Centralized Procurement and Transfer Pricing: Key Insights for MNEs

In today’s global business environment, many multinational enterprises (MNEs) adopt centralized procurement models to gain efficiency and cost savings. However, such structures come under close scrutiny from tax authorities worldwide due to their transfer pricing implications.

Understanding Centralized Procurement

Centralized procurement refers to an entity handling purchasing or sourcing functions on behalf of other group entities. These functions can range from basic purchasing to more strategic sourcing, involving vendor negotiations, quality control, and supply chain management.

Transfer Pricing Considerations

Three key factors impact how these activities should be remunerated under the arm’s length principle:

1. Functions performed – Sourcing (complex) commands higher remuneration than basic purchasing.

2. Nature of goods/services – Core spend (essential items) implies higher value and risk than non-core (support items).

3. Risks assumed – Companies assuming price, volume, or inventory risks must be appropriately compensated.

Common Procurement Structures

• Service Models: Where the procurement entity acts only as a facilitator.

• Buy-Sell Models: Where the procurement entity briefly takes title to the goods.

Compensation Methods

• Cost Plus Model: Suitable for low-complexity services (e.g., purchasing), with typical markups of 5–10%.

• Commission-Based Model: Ideal for strategic sourcing, based on a percentage of managed spend.

• Gain Share Model: Shares savings achieved with group entities; suited for highly strategic procurement.

OECD and Global Perspectives

• OECD guidelines restrict simplified transfer pricing for procurement of core inputs.

• Dutch and Australian tax authorities have issued detailed guidance emphasizing substance and appropriate profit allocation.

Indian Jurisprudence

In the case of GAP International Sourcing, Indian courts upheld a cost-plus remuneration model, emphasizing low risk and limited functional control. The tribunal allowed a markup but adjusted it to reflect actual contributions.

Key Takeaways

• Maintain robust documentation (FAR analysis, agreements, benchmarking).

• Ensure alignment between contracts and actual conduct.

• Evaluate local tax rules, including India’s Deemed International Transaction provision