You’re growing your business internationally. That’s a massive win! But with every cross-border transaction, every sale to a foreign subsidiary, every shared service, every royalty payment… you’re generating a magnet for tax audits.
Why? Because tax authorities around the world demand proof that your internal prices are “arm’s length” (as if you were dealing with a completely independent third party). This proof is primarily contained in essential documents known as the Master File and Local File.
If you’re still thinking, “That’s only for the multinationals,” you could be unknowingly setting yourself up for an expensive surprise. We’ll break down one of the most crucial elements of this necessary documentation: Local File.
Author: Ernst, transfer pricing advisor
1. What is a Local File?
Think of the Local File as the nitty-gritty, country-specific evidence for all the international transactions that occurred within a single tax jurisdiction (e.g., the Netherlands, Germany, or the US).
While the Master File provides the broad, global context of your entire international group, the Local File zooms in to prove that the transactions recorded in that specific country comply with the arm’s length principle.
It’s your proof book for the local tax inspector, demonstrating why your company in that country earned the profit it did.
2. When do you need a Local File?
The need for a Local File is primarily driven by local regulations and thresholds based on revenue or transaction volume.
However, from a risk perspective (our “Audit Magnet” concern) the rule is simple: If your company is engaged in cross-border transactions with affiliated group entities, you need to consider preparing one.
The specific legal requirements often kick in when:
- You exceed certain annual revenue or asset thresholds in that country (these differ per country, but often target SME+ and Large SME).
- The total value of your transactions with foreign group companies exceeds a defined local limit.
If you have foreign entities, invoicing is happening, and you meet local requirements, the Local File is not optional; it’s your primary defense against costly tax adjustments and double taxation.
3. What needs to be included?
The Local File is all about the details of the specific transactions that took place in a country. To make your life easier and your documentation watertight, it typically includes three key sections:
| Section | What to include | Why it matters (audit proof) |
| I. Local entity information | Management structure: Who makes the decisions locally? Business strategy: The specific local market, operations, and competition. | It demonstrates that the local entity is an active participant with a specific function, not just a shell company. |
| II. Specific intercompany transactions | Financial figures: Amounts of payments for goods, services, and intangibles. Written agreements: The actual contracts and invoices. | It proves that the transactions are documented and accurately reflected in the accounts. |
| III. Financial information and benchmarking | Comparability analysis: How the transaction prices compare to prices charged between independent parties (the core of the arm’s length principle). | This is the most crucial defense. It legally justifies the pricing used and proves the local profit is fair. |
4. Relationship between Master File and Local File
The Master File and Local File are two sides of the same fiscal coin; one cannot be truly effective without the other.
- The Master File (global story): Provides a high-level overview of the entire international group: the business model, the supply chain, the overall strategy, and where the IP and financing are located. It’s consistent for all countries.
- The Local File (local proof): Uses the context from the Master File to provide specific financial data and the local benchmarking study (comparability analysis) that proves the prices in that specific country are correct.
Together, they create a cohesive, defensible narrative that the tax inspector can follow: a clear story of your global business that is backed up by hard, local data.
5. Important points for preparing your Local File
The biggest mistake is waiting until an audit begins. Here’s what you need to know to move from unaware to proactively protected:
- Don’t use generic templates: Your business is unique. Your Local File must be based on a tailored functional analysis that accurately describes the specific functions, assets, and risks of the local entity.
- Focus on the narrative: A good Local File tells a story. It should clearly and logically explain why the local company is paid what it is paid. A simple invoice isn’t enough; the surrounding business justification is what matters.
- Benchmark is key: The comparability analysis (or benchmarking study) that proves your prices are arm’s length is the most complex part. It requires access to specialized financial databases and expert interpretation—this is where generalized advice falls short.
- Keep it current (“contemporous”): Your business evolves, and so should your documentation. The Local File should be prepared annually to reflect any new strategies, transactions, or economic changes.
Take control of your international growth
The Local File is your shield against the “audit magnet” of international business. By understanding it and ensuring its accuracy, you transform a hidden risk into a strategic asset.
Are you ready to stop worrying about tax surprises and focus on your international ambitions?
We provide the strategic insight and in-depth expertise to transform your complex international situation into a clear, concise, and audit-proof narrative.
Don’t wait for the tax authorities to knock on your door.
Contact us today for an initial, confidential assessment of your transfer pricing risk, and let’s turn your international compliance into a strategic advantage.