Transfer Pricing: A Guide for International Businesses

If you currently do business internationally or are considering it, a basic knowledge of transfer pricing is vital. This key accounting practice impacts various activities — from the day-to-day tasks associated with operating internationally to the higher-value matters like sales and research.

Here’s what you need to know about transfer pricing and how it can affect your business.

Transfer Pricing Defined

Transfer pricing refers to the pricing of transactions between related entities within a controlled group — for example, two distinct companies that operate in different countries but are controlled by a single parent corporation.

These transactions can include:

• Tangible property: Products, inventory, capital assets, or other physical goods
• Intangible property: Technology, processes, know-how, trademarks, intellectual property, patents, or customer lists
• Services: Administrative, back-office, research and development (R&D), marketing, managerial, and other services
• Financing: Loans, guarantees, or other financial arrangements

At its core, transfer pricing determines how a company’s operating profit (or loss) is distributed across these transactions. An important principle in transfer pricing is ensuring that each related entity’s share of profits is “fair,” based on the functions performed, risks taken, and assets utilized.

Achieving fairness often requires a detailed functional analysis to answer questions such as:

Why is Transfer Pricing Important?

Tax rates and rules vary by country, which may lead to friction between multinational firms and tax authorities across jurisdictions. The goal of transfer pricing is to proactively address tax confusion for companies doing business internationally. It can help reduce the compliance risk and potentially minimize the net effective global tax burden of companies.

Tax Implications:

• Different tax jurisdictions have varying tax rates and regulations
• Multinational companies strive to minimize their global tax burden while complying with the tax laws of each jurisdiction

Compliance:

• Incorrect or poorly documented transfer pricing can lead to disputes with tax authorities
• Non-compliance may result in costly penalties, interest, and audits
• Transfer pricing is by nature multi-jurisdictional, meaning that the same transaction must be examined from each jurisdiction’s perspective

Profitability and Cash Management:

• Transfer pricing significantly impacts a company's overall profitability and cash flow
• Transfer pricing can help fund newly established entities and/or those that do not earn third-party revenue

Key Considerations in Transfer Pricing

By reducing overall tax payments and ensuring compliance with international regulations, proper transfer pricing can help businesses optimize performance, avoid penalties, and prosper into the future.

To ensure that your transfer pricing practice is effective and legal, consider the following:

• The Arm’s Length Standard: This principle requires that the prices charged between related organizations be similar to those that would be charged between unrelated parties under similar circumstances. This is to ensure fairness and prevent tax evasion.
• Functional and Value Chain Analysis: A thorough analysis is crucial to determine the functions performed, risks assumed, and assets utilized by each entity within the controlled group.
• Documentation: Robust documentation is essential to support transfer pricing decisions and demonstrate compliance with tax regulations.

Transfer pricing requires significant documentation. Trained transfer pricing specialists can help you with these documentation requirements as well as a transfer pricing analysis.

Recent Developments in Global Transfer Pricing

• Global Tax and Trade Disputes: National tax jurisdictions increasingly view transfer pricing audits as a means to increase their corporate tax collections. Meanwhile, the imposition of tariffs and other trade-related duties can significantly affect intra-group pricing and profitability.
• OECD’s Inclusive Framework on Base Erosion and Profit Shifting (BEPS): Pillars One and Two of this initiative may change how multinational enterprises allocate taxation rights across jurisdictions, and the rate of tax they pay on profits allocated to those jurisdictions.
• Domestic Legislation: The United States has introduced (and may soon elaborate on) rules designed to penalize excessive offshore profits, incentivize domestic production and profits, and enhance reporting requirements relating to intra-group transactions.

Next Steps for Your Business

Transfer pricing is a complex but essential aspect of international business. To ensure compliance and optimize your tax strategy, take the following steps:

• Conduct a Transfer Pricing Analysis: Evaluate your current transfer pricing policies and identify potential areas for optimization.
• Stay Informed on Global Regulations: Keep up to date with evolving international tax laws and transfer pricing guidelines, including the OECD’s Base Erosion and Profit Shifting (BEPS) framework.
• Implement Comprehensive Documentation: Ensure your transfer pricing policies are well-documented, globally consistent, and supported by functional analyses and benchmarking studies.
• Seek Expert Guidance: Engage with experienced international tax professionals to navigate the complexities of transfer pricing and ensure compliance.