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ESG & Transfer Pricing

ESG & Transfer Pricing


ESG & Transfer Pricing

The momentum for ESG is there: the Covid 19 pandemic has made many people aware again of how closely our health, ecosystems, supply chains, consumption patterns and planetary boundaries are connected. Our tax experts have summarised everything about sustainability and ESG from a transfer pricing perspective in the following article.

Both the United Nations and the European Commission have adopted their own agendas (Sustainable Development Goals and the European Green Deal respectively). This results in new reporting requirements for companies (non-financial reporting, new criteria for lending, public CbCR, etc), new legal frameworks, but possibly also new opportunities, competitive advantages and new business areas.

As a result of measures and ESG projects, a number of transfer pricing issues arise.

ESG as a management focus

Regardless of the industry and the ESG measures a company actually takes, a number of new management tasks arise in companies in connection with ESG, especially also with regard to ESG reporting. Here is a selection of the management issues that may arise for companies throughout their organisation as well as along the entire value chain:

  • Assess the impact of ESG-related risks and opportunities on the business, strategy and financial planning of the Group organisation, including climate-related risks and opportunities.
  • Assessment of site-specific climate risks, such as local water availability, regional carbon pricing mechanisms and physical climate risk scenarios
  • Overall stress test in relation to key climate risks.
  • Definition of the company’s sustainability development goals, including a Net Zero Policy
  • Development of permanent, long-term climate adaptation strategy
  • Development of processes to identify and assess sustainability threats
  • Integration of ESG-related processes into general risk management
  • Development of climate-optimised supply chains (analysis of suppliers and spend categories), analysis of product life cycle risks and identification of circular economy opportunities
  • Determine the metrics used by the Group to assess the fulfilment of sustainability development goals or to evaluate risks and opportunities in line with the strategy and risk management process
  • Assess the link between ESG risks and credit risk for the Group.
  • Development and implementation of human rights policies and processes
  • New workforce strategies, including workplace (“future of work”) set-up, business travel, etc.
  • Revision of good governance policies or code of conduct
  • Revision of performance compensation for senior management in relation to ESG KPIs.
  • Revise supplier contracts and integrate ESG-related clauses (beyond legal requirements, e.g. child labour, conflict minerals reporting, etc.)
  • Fulfilment of reporting obligations, including
    • Preparation of non-financial reporting / sustainability reporting
    • ESG disclosures required of banks in line with the European Banking Authority’s guidelines on lending and credit monitoring
  • Development of an investor relations strategy for ESG engagements
  • Develop a communication strategy for sustainability development objectives as part of brand management.

Transfer pricing implications

The impact of ESG requirements on the transfer pricing system is manifold and can be quite different for each company, depending on the measures taken within the company. A few examples are presented below.

Restructuring and supply chain projects

According to our experience so far, the following measures in particular come into question:

  • Decentralisation of production functions with the aim of reducing the group’s carbon footprint:
    From a transfer pricing perspective, it should be noted that the resulting reallocation of production functions may require appropriate compensation fees. Likewise, it must be examined whether such decentralisation results in the transfer or new use of intangible assets, which must also be remunerated at arm’s length.
  • Merging or insourcing of production steps:
    To the extent that in-house production is undertaken to ensure compliance with the company’s own ESG criteria, previously mere contract manufacturers could take on more comprehensive production functions with more risks, which may require a separate analysis of the transfer pricing method and remuneration.
  • Central ESG risk management function for the supply chain:
    Such a function may be strategic in nature and develop guidance for the group, but may also be deeply involved in operational processes. In any case, from a transfer pricing perspective, a detailed functional analysis should be carried out, it is a service that can be remunerated on a cost-plus basis or whether another transfer pricing method should be applied in case of a significant impact on the group’s value creation and high integration with other functions.
  • CO2-efficient logistics or fleet management:
    Such services are usually provided by central logistics centres and are remunerated on a cost plus basis. However, the mark-up on costs should be analysed individually, as such services can have a significant impact on the group’s net zero policy and are usually not covered by the OECD low value added services relief with a fixed profit margin of 5%.

Assumption of ESG risks by local units

ESG can also affect the cost structure of local units. Wage increases at previous “low cost locations” in order to meet minimum wage standards or investments in more occupational safety are possible. Particularly sensitive are situations where such adjustments lead to costs that cannot be passed on to customers. In such cases, complex questions arise as to which unit in the group should bear the resulting losses.

ESG requirements can also lead to more risks being assumed by local units. Risk allocation in the transfer pricing analysis should be delineated in detail in accordance with the OECD’s six-tier framework. Such an analysis may lead to a necessary change in some circumstances, for example, with regard to the choice of the most appropriate method (e.g. profit split instead of cost plus).

SG costs and their allocation within the group

Costs incurred in connection with ESG projects in the group must be borne by the units that also bear the corresponding risks or for whose benefit the costs ultimately are, in accordance with the OECD Transfer Pricing Guidelines.

  • Centralised management of supplier contracts:
    Such centralisation may be necessary to ensure that these contracts comply with the group’s ESG criteria and that all necessary information is provided by these suppliers to enable the group to meet its reporting obligations. From a transfer pricing perspective, it is necessary to consider whether and how to charge for such a function within the Group.
  • Costs related to ESG reporting and branding:
    Costs that may be incurred in relation to ESG include preparation of non-financial reporting, preparation of detailed ESG information or other communication activities. It is important to note that such costs may only be passed on to the group members in accordance with the arm’s length principle if the benefit test is met and no so-called shareholder activities are involved. According to the OECD Transfer Pricing Guidelines, shareholder activities are:
  1. Costs related to the legal structure of the parent company itself;
  2. Costs related to the reporting obligations of the parent company;
  3. Costs of raising funds for the acquisition of its shareholdings; and Costs of investor relations of the parent company;
  4. Costs associated with the parent company’s compliance with relevant tax laws;
  5. Costs related to the corporate governance of the multinational enterprise as a whole.

In any case, a detailed transfer pricing analysis is useful here.


Not least due to the EU Green Deal, ESG as well as various sustainability goals are high on the agenda of companies, investors and also public institutions. The requirements placed on companies and the measures that companies take affect business and organisational models in many ways.

This means that internationally active groups must also examine whether transfer pricing implications arise from this. A detailed analysis and precise delineation of the potentially new function, risk and asset profiles in the case of changes in the supply chain, new ESG functions as well as the charging on of costs of ESG projects is in any case useful in the context of tax risk management.

Contact our experts if you have questions on ESG and sustainability: transfer pricing aspects.

Contact our experts

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