Transfer Pricing Studies | Analysis
Transfer pricing involves the terms and prices at which related parties sell (or should sell) goods or services to each other. When the parties are located in different taxing jurisdictions, opportunities exist for the movement of income to a lower-taxing jurisdiction. To combat potential losses of income tax revenue, more than 40 countries have adopted transfer pricing rules and requirements. Some countries require the completion of transfer pricing documentation to support the taxpayer’s reporting position by comparing a company’s results to comparably situated unrelated parties. Such an analysis can help a company comply with the documentation requirements and enhance its tax planning. Whether transfer pricing documentation is needed or not, this analysis can uncover possible tax savings or justify price adjustments that may be planned for business reasons.
What is a Transfer Pricing Study?
Transfer pricing studies are typically conducted by experienced accountants and economists with considerable background and experience in international tax matters. A transfer pricing study examines the pricing of controlled transactions between related parties. By applying and documenting various testing methods, it attempts to determine whether the transactions were conducted at arm’s length and will survive scrutiny from the IRS and other tax authorities.
IRS regulations specify that the “best method” be adopted — that is, the testing method that provides the most reliable measure of an arm’s-length result under the facts and circumstances of the controlled transaction under review. A transfer pricing study will justify how a particular method is selected for the companies and transactions being reviewed. The usual motivation for conducting a transfer pricing study is to ensure that related companies comply with IRS regulations regarding transactions between the two. However, a study can also uncover opportunities for future tax planning that can potentially reduce costs and improve operations.
Optimizing Your Transfer Pricing Arrangement
Who pays the tax, and where, on international business transactions can mean millions of dollars to countries and businesses. With more than half the world’s trade occurring within multinational enterprises, and global trade continuing to rise, companies and governments are increasingly focused on transfer pricing. By taking control of the sometimes complicated transfer pricing process, midsized businesses can save thousands of dollars in taxes and better manage the risk of running afoul of tax authorities. The key, say tax professionals, is planning ahead, keeping abreast of changing regulations in the countries where you sell and working with foreign and U.S. tax officials in advance to help ensure that your company is in compliance.
Although transfer pricing laws have been in effect in the United States since the 1930s, they were loosely enforced until the late 1970s, when global trade began to make up a larger share of the country’s gross domestic product. And until recently, some countries such as China and Germany either did not have or did not enforce transfer pricing regulations. But whether a country is rich or poor, an emerging player in the international economy or an established trading force, its government will not want its tax base to suffer because of questionable transfer pricing practices.
How Transfer Pricing Arrangements Work?
Because so much more is now at stake, virtually all countries now have and enforce transfer pricing laws. The basic rule of thumb is that transfer pricing of inter-company transactions should be at “arm’s length,” or within a range that would be charged if the companies were independent of each other. But how you establish that arm’s length relationship can have a huge effect on your tax bill — particularly if the tax burden in one country is significantly less than the burden in another.
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