At Graphene Economics, we are privileged to serve a variety of clients across wide-ranging industries. While we bring our taxation expertise to the table, along with our experience of managing transfer pricing across the African continent, we know we need to spend a lot of time getting to know our clients’ businesses and understanding their operating models to be able to deliver the best possible solutions for them.
Something we have found enormously helpful in this regard is when clients invite us to experience their operations – for example through a site visit – which enables a deeper understanding of how their businesses work, what the on-the-ground challenges are, and the realities facing their people on a day-to-day basis.
Observing a business in action
As Henry Dicks, Manager at Graphene Economics, explains, “Perhaps one of the most beneficial ways to deepen the understanding of a client’s business, and the transactions entered into by it, is to spend time observing the actual business operations in person. Members of the Graphene Economics team recently had the opportunity to conduct two plant tours of the manufacturing facilities of a client engaged in the manufacturing of chemical products.”
Graphene Economics has been assisting the client for several years in preparing TP documentation and with various TP advisory engagements. This was, however, the first opportunity the team had to conduct a site visit.
“Preparation for the site visit began well in advance of the actual day,” says Henry. “Safety training induction had to be undertaken and several tests had to be written and passed on health and safety and emergency procedures. Personal Protective Equipment (PPE) sizes had to be communicated to ensure correct sizing. On the day of the site visit, we reported to a security checkpoint off-site, where additional safety training induction was completed, and security checks were done. Another separate security checkpoint had to be navigated at the site entrance, breathalyzers were done and then – success – we were able to access to the site.”
Henry says this process made it abundantly clear that security, health and safety are not just tick-the-box exercises but of utmost importance for the business, both in terms of protecting the wellbeing of employees and any site visitors, as well as safeguarding the company’s valuable IP.
“The sites are structured into various plants that manufacture different types of products,” says Henry. “Being led through these facilities by highly capable engineers and plant foremen can only be described as impressive. Immediately noticeable is the level of automation and advanced manufacturing processes. Computer screens are manned by engineers who, with the click of a button, can view any level or point within the manufacturing process, track raw material levels, monitor outputs and instantly identify any abnormalities or anomalies in the manufacturing process.
“We were accompanied by a group of engineers and other technical staff who explained the process from start to finish. When not presenting themselves, the engineers would talk amongst themselves, discuss ideas, process, and operational improvements. Their genuine passion for their work is apparent. Their interactions with each other were a reminder that operational improvement and process development is a continuous task. It is easy to notice the advancement and development of processes and products over a hundred-year operating period, however it’s the daily tasks and continuous development that leads to becoming a world-class player in the chemicals sector. When touring the plants, one obtains a greater appreciation for the technical skill required throughout the Group. From procurement of raw materials to the delivery of products to mines globally, each step in the value chain must run optimally and uninterrupted to ensure the Group’s strategic outcomes are met.”
Michael Hewson, Director at Graphene Economics, adds that visiting a client’s business gives insights that can never be delivered in a boardroom or on a Teams or Zoom call. “For example, with this client, we had been unaware of certain licencing agreements they have in place until we visited their facilities and asked questions about where certain technologies came from as we chatted with their R&D teams. Understanding the licencing agreements gives us insights into their IP and is now another consideration that we will take into account as we advise them on their TP.”
Extensive TP benefits
Michael suggests that by exposing TP consultants to a business’s operations, they gain a deeper understanding of the company’s business model, including its value chain, cost structures, and profit drivers. “This insight allows us to develop TP strategies that are more aligned with the company’s actual economic activities,” he says. “Being in tune with the operational realities of a business ensure we’re able to better tailor our solutions to the specific needs and circumstances of the company. This in turn results in improved risk management (by addressing potential compliance issues proactively), streamlined decision-making (as we can provide insights into how operational changes might impact TP strategies), and better contribution to value creation (as we’re not just managing TP compliance, but able to ensure TP strategy plays more of a part in the overall efficiency and profitability of the business).”
Henry uses accurate delineation as a practical example. “The term accurate delineation refers to, in broad terms, the identification of the economically relevant characteristics of the transaction,” he explains. “This can include the relevant functions performed, assets used, and risks assumed by the parties to a transaction. Accurate delineation of a transaction is at the very core of considering that transaction from a transfer pricing perspective. Firstly, it informs the so-called comparability analysis, to compare the transaction to similar transactions entered into by independent third parties. Secondly, in accordance with the arm’s length principle, a transacting party should be remunerated commensurate to the functions performed, assets used, and risks assumed by the party. Accordingly, the arm’s length nature of a transaction cannot be considered without the transaction being accurately delineated.”
Why is this important from a taxpayer’s perspective? April Nicholson, Associate Director at Graphene Economics, explains that there are several reasons. Accurate delineation:
- Supports that the allocation of profit within the group is aligned to the value chain and activities that drive revenue within the business
- Ensures that the economic substance of the transaction (including the actual business and commercial operations) matches its legal form
- Assists with risk management within the group, as accurate delineation of the transactions is aimed at reducing instances of disputes with revenue authorities, and therefore reducing the risk of double taxation within the group
“TP advisors can accurately delineate a transaction through gathering and considering relevant information, conducting functional analyses meetings and gaining a deeper understanding of the industry and economic factors impacting the transaction, together with the broader sector within which their client operates,” says Henry. “By obtaining a real and deep understanding of how a client’s business operates, and seeing it practically, not only assists in the accurate delineation of transactions but makes the whole TP analysis come alive.”
Henry adds that understanding the business at a granular level not only informs the accurate delineation, but the comparability analysis. “By obtaining a deeper understanding of the Group’s business we can more effectively conduct benchmarking studies, consider potential comparable companies and provide even more robust and accurate testing of transactions. Perhaps a noteworthy example of this is the discovery of an internal Comparable Uncontrolled Price (CUP) agreement we became aware of through our discussions with one of the engineers on site,” he says. “The agreement was not previously identified as it is only applicable to certain of the products manufactured and has been in place for a long period of time. Through the discovery of this agreement, we were able to compare it to a licensing benchmarking study performed recently for the client. This CUP agreement enabled us to compare the agreement against the analysis we performed and ultimately bolstered the analysis and results further.”
Making TP analysis come alive
“I can only describe the overall experience as incredible,” Henry says, of the site visit. “The observations made and lessons learned are things we can actively apply when preparing TP documentation for the client, as well as when we provide advisory services. It assisted us, in real and practical terms, to more accurately delineate transactions, understand the functions performed, risks assumed, and assets used by the South African operations as well as the group subsidiaries. We walked away from the experience with a much deeper understanding of the IP used by the group and the paramount importance of continuous enhancements and development of the IP, which often comes down to the day-to-day continuous enhancements, improvements and optimisations made by the highly technical staff on site.”
Beyond the visit itself, Henry says, the experience emphasised the need for truly understanding clients’ businesses and how activities such as an opportunity to experience their operations can assist advisors in providing better services.
“We were fortunate to be able to witness the operations of a truly exceptional company, expand our understanding of the group’s business and came away with our own nuggets of gold to be incorporated into every piece of work we produce for this client,” he concludes.