Cross-border transactions between related parties have become one of the more controversial issues in international taxation. That’s why an understanding of transfer pricing and the related compliance requirements is essential for all sizes of multinational companies.

This article from the international tax team at PBMares explores the following topics:

  • What Is Transfer Pricing?
  • Why Is Transfer Pricing Important?
  • Audits are on the rise
  • Benefits of a Transfer Pricing Study

What Is Transfer Pricing?

Transfer pricing involves determining arm’s length pricing for related-party transactions and often involves cross-border transactions.

The pricing of activities with foreign affiliates can shifts profits between countries. Each country wants its fair share of the tax base. Meanwhile companies prefer to move profits into lower taxed locations.

Transfer pricing is more of an art than a science, which makes it complex. Transfer pricing rules are addressed by the US in the Internal Revenue Code (IRC) section 482 and in much of the rest of the world through the adoption of Organization for Economic Co-operation and Development (OECD) transfer pricing guidelines.

The two are quite similar. The IRC 482 and OECD guidelines both aim to ensure that transactions between related parties are at “arm’s length” and consistent with transactions between independent parties.

Why Is Transfer Pricing Important?

Transfer pricing is important because mistakes — even if unintentional — can result in missed opportunities or expensive audits.

Transfer Pricing Audits Are on the Rise

Large multinationals have always been scrutinized and at risk for transfer pricing audits. But in 2023, the IRS reported that it would increase its focus on transfer pricing after noticing that “foreign companies report losses or exceedingly low margins year after year through the improper pricing to avoid reporting an appropriate amount of US profits.”

The IRS plans to recruit and train specialized staff and enhance data analytics. With this increased focus, small and middle-market multinationals that engage in intercompany arrangements will now also be on the radar.

Even companies with the best intentions can improperly apply transfer pricing and shift taxable income outside the US to low tax jurisdictions. Therefore, it’s wise to ensure compliance by collaborating with an international tax team that is well-versed in transfer pricing.

Benefits of a Transfer Pricing Study

A transfer pricing study is an economic analysis by credentialed experts which identifies a range for reasonable pricing. The report provides the documentation for pricing decisions to support challenges by the US or foreign tax authorities.

Obtaining a transfer pricing study can be beneficial for many reasons:

  • A well-documented transfer pricing report will reduce expense and disruption in case of an IRS audit.
  • Inevitably there is a range of fair prices that can be justified. With professional advice, you can confidently invoice toward the end of range that will reduce your overall global tax.
  • While pricing certain costs like labor can be relatively easy to quantify, pricing for royalties and other intangibles can be quite complex. With more confidence in price ranges, there are more planning opportunities for structure changes to meet compliance requirements and minimize global tax.
  • Tech advancements – AI and data analytics – are transforming the ways you can justify transfer pricing decisions.  Professionals armed with these tools will add value and clarity to transfer pricing strategies.
  • When selling a company, the buyer will look at historical tax compliance in general. When the related party pricing is not well documented, the buyer may leverage this weakness in negotiations.

Learn More About Transfer Pricing Compliance

In today’s global landscape, all shapes and sizes of companies engage in cross-border activities with affiliates. Balancing regulatory compliance and ethical responsibility with strategies to minimize global taxes is challenging.

Find out how PBMares can assist with these challenges. Contact us today.