The transfer pricing complexity of digitised supply chains

For one thing, it has completely upended the physical presence test.
Data is intangible, but it has to be valued. Image: Chris Ratcliffe, Bloomberg

Traditional taxation models were based on the physical presence of a business, referred to as brick and mortar businesses. The digitisation of the global economy has completely upended the physical presence test, allowing for the fragmentation of businesses’ operations and assets, including intangible assets.

The lack of a physical presence enabled by digitised technology is a major problem that tax authorities and the Organisation for Economic Co-operation and Development (OECD) have been grappling with for nearly a decade.

Transfer pricing is also trying to deal with other problems, including how to value a unique intangible asset such as the personal data of users collected by online organisations.

Transfer pricing refers to the pricing of transactions that take place between connected parties, which can be substantiated by comparable data. There are established methodologies for valuing intangible assets, though subjective. But there are no comparables for unique intangible assets.

Taxing the proceeds of the digital revolution – many questions

At the recent 10th Africa Transfer Pricing summit hosted by the South African Institute of Taxation (Sait), an expert panel comprising Michael Hewson, director and founder of Graphene Economics, Jeremy Basckin, managing director and supply chain transformation manager at Neways in the United Kingdom, and Philippe Paumier, founding member of Vector TP in France, discussed the transfer pricing complexities of supply chain management.

Hewson said digital transformation is a key feature of most companies. It allows the company to be in the cloud, borderless, without having a physical presence in any country. He raised the question: “How does one go about taxing the proceeds of the digital revolution?”

He referred to the latest proposed global tax reform spearheaded by the OECD: “While the world has been fascinated by Pillar 1 and Pillar 2, how does one go about determining the arm’s length price of digital transactions?”

Read: Will global tax reform lead to a fairer tax system?

Technological transformation

According to Hewson, technology has transformed many industries, for example, consumer electronics, automotive electronics, industrial electronics, data processing, communication, electronics, military and civil electronics.

“No industry has missed out on the opportunity to be connected.”

Hewson provided the example of the cost contribution of automotive electronics and semiconductor content in a motor vehicle having increased from 18% in 2000 to 40% in 2020, and which is expected to reach 45% in 2030.

He explained that a traditional supply chain commences at development, and moves through the planning stage, sourcing of products, making of products, delivery and ongoing support functions. A digital supply network however has a digital core connected to the various components, the connected customer, a smart factory, digital centralised planning, digital development, dynamic order fulfilment, and an intelligent supply.

Hewson said there are no specific guidelines on the valuation of digital arrangements.

Seismic change to supply chains in 2020

Basckin explained that supply chains are good at reacting to single events, such as a transport issue. But in 2020 there was a multi-dimensional seismic change, caused by the Covid-19 pandemic. The lockdowns caused a change in the supply chains; for example, people bought food from different outlets.


He said prices are fluctuating, which has a massive effect on the transfer prices. Transport prices have gone up, and there is a shortage of containers and ships.

Brexit also resulted in massive changes: it was, for example, difficult to move products from the UK into Europe, and ferries went from Europe to Ireland, instead of going via the UK.

Basckin said that whereas large companies could invest in new systems, smaller companies could purchase off-the-shelf applications that carried out the functions of the traditional IT systems, such as forecasting tools, demand inventory tools, and financial tools.

The transfer pricing perspective

Paumier explained that it is necessary to evaluate each activity in a company’s value chain to understand how value is created. Each function must be valued in order to be transfer-priced.

The most basic difficulty for the purposes of transfer pricing is to keep track of what is going on.

The various initiatives of digitalisation don’t all have the same value.

Digitisation is an enabler for horizontal fluid transactions. Covid was a catalyst for the fragmentation of things, which can take place remotely.

Paumier said we now have scattered teams, working from different locations. There is a collaboration of data.

Data is intangible, and it has to be valued. Users also have to be valued. But there are active users who provide accurate data, and passive users, who don’t provide accurate or useful data.

Basckin explained that a business can now share the upstream and downstream data of the supply chain via message hubs. The hubs are connected to the suppliers and to customers. You can react quickly to changes in demand or supply.

He said that collaboration hubs create end-to-end visibility, which brings down risk, and leads to efficiency, and that technology has enabled all the players including third parties to come together, which was previously only possible in a multinational company.

He suggested that from a transfer pricing perspective it is advisable to remain within the established framework, and look at the least complex entity.

Important takeaways

The panel agreed that the important takeaways are:

  • Identify the areas in the organisation in which digitisation has been applied;
  • Evaluate the impact on the value chain;
  • Consider the contributions of the relevant parties;
  • Determine how the parties should be compensated for their contributions;
  • Ensure proper implementation, for example, per contracts; and
  • Document in detail all the steps taken.



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