Local File | Aibidia

1. What is a Local File in Transfer Pricing?

A Local File is a key component of transfer pricing documentation that provides detailed information on intercompany transactions conducted by a business within a specific country. It serves as supporting evidence that the prices set between related parties comply with the arm’s length principle—a fundamental rule ensuring that transactions between associated enterprises resemble those between independent companies.

In simple terms, it’s a country-specific report that tax authorities use to verify that a company’s transfer pricing policies align with local tax laws.

2. Why is the Local File Important?

The Local File is essential for:

• Tax Compliance – Ensuring that multinational companies (MNEs) follow local tax laws and avoid penalties.
• Transparency – Providing detailed insights into intercompany transactions for tax authorities.
• Audit Defense – Serving as proof that transfer pricing practices are fair and reasonable.
• Risk Mitigation – Reducing the chances of tax disputes and adjustments that could lead to additional tax liabilities.

Without proper documentation, companies risk facing transfer pricing adjustments, financial penalties, or even legal consequences.

3. What Information Does the Local File Contain?

While specific requirements vary by country, a typical Local File includes:

A. Organizational Overview

• A description of the company’s business operations in the local country.
• Details about ownership structure and any relationships with foreign entities.

B. Controlled Transactions

• A list of all related-party transactions involving goods, services, intellectual property, or financing.
• The value of these transactions and the entities involved.
• Functional analysis explaining the roles, risks, and assets of each party.

C. Economic Analysis

• Transfer pricing methods used to determine pricing for intercompany transactions.
• Comparability analysis showing how prices align with market rates.
• Justifications for the arm’s length nature of the transactions.

D. Financial Information

• Financial statements of the local entity.
• Data supporting transfer pricing calculations.

By structuring the Local File correctly, companies can demonstrate compliance with tax regulations and avoid unnecessary scrutiny.

4. How is the Local File Different from the Master File?

The Local File and the Master File are two components of the three-tiered documentation approach introduced by the OECD's Base Erosion and Profit Shifting (BEPS) Action Plan 13.

While the Master File provides a high-level summary of an MNE's global transfer pricing policies, the Local File dives deeper into how those policies are applied within a particular country.

5. Who Needs to Prepare a Local File?

Any company engaged in cross-border related-party transactions may be required to prepare a Local File. However, local regulations dictate specific thresholds, which vary by country.

Generally, companies that must maintain a Local File include:

• Multinational Enterprises (MNEs) operating in multiple countries.
• Subsidiaries of foreign corporations involved in intercompany transactions.
• Entities exceeding certain revenue or transaction value thresholds (as defined by local tax authorities).

For example, in the European Union, most member states have adopted OECD transfer pricing guidelines, requiring businesses with related-party transactions exceeding a certain value to maintain a Local File.

6. When is the Local File Due?

The deadline for submitting the Local File depends on local tax regulations. In many countries, it must be prepared and available by the time the annual tax return is filed. However, authorities typically request it only during an audit or compliance review.

Common timelines include:

• Annually (to coincide with tax filing deadlines).
• Upon request by tax authorities, with response times ranging from 30 to 60 days.

Failing to prepare or submit the Local File on time can lead to penalties, adjustments, or increased scrutiny from tax authorities.

7. How Do You Prepare a Local File?

Preparing a Local File involves several steps:

1. Gather Relevant Data – Collect financial statements, transaction records, and agreements.
2. Analyze Related-Party Transactions – Identify intercompany transactions and document their nature.
3. Perform a Functional Analysis – Define the roles, risks, and assets of each entity involved.
4. Select and Apply a Transfer Pricing Method – Use OECD-approved methods like CUP, TNMM, or Cost-Plus to justify pricing.
5. Conduct a Benchmarking Study – Compare transaction prices with market rates to prove they meet the arm’s length principle.
6. Prepare the Documentation – Structure the report according to local requirements.

Many businesses use transfer pricing software or work with tax professionals to streamline the process.

8. What Are the Consequences of Non-Compliance?

Failure to comply with Local File requirements can lead to:

• Transfer pricing adjustments – Resulting in higher taxable income.
• Financial penalties – Fines imposed for missing or incomplete documentation.
• Reputational damage – Increased scrutiny from tax authorities.
• Double taxation – If adjustments lead to increased tax payments in multiple countries.

By proactively maintaining a well-prepared Local File, companies can avoid costly disputes and demonstrate compliance.

In Summary

Understanding the Local File in transfer pricing is crucial for multinational companies navigating international tax regulations. By maintaining accurate documentation, businesses can ensure compliance, reduce risks, and strengthen their defense against tax audits.

If your company engages in cross-border intercompany transactions, staying up to date with local transfer pricing rules will help you avoid penalties and maintain good standing with tax authorities.