Transfer pricing compliance applies to all U.S. companies having either a foreign subsidiary or a foreign parent company. IRS transfer pricing rules require that intercompany pricing between a U.S. company and a foreign affiliate must be based on an “arm’s length” price that would be charged in a similar transaction with an unrelated third party. U.S. transfer pricing is enforced under the authority of IRC Section 482, which allows the IRS to reallocate gross income, deductions or credits between two or more organizations and, under Section 6662, impose substantial penalties (as much as 40% of the deemed tax underpayment) for failed transfer pricing compliance.
Qualifications of Transfer Pricing
- Mechanism for allocating a multinational’s profits between its affiliates
- Transfer price must be computed in order satisfy various financial reporting, tax and even regulatory requirements
- Will not affect the combined income of a controlled group of entities, but will impact how the income is allocated among members
- Domestic and international applicability
Why does it matter?
- Prevents an entity from artificially allocating its worldwide profits to lower taxed jurisdictions
- Impacts the group’s overall effective tax rate
- Was a “Tier 1” issue (assume still subject to great scrutiny)
- An income-generating tool for tax authorities
- Gaining mainstream attention
Transfer Pricing Methods
Basic principles of § 482:
- Arm’s length or market value standard.
- Must select and apply the method that provides the most reliable result (Best Method).
- Reliability is determined by the degree of comparability between controlled and uncontrolled transactions.
- Quantify the data (range).
Loans and Advances
- Must charge an arm’s length rate of interest.
- Exception – intercompany trade receivables:
- Arise in ordinary course of business
- Not evidenced by written agreement
- Arm’s length rate – consider relevant factors:
- Safe harbor – 100%-130% of AFR
Performance of Services
- Arm’s length fee must be charged where one party performs services for a related party.
- Separate charge not required for ancillary services to a controlled transfer of tangible or intangible property.
- Charge not required for services performed by a parent company for a subsidiary if the service duplicates subsidiary services or is solely for the benefit of the parent (“stewardship”).
- What transcends stewardship?
Our team can also review the following:
- Use of Tangible Property
- Transfer of Tangible Property
- Information Reporting Requirements
- Safe Harbor
- Practical Needs
Get in touch to learn more!