Busting the Myths of Transfer Pricing
There are many myths when it comes to a transfer pricing study, namely that they are massively complex, extremely expensive, only for the largest multinational corporations, or purely performed for compliance purposes.
Instead of avoiding a study because of these myths and taking on the risk of tax penalties, businesses should understand what a transfer pricing study is, and when and why a study is necessary. According to IRS guidelines, intercompany pricing between a U.S. company and a foreign affiliate must be based on an “arm’s length” price similar to what would be charged in a transaction with an unrelated third party. To support the arm’s length nature of the transaction, a company must provide contemporaneous documentation to substantiate its transfer pricing methodology in the form of a transfer pricing study. Put simply, if a business is engaging in international transactions and filing forms 5471 or 5472, a transfer pricing study that benchmarks comparable third-party transactions must be in place on the date tax returns are filed.
Some businesses view this study as pure compliance, a box to tick in their global business transactions, and almost a punitive action given the aforementioned myths surrounding a study. These pervasive myths that a study is scary, complex, and expensive have certainly been promulgated by some tax advisory firms. Studies with a large firm can range anywhere from $50-$60k and come in the form of a 100-page report filled with complex charts and gratuitous pontification on macro-economic theory. This leads many businesses to hesitate about completing studies despite the risk of penalties, as they simply cannot find a cost-effective or straightforward solution that satisfies the regulations.
Let’s consider the core needs of a transfer pricing study. When you peel back the studies from a large firm, there are typically 4-5 pages of actual substance. The reality is that transfer pricing is one of the rare areas of the Internal Revenue Code where the IRS gives a clear roadmap and table of contents for what it must entail, and as long as those criteria are met, the study is compliant. This can typically be done in 20 pages or less and meet every requirement under the regulations.
What if transfer pricing studies were not completed in a vacuum, and we viewed them not as an obligation, but as an opportunity? Viewing a study as purely a compliance obligation is short-sighted. Of course, the study is going to tick a box, but it can also be an excellent opportunity for efficient planning. Efficient planning begins with understanding commercial business objectives – what does the company want to accomplish on a global scale? Where is the company seeing growth? Contraction? What drafted agreements need to be in place for intercompany transactions to achieve these goals?
Planning from a commercial standpoint offers an opportunity to scrub intercompany cash flow, establish treasury management, lower the overall effective tax rate for the global organization, and tailor a transfer pricing posture to meet the company’s commercial needs. When it comes time to do a transfer pricing study to support the form filings, contrary to the myths, it is straightforward and easy to accomplish.
Sean King is a renowned legal, tax and business advisor who brings to his clients not only technical expertise, but also a cultural and commercial awareness that can only be gained by living and working in numerous countries and on multiple continents.
In addition to leadership responsibilities, Sean’s leadership of the firm’s globally recognized practice focuses on international corporate structuring for both the outbound operations of U.S. multinationals and the inbound operations of foreign multinationals.