A Primer on Transfer Pricing Agreements

How can my business avoid a transfer pricing dispute with tax authorities?

Foreign transactions continue to see enhanced scrutiny by the Internal Revenue Service, as evidenced by the ongoing transfer pricing disputes with a number of large, high profile corporations. Transfer pricing refers to the amount that is charged for goods and services in transactions between related entities such as parent companies and subsidiaries. In short, IRS regulations require these businesses to identify the value that is created in the transfer. Also, the price must meet the “arm’s length standard” that is, a price that would have been reached between unrelated entities.

Transfer Pricing Essentials

Given the tax implications of these transactions, and the increased likelihood of litigation being brought by the government, it is crucial to put in place well designed transfer pricing agreements that will pass muster with IRS.

First, these agreements need to be supported by thorough documentation that is compiled by those who have the knowledge of the company’s business and an understanding of the goods and/or services being transferred. This documentation should include a description of the parties, the nature of the transaction, and the role of each party in the deal. It is also necessary to show that the fundamentals of the deal (prices, royalty rates, license terms and interest rates), are in line with comparable transactions in the industry.

Further, in cross border transactions, transfer pricing arrangements must not only meet IRS standards, but the tax authorities in countries in which the transaction occurs as well. Accordingly, it is essential to prepare separate documentation that demonstrates the economics of the transaction meet the arm’s length standard in that jurisdiction.

Lastly, it is important to select an appropriate pricing method for allocating income and profits between entities domiciled in the United States and foreign affiliates. Depending on the size of the organization, tax treatment of intercompany transactions can be determined in an advance pricing agreement with the IRS. While this approach works for large multinationals, it may be too expensive for small and mid-level businesses.

The Takeaway

In the final analysis, any business involved in intra-company cross border transactions needs to be proactive in working with tax authorities. At the same time, it is crucial to put in place transfer pricing agreements that demonstrate the deal meets the arm’s length standard. By engaging the services on an experienced international tax attorney, you can mitigate the potential for litigation at home and abroad.

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