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In an increasingly global business environment, the IRS and other revenue-starved tax authorities have renewed their focus on transfer pricing. Transfer pricing issues are most common among large, multinational corporations. But they can arise in public companies of all sizes and can even apply to domestic companies that do business in several states. The international tax accountants at Doeren Mayhew offer three keys for getting your transfer pricing house in order.
Transfer pricing refers to pricing arrangements for transfers of goods, services and intangibles between related companies in different jurisdictions. Cross-border pricing arrangements between related companies — such as parent and subsidiary — are somewhat subjective. As such, they can be easily manipulated to reduce a company’s tax liability by shifting income to jurisdictions with lower tax rates.
Transfer pricing rules are designed to deter this sort of manipulation by requiring the terms of intercompany transactions to be similar to “arm’s-length” transactions between unrelated parties. Some countries, including the United States, require companies to prepare documentation to support their transfer prices.
The penalty for noncompliance is stiff: as high as 40 percent of the underpaid tax in the United States. The rules apply to most transactions involving both tangible and intangible property.
To ensure transfer price rule compliance, you should:
There are several acceptable methods for setting transfer prices, and your company must select the “best” method in light of your particular circumstances.
One common approach, the service cost method, is essentially a safe harbor that allows you to charge for covered services at cost if you meet certain requirements. Also common is the comparable profits method, which determines an arm’s-length price by analyzing the profitability of comparable transactions involving similar companies. Several other methods also may be used, so long as they’re appropriate to your company’s circumstances.
An audit adjustment can result in a substantial assessment of back taxes, interest and penalties — so it pays to take steps to protect your company.
The first step is to conduct a risk assessment. The extent of your investment in transfer pricing compliance depends on your company’s risk profile.
Second, review your transfer pricing policies, procedures and methods. Ensure that they’re appropriate given the nature of your company and its activities, and that they reflect the best methods for determining arm’s-length prices.
Third, consider preparing a transfer pricing study to document your methodology and support your position in the event of a challenge. Even in jurisdictions that don’t require it, documentation is advisable. It may help you negotiate an advance pricing agreement with the IRS, agreeing on transfer pricing methods for a specified time period. Also, preparing contemporaneous documentation allows you to respond quickly and decisively to inquiries from tax authorities.
Finally, making a good-faith effort to document your pricing before you file your tax return can reduce or even eliminate penalties in the event the IRS comes to a different conclusion and makes an audit adjustment.
A transfer study’s benefits extend beyond regulatory compliance. For example, it can help ensure that you’re using the most reliable methods and reveal new tax-planning opportunities and cost-reduction strategies.
If you do business with related companies in other countries or in other states, take a close look at your transfer pricing policies and practices. Documenting your transfer prices upfront requires some work, but this investment is likely to pay off in the form of planning opportunities, fewer tax surprises and smoother interaction with tax authorities.
For assistance getting your transfer pricing in order, contact Doeren Mayhew’s international tax accountants in Michigan, Houston or Ft. Lauderdale.
This publication is distributed for informational purposes only, with the understanding that Doeren Mayhew is not rendering legal, accounting, or other professional opinions on specific facts for matters, and, accordingly, assumes no liability whatsoever in connection with its use. Should the reader have any questions regarding any of the news articles, it is recommended that a Doeren Mayhew representative be contacted.
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