Sleeping Dogs & ‘Stale’ TP Policies

In this 'Margin Note,' we consider whether conventional wisdom about leaving ‘stale’ transfer pricing policies alone is wisdom at all.

A former colleague confided recently that their TP policies had been in place for twenty years without an audit. We casually observed the conventional wisdom: “Best to let sleeping dogs lie.” And there was strong institutional resistance to change. But then came the aside: Some of the policy rates were probably too conservative.

Perhaps the dogs weren’t sleeping at all—they were keeping the tax authorities happy.

And that’s not even the whole story. Even when the mechanics of a transfer pricing policy do not change, the company underneath is almost always evolving, adapting, and hopefully expanding—but sometimes, the opposite is true. A policy doesn’t define the character of a transaction. Applying a “limited risk” or “simple cost plus” label does not make it so. Rather, a policy should reflect the collective factors that contribute to a proper delineation of that controlled transaction. And if the latter is constantly changing, why not also the former?

This begs the question: When is it better to nudge that dog awake?

Letting Sleeping Dogs Lie

For many practitioners, “never getting audited” may feel like a badge of honor. It suggests tidy files, strong policies, and rock-steady compliance. Of course nobody wants to be audited. But is a quiet(er), audit-free life emblematic of success? Or do the underlying policies signal: “There’s just no way this company is being too aggressive.” Was that the intent?

After all, tax authorities are not shy about routine audits. They want to pressure-test the mechanics of a benchmark, probe the allocation of risk, or confirm that intercompany contracts align with conduct. They also want to verify that a reasonable policy appropriately covers all of the controlled activities. These are normal steps.

And since taxpayers are likely to disagree with tax authorities about how to quantify a ‘reasonable policy,’ a certain volume of routine audit attention is to be expected. What tax authorities don’t need to spend time on are policies so conservative—so tilted in the government’s favor—that there’s little point in auditing.

A Life of its Own…

Once a transfer pricing policy becomes institutionalized, its interpretation can take on a life of its own. Variations of legacy transaction flows and similarly named—yet completely novel—activities can inadvertently be swept into the same characterization as the legacy arrangements by finance and accounting staff.

In an era of fast-moving business models, high workforce turnover, and streamlining (or automation) of functions, this occurs quite naturally. Activities that have little in common with the original policy can find themselves lumped together under the guise of keeping things simple. Without close engagement or monitoring by tax, much of the breadth of aggregated activities may ultimately have little in common with what was originally intended (and benchmarked).

The Chart of Accounts seldom evolves as quickly as the company itself.

So, suddenly we may find ourselves back with the state of a proverbial sleeping dog. And if you’ve ever startled a real dog awake, things don’t usually start with belly rubs. So why wait until a tax authority steps on its tail?

And Other Related Services…

The current era of marked workforce mobility and volatile business models can trigger shifts in the center of gravity of an entity’s functional profile. As a classic example, back-office hubs in low-cost markets can unexpectedly expand into new teams with very new functions. Were these part of the original vision for the function?

If it hasn’t already occurred, we can reasonably expect to see such functions overhauled by deployed AI assets (with their own support teams). Will this new AI-augmented service and team be functionally equivalent to the original, fully-staffed customer support team? While most intercompany service agreements have a clause suggesting it covers “Other Related Services,” that clause can end up doing A LOT of heavy lifting.

At some point, reliance on being able to always benchmark a typical profitability ratio may be eroded by the question of whether that profitability ratio and its benchmark even still apply to the tested activity.

But even then, there can be Benchmark Drift.

Catching Benchmark Drift

Economic conditions change. Business cycles churn. Median returns move. And interquartile ranges from 2020 aren’t guaranteed to be the same when updated for 2025. An unchanged policy can drift out of alignment with the market evidence that was meant to support it. Why would it be expected for a policy rate to be the same no matter what is in the function or what has happened in the market?

There might indeed be an unbroken string of annual reports on file, each representing that the policy is sound. But demonstrating that the applied policy is not unreasonable can be quite a different task than determining what a reasonable range of policy outcomes would be today, based on a proper delineation of that controlled transaction and the corresponding comparability and economic analyses.

There can also be another well-disguised risk in sticking with a policy rate for long after it’s gone stale. Your advisors might begin resorting to less conventional measures to benchmark your transactions. They may even inform you that it’s time to revisit the policy from the ground up. But in reply, you may push back, citing the latest analysis and seemingly healthy interquartile range in the report you were just handed. It can be a tricky moment, but when in doubt, perhaps consider getting a second opinion about staying the course.

Arm’s-Length Inertia

As a final consideration, a policy that hasn’t been re-examined in years can look less like a deliberate arm’s-length outcome and more like an expression of arm’s-length inertia. And since “arm’s-length inertia” is a freshly-coined term, it may be less likely to provide penalty protection.

It’s very common for original intercompany agreement language to feature heavily in the initial functional analysis narrative of a controlled transaction. Agreement-sourced narrative can be ‘sticky’, and it is typical for this core language to change very little over time. In fact, it can be a bit of a struggle to clearly document a controlled transaction if and when—for all the reasons noted above, and a handful more—the agreement ceases to fully-reflect the latest iteration of the active business. It is quite possible to end up with a very nice-looking report with a confident, arm’s length conclusion; but one that no longer matches the real-world operations.

The time to figure this out is not during preparation for the first transfer pricing IDR.

A Gentler Wake-Up

The scramble that can follow a robust IDR— the functional equivalent of abruptly waking a sleeping dog—rarely goes well. But approached calmly and with thoughtful actions, most slumbering dogs wake up happily enough. Tails soon set to wagging. The same is true of transfer pricing policies. Sometimes all that’s needed is a gentle scratch under the chin.

So go check in on whether your policies deserve some attention. Maybe even a scratch behind the ears. And I’ll do the same with my own four-legged companions.