Does transfer pricing affect shareholder value? What are the real priorities for an in-house tax director?

Stephen Covey wrote his famous book The Seven Habits of Highly Effective People in 1989 and has sold 15 million copies in 38 languages. This is a very inspiring book with any number of deep insights.

Habit number 2 is ‘begin with the end in mind’. Although he develops this idea, in considerable depth a core theme is that we should begin each day, task or project with a clear vision of our desired direction and destination.

Shareholder value depends on after tax earnings per share which, of course, depends on the effective tax rate. We can all envisage cases where the rate would be too high. For example it may be higher than that of the competition and thus be a source of competitive disadvantage in terms of shareholder value.

There is a debate to be had as to whether a rate might be too low. Certainly there would be cases where a revenue authority might consider a rate to be too low and this might drive their approach to dealing with a particular taxpayer.

Equally the shareholders and analysts might consider a rate to be too low if they regarded it as indicative of excessive risk taking or as inherently unstable. Between these two extremes will lie a rate or a range of rates which the board would consider to be appropriate and the tax director should aim to maintain a stable and sustainable tax rate at this level. We could therefore start each morning by asking what can be done today to achieve and maintain our appropriate tax rate.

How does transfer pricing feature in this debate? With some exceptions the larger exposures and settlements tend to involve transfer pricing rather than corporate structure or more technical matters. Successful and appropriate transfer pricing strategies can go far to support an appropriate effective tax rate.

Failed strategies or large and unanticipated adjustments can increase the effective tax rate permanently or cause large and sudden movements in the rate. Sudden movements destroy shareholder value even where the net present value of the cash flows is hardly different from a hypothetical smooth flow of earnings because they undermine confidence in the ability of the company to achieve stable and sustainable after tax earnings per share.

Returning to Habit number 2, a corporate tax director or his or her adviser could simply focus on the factors which impact on the tax rate and hope for the best but might be better advised to have in mind an appropriate effective tax rate for the company and begin each day, task or project with a clear vision of how to maintain or achieve that rate.

Paul Morton, Head of Tax, Reed Elsevier