s jurisdictional effective tax rates and potential Top-up Tax obligations. This is particularly important in jurisdictions where the effective tax rate is close to the 15% minimum, as even a relatively small change in income or covered taxes may significantly affect the Top-up Tax position.

Conclusion

The relationship between transfer pricing and Pillar Two has become an essential consideration for multinational enterprises. Transfer pricing adjustments can affect income and taxes across different jurisdictions and, consequently, change the GloBE effective tax rate and potential Top-up Tax liability. The risks of double taxation, timing differences, and data challenges further increase the importance of coordination between transfer pricing, tax, accounting, and finance functions.

Multinational enterprises should therefore avoid treating transfer pricing and Pillar Two as separate matters and instead consider them as interconnected components of an integrated international tax strategy. This approach can help companies manage tax risks, avoid unexpected tax costs, reduce the risk of double taxation, and ensure compliance with the increasingly complex requirements of the international tax environment.

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