Transformations in the automotive industry and the implications from a transfer pricing perspective

Opinion by Adelina Bobe, Senior Manager, Transfer Pricing, Deloitte Romania

The automotive industry in Romania and around the world is going through one of the most complex periods in recent decades. The pressure exerted by car manufacturers on costs, the volatility of supply chains, the transition to electric vehicles and the increasing importance of research and development activities are transforming not only business models, but also the way the operations of multinational groups are organized. These transformations do not, in themselves, constitute tax risk factors, but, from a transfer pricing perspective, present a number of challenges related to the way in which functions, risks and profits are distributed among group entities.

Transfer pricing is based on the principle that the remuneration of each entity within a multinational group should reflect the functions it performs, the assets it uses and the risks it assumes. But in a sector undergoing an accelerated transformation, the business model must be periodically evaluated to determine whether it still reflects the operational and economic reality of the group. As the responsibilities of some entities evolve, new research and development activities emerge, value chains change or certain economic risks are managed differently, an analysis of the impact of these developments on transfer pricing policy and on the way in which those group entities are remunerated may become necessary.

These aspects are relevant because they can influence the assessment of the market character of intra-group transactions, the level of profitability attributed to the member companies and, implicitly, the tax position of the group in the context of a possible tax inspection.

Cost volatility and allocation of economic risks

The past few years have demonstrated how exposed the automotive industry is to fluctuations in energy, raw material and logistics costs, as well as disruptions in supply chains.

These developments have significantly influenced the profitability of many companies in the industry and have led groups to adopt various mechanisms for managing their economic impact. From a transfer pricing perspective, an important aspect is to understand how the economic effects of these developments are distributed among the group entities. In practice, it is relevant to analyse who bears the cost increases, who assumes the risks associated with supply chain disruptions, who decides on the measures to mitigate the impact and who manages the risks that generate these additional costs.

These elements may influence the assessment of the market nature of the financial results recorded by the different entities and the adequacy of the existing remuneration mechanisms. Thus, it is useful for management to understand not only the financial impact, but also how such events are reflected in the economic relations between the group companies.

Relationship with OEMs and ongoing cost pressure

The pressure exerted by car manufacturers on suppliers is one of the defining characteristics of the automotive industry. Cost reduction requirements, efficiency programs and periodic commercial renegotiations are part of the operational reality of most companies in the sector.

These trade constraints can directly influence the profitability of supply chain participants and lead to significant differences between reporting periods or between entities within the same group.

From a transfer pricing perspective, it becomes important to understand how the effects of these commercial pressures are distributed among the companies involved – who negotiates the relationship with the OEM (original equipment manufacturer ), who sets the commercial strategy, who approves significant commercial concessions and who bears the economic impact of the price reductions or efficiency programs requested by the original equipment manufacturers?

These aspects can influence the profitability expectations of each entity involved. For this reason, it is advisable for management to understand how industry-specific commercial pressure is absorbed and distributed within the group.

The transition to electric vehicles and changing the value chain

The transition to electric vehicles is probably the most important structural transformation that the automotive industry is going through. As software, batteries and electronic systems become increasingly important in the architecture of modern vehicles, the value chain in the automotive industry is evolving, and technological development and innovation activities are becoming increasingly relevant within multinational groups. These changes may influence the role of the entities involved in the development, production and marketing of products and may lead to a reassessment of their economic contributions.

From a transfer pricing perspective, it becomes important to understand how these transformations influence the distribution of functions and profit within the group – where key technologies are developed, who coordinates research and development activities, who finances innovation projects, who assumes the risks associated with them and which entities actually contribute to the development of new products and technologies.

As the value chain transforms, these aspects may become relevant for assessing the economic contribution of different entities and for the adequacy of existing remuneration policies. For this reason, a regular analysis of how value is created within the group can help to identify possible tax implications at an early stage.

More complex supply chains and growing local responsibilities

Recent transformations in the industry have led many groups to rethink their supply chains and give a greater role to certain local entities.

Thus, Romanian companies can take on additional responsibilities in managing supplier relations, optimizing processes, coordinating operational activities or implementing efficiency initiatives. From a transfer pricing perspective, it becomes important to understand the nature and limits of these responsibilities – whether the local entity implements decisions and processes established at the group level, whether it actively participates in defining them, who coordinates strategic relationships with suppliers and customers, who approves key decisions and who assumes their economic consequences.

These elements may influence the assessment of the economic role of the local authority and the way in which it is remunerated. For this reason, it is recommended that management regularly monitor the evolution of local responsibilities and assess their impact on the group’s operational and fiscal model.

In conclusion, the transformations that the automotive industry is going through do not automatically generate transfer pricing risks, nor do they necessarily require changes to existing remuneration models. However, they highlight the need to continuously monitor how value is created within the group and the impact that operational and technological changes may have on the implemented tax policies.

From this perspective, companies that constantly monitor the evolution of functions, risks and value chains are usually better prepared to support the market character of their transfer pricing policies and to effectively manage any tax controversies.