For those of you who are involved in the management of a multinational entity, you are most likely aware of the complex tax and legal obstacles and rules that you have to navigate in order to keep the entity running smoothly.
One of the most important challenges relates to transfer pricing – the amount charged for goods, services, capital, intangible property and/or risks transferred between related parties. If there is any common ownership between your business and another business that operates internationally, transfer pricing rules will dictate how to value those goods and services.
Common types of transactions/transfers include:
- Sales of goods
- Leases of equipment
- Providing back office, sales or administrative services
- Intercompany loans or being a loan guarantor
- IP license
- Cost-sharing agreements
Essentially, transfer pricing is involved any time funds are transferred between a U.S. parent and non-U.S. subsidiary, foreign parent and U.S. subsidiary, commonly controlled brother sister companies, and/or U.S. companies, if the entities do not file a consolidated federal income tax return.
The IRS uses an “arm’s-length” principle to determine reasonableness of transfer prices, meaning the amount charged by one related party to another for a given product must be the same as it would if the parties were not related. An arm’s-length price for a transaction should be what the price of that transaction would be on the open market. It is the taxpayer’s responsibility to determine the method that provides the most reliable measure of an arm’s-length result. If the taxpayer is unable to justify the method chosen – or why other methods were not considered – IRS penalties can be severe.
Methods the IRS recognizes include those mentioned under the Organization for Economic Cooperation and Development’s (OECD) Transfer Pricing Guidelines. The OECD is a global organization with 35 member countries whose mission is to promote policies that will improve the economic and social wellbeing of people around the world. OECD methods include Comparable Uncontrolled Price method (CUP), Resale Price method (RPM), Cost Plus method, Transactional Net Margin method, and Transactional Profit Split method.
The technical aspects related to these methods are too vast to be covered in this posting, but we are always glad to have a conversation with you if you would like to learn more. As tax advisors, we can recommend which method works best for your multinational entity and guide you in the right direction as far as what the next steps in documentation should be.