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Transfer Pricing Compliance Issues & Best Practices

What kinds of transfer pricing compliance issues should I be considering when establishing a cost plus intercompany service provider?


Justin Smith
Title: Sr. Director, Advisory Service
Company: High Street Partners
(Sr. Director, Advisory Service, High Street Partners) |

The first thing to take into consideration is the compliance requirement in the local country: are there annual transfer pricing documentation and filing requirements, and if so what do they entail? Secondly, even if documentation requirements are not mandatory, you need to weigh the cost of doing a full analysis of your transfer pricing with the potential exposure associated with not meeting the relevant jurisdictional requirements. Most countries have rules in place dictating that intercompany transfer pricing meet something along the lines of an “arm’s length standard”. In other words, intercompany transfer pricing must generally be representative of what two independent third parties would reach if they were dealing at arm’s length. Testing this standard would generally involve looking at market transactions, engaging in benchmarking exercises, and doing other economic analyses of the intercompany transactions. The time and effort spent analyzing the arm’s length nature of your transfer pricing should be commensurate with the potential exposure associated with an income tax adjustment, as well as any relevant penalties.

Topic Expert
Jake Feldman
Title: Managing Director
Company: Global TaxFin Advisory Group LLC
(Managing Director, Global TaxFin Advisory Group LLC) |

I fully endorse Justin's comments and want to elaborate on the range of approaches one can take with a corresponding risk/return tradeoff. In the US and most countries that follow similar OECD transfer pricing standards, the customary approach to protect against the imposition of penalties (20-40% in the US) plus interest on top of a potential transfer pricing tax adjustment is to prepare a full transfer pricing documentation study (aka penalty-protection study), as briefly described by Justin. Such a study would also help in any financial auditor's evaluation of your tax reserves under an ASC 740-10 (aka FIN 48) analysis.

At the other extreme, one could just use some rule of thumb as to the proper service cost markup and take your chances with both the tax authorities and your financial auditors. In between these two extremes, one could prepare only a benchmarking analysis of the proper markup rate to have a firmer idea regarding the arm's length range but this would not provide penalty protection that a full study does.

Additional intricacies that come into consideration are that shareholder or management stewardship costs are not charged. If part of the service provider's costs include third party legal fees, for example, should these pass-through costs be re-charged with or without a markup? Finally, under certain conditions, it may be feasible to charge without a markup, though this is not necessarily beneficial.

In conclusion, advisors like Justin and myself are naturally happy to assist you with fleshing out the approach best suited to your circumstances.


Robert Gerughty
Title: Owner/Senior Consultant
Company: Interim Finance Services
LinkedIn Profile
(Owner/Senior Consultant, Interim Finance Services) |

I mostly agree with both the gentleman's comments before mine, but would like to add that you need to support the transfer pricing agreement to both countries taxing agencies. The IRS has specific guidelines on transfer pricing that were discussed by Jake above.

Determining an arms length transfer price generally starts in the country performing the services. For example, India performs transfer price services for many U.S. corporations. if your company is performing R&D services, those previous transactions can be deemed "comparable" for the pricing of future R&D service contracts, depending on the specifics of each contract. Even if they aren't 100% comparable, they can be a starting point to which adjustments can be made. There is also court law in India regarding transfer pricing. Don't stray too far from past guidelines without adequate support, or the risk of tax adjustment increases. Transfer pricing is very tricky; get some help if you don't have some previous experience with it.

John Herndon
Title: Senior Director of Revenue Recognition.
Company: WideOrbit
(Senior Director of Revenue Recognition., WideOrbit) |

In technical terms (i.e., IRC 482 and OECD guidelines), transfer pricing is defined as "...a comparable transaction conducted between two unrelated parties in an uncontrolled environment." In practical terms, the 'transfer price' is the price charged between a parent and a subsidiary for the subsidiary's involvement in getting the product or service to market.

The 'transfer price' charged between the two parties is substantiated by the transfer pricing agreement, each entity must have its own agreement as there is no 'one size fits all' for all the circumstances in the parent/subsidiary environment.

Transfer pricing is important when the economic conditions of the parent and subsidiary do not match the individual risk profiles of the parent and subsidiary. In other words, when a match is needed comparing the tax impact of the transaction to the risk distribution of each entity.

There are many drivers to creating a TP agreement:
1. Type of services performed by the subsidiary.
2. Legal entity risk distribution
3. Comparable transactions in an uncontrolled environment between two unrelated parties (i.e., related parties arms length transaction)
4. Stage of the contemporaneous documentation in parent and subsidiary.

Creating transfer pricing agreements is not an easy task and it depends on both the country in question and their system of law. For example, in the US we are governed by Common Law whereas on parts of Europe they are governed by Civil Codes of Justice. The point is, certain TP agreements and the underlying methodology applied are acceptable for one code of law but not another.

Points to consider:
1. Nature of the cost plus agreement? Is this an tangible product or service being exchanged between the related entities?
2. Existence of contemporaneous documentation? What documentation exists to describes the relationship between the two entities?
3. Location of the parent and related entity.
4. Will the I/CO AR and AP be settled?
5. Extent and type of currency restrictions in the respective countries.
6. Risk analysis of each entity involved in the transaction.
7. Extent of regulatory enforcement in each jurisdiction.

....there are simply too many points to consider. A direct discussion is needed...


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