A transfer price is the price paid in transactions between related parties. In recent years, several commentators have equated transfer pricing with tax evasion.[1] While there have been cases of abusive transfer pricing, transfer pricing is in fact a requirement for any multi-national enterprise (MNE) with cross-border intercompany transactions. In fact, even if no intercompany transfer pricing agreement exists, the IRS may impute such an agreement.
While each country has its own unique transfer pricing requirements, the general principle is that transactions must occur at prices consistent with that which would have been charged if the transactions occurred at arm’s length (between two unrelated entities). This “arm’s length standard” is defined in Organization for Economic Cooperation and Development (OECD)’s Transfer Pricing Guidelines and has been adopted by the OECD member countries.
The consequences of mispricing intercompany transfers can be devastating. Under IRC §482, the IRS is authorized to adjust the results of certain related-party transactions to reflect the income of the parties in accordance with the arm’s length standard and, in the case of intangible property,[2] to be commensurate with the income attributable to the intangible property. In addition to increasing the amount of tax owed through IRC §482, the IRS can impose penalties as high as 40% of the amount of underpayment and charge interest on the tax deficiency under IRC §6662. Additional consequences of poor transfer pricing can include:
- Double taxation;
- Worldwide tax burden uncertainty, resulting in potential earnings restatements and investor lawsuits;
- Expensive and time-consuming conflicts with regulatory authorities; and
- Damage to a company’s reputation or corporate brand if it is seen as a “bad citizen”.[3]
For these reasons, multi-national enterprises (MNEs) should take all practicable steps to ensure their transfer prices are consistent with the arm’s length standard. The best practice for doing so is to maintain contemporaneous annual transfer pricing documentation. The IRS requires that documentation be prepared contemporaneously with the pricing of the transactions in order to avoid penalties under IRC §6662; that is, the documentation cannot be completed ex-post in the event of an audit. Transfer pricing documentation can be used to (a) avoid penalties by demonstrating that the taxpayer had reasonable cause and acted in good faith with respect to the deemed underpayment and (b) defend the taxpayer’s transfer prices and convince the IRS that no adjustment is warranted in the first place.
Transfer pricing is such a significant source of tax uncertainty it must be considered in developing a tax provision in accordance with Accounting Standards Codification 740-10 (ASC 740-10, formerly FIN 48). In a transfer pricing context, the tax benefits are often considered equivalent to the lack of increased income recognition in a given country resulting from transfer pricing adjustments imposed by the local tax authorities.
In addition to being an international issue, transfer pricing can be an interstate issue. Several US states have enacted similar rules to IRC §482 for state transfer pricing and the Multistate Tax Commission is hiring outside transfer pricing economists to conduct audits.
Transfer pricing can involve tangible property, intangible property, services, or financing. The experts at Teknos are equipped to assist companies with:
- Cost sharing arrangements;
- Intercompany services cost allocation studies;
- Pricing of intercompany loans and guarantee fees;
- Transfer pricing documentation;
- Tax controversy and audit support;
- Intangible migration;
- Benchmarking and valuation; and
- Tested party analyses.
The experts at Teknos have experience working with both taxpayers and tax authorities to solve transfer pricing issues. We have been engaged by and maintain security clearances with the IRS and our experts have also provided transfer pricing assistance to the Canada Revenue Agency (CRA) and Australian Taxation Office (ATO).
[1] See, for example, https://www.forbes.com/2010/06/24/tax-finance-multinational-economics-opinions-columnists-lee-sheppard.html and http://abcnews.go.com/Business/companies-ge-lower-taxes/story?id=13258952
[2] As defined in IRC §936(h)(3)(B)
[3] See, for example, https://www.cnbc.com/id/100745246.