Transfer pricing is the setting of prices for goods and services sold or provided between susidiaries, affiliates, or controlled companies that are part of the same larger enterprise. An example of this is when a parent company sells goods or products to a subsidiary company, the cost of those goods or products paid by the subsidiary company to the parent is the transfer price. Transfer pricing also covers the intercompany sale or license of intellectual property (IP), as well as financing arrangements. Effective transfer pricing can lead to tax savings for companies. Tax authorities impose rules regarding transfer pricing to help prevent companies from using it to avoid taxes. In the U.S., the tax treatment of related party transactions is governed by the Internal Revenue Code (IRC) Section 482 and related regulatory sections.

There are several methods tax advisors use to calculate transfer pricing. Factors to be considered include, but are not limited to, the nature of the transaction, jurisdiction, the tax implications, and the industry. For instance, those operating in Fintech, cybersecurity, AdTech and digital media sectors increasingly face transfer pricing challenges concerning IP, sales and marketing, commercial relationships, and data. 

Historically, the approach to evaluating intercompany pricing has involved the application of the arm’s length principle, which states that the price charged in a transaction between related parties should be the same as the price charged in a comparable transaction between unrelated parties. To determine whether a transaction has been conducted consistent with the arm’s length standard, the U.S. transfer pricing regulations provide a number of different testing methodologies.

Typical transfer pricing methods include both transactional and profits-based methods. For example, in relation to the intercompany sale of tangible property, methods include:

• Comparable Uncontrolled Price Method: Compares the unit price charged for tangible property transferred in a controlled transaction to the unit price charged for the same (or very similar) tangible property transferred in a comparable uncontrolled transaction.

• Resale Price Method: Compares the gross profit margin realized by the distributor (in connection with the controlled transaction) to the gross margin realized by it or a similar distributor in a comparable uncontrolled transaction.

• Cost-Plus Method: Compares the gross profit markup in a controlled transaction to the gross profit markup realized in a similar uncontrolled transaction. Ordinarily, this method is appropriate in cases involving the manufacture or assembly of tangible goods that are sold to a related party.

• Comparable Profits Method/Transactional Net Margin Method: Compares the profitability of a controlled taxpayer or one of its business units to the profitability of comparable uncontrolled taxpayers.

• The Profit Split Method: Evaluates the allocation of the combined profit or loss attributable to one or more controlled transactions by reference to the relative value of each controlled taxpayer’s contribution. Two common profit split methods include: (1) the comparable profit split method and (2) the residual profit split method.

Although the arm’s length standard remains a core principle for transfer pricing arrangements, it has come under increasingly fraught review by tax and regulatory authorities seeking to ensure that low-tax jurisdictions are not capturing “too much” profit. This may particularly be the case for companies with significant digital operations or consumer sales. For example, recent work by the Organisation for Economic Co-operation and Development (OECD), under the purview of its Base Erosion and Profit Shifting (BEPS) initiative, may lead to substantial changes in taxing rights that could have a substantial effect on where profits are taxed and the overall level of taxes charged.

Determining the best method depends upon the company’s overall tax strategy and is highly situational. In short, strategy and methods will vary greatly depending on the company, the industry, the transaction, the availability of reliable data, and the business operations.

Echelon offers the experience and know-how to design transfer pricing solutions that fit the needs of your company, industry and overall business strategy. We are a specialty tax consulting firm with the network and resources to deliver highly efficient transfer pricing solutions. We are focused on providing the highest level of service and delivering exceptional results that are aligned with our clients’ overall business strategy, operations, and transactional needs.

As global trade increases and tax regulations evolve, multinational businesses of all sizes will increasingly create opportunities and confront challenges associated with transfer pricing, or arm’s length pricing between its internal business units. In short, transfer pricing solutions should reflect a holistic review that is customized to each business and should consider its needs for planning, compliance, and dispute resolution, to achieve optimal structures and benefits.

Multinational companies should be mindful to:

• Comply with Internal Revenue Code (IRC) Section 482 and the regulations thereunder, as well as rules and regulations in the other jurisdictions in which they operate.

• Calculate the correct transfer price relative to the associated jurisdictions.

• Document compliance contemporaneously with the filing of an income tax return.

• Equitably distribute profits across an affiliated enterprise.

For some multinational companies, transfer pricing strategy can be a significant component of an overall business strategy. Reviews uncover ways to:

• Create optimal business structures that maximize tax and operating benefits.

• Inform decisions concerning foreign investment opportunities.

• Adopt policies that avoid tax adjustments and/or penalties.

• Satisfy ASC-740 tax requirements for U.S. GAAP Financial Statements.

• Minimize tax burdens across business transactions, such as M&A and IPOs.

Each jurisdiction seeks what it defines as its fair share of the income tax on transactions. Effective planning and documentation are essential for minimizing a company’s exposure and can also highlight and cover transactions that are not currently remunerated.

Common tax triggers include U.S. Tax Reform – U.S.-based parent or significant operations, BEPS, IPOs, new M&A, high R&D expenditures or other cost inefficiencies, regulatory inquiries (e.g., antitrust issues, and/or issues with IP protection).

Section 482 of the Tax Code authorizes the IRS to adjust the income, deductions, credits, or allowances of commonly controlled taxpayers to prevent evasion of taxes or to clearly reflect their income. The regulations under section 482 generally provide that prices charged by one affiliate to another, in an intercompany transaction involving the transfer of goods, services, intangibles, or financing, yield results that are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same conditions.

Business continues to become increasingly global. Businesses continue to outsource labor, extend supplier relationships across borders, and cater to an increasingly global consumer. As a result, “inbound” and “outbound” transfer pricing is needed for:

• International structuring

• Structuring inbound U.S. investments

• Cross border transactions, including M&A and other strategic transactions.

• Tax treaty planning

• Earnings repatriation planning

• Supply chain planning

• Foreign tax credit maximization

• Tax deferral planning

• International tax compliance

• Transfer pricing studies and advisory

• Tax controversy / Audit defense

• ASC 740-10 (formerly FIN48) reviews

Multinational companies serving customers abroad face numerous international tax laws. These laws are continuously evolving. With the help of knowledgeable international tax advisors, companies can adopt an international tax strategy and policy that helps them to understand, comply with and benefit from the international tax laws that are specific to them. Often, strategy centers around tax treaty planning, cross-border expansion and international transactions, and repatriation and foreign tax credit planning.

Entering new international markets creates tax issues that can affect the value and optimal structure of corporate finance transactions including mergers, acquisitions, divestitures, capital raising, and joint ventures - as can expanding the physical or virtual geographic footprint of a business. Meeting tax filing and compliance obligations in the U.S. and around the world is ever-changing and nuanced.

No, transfer pricing applies to any cross-border operation or transaction that requires arm’s length pricing. These may include start up or established companies of every size, family businesses and HNW individuals, etc.