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.

Take the case of the subsidiary located in country A that pays 20 percent tax on $100 worth of goods, which it repackages and exports to the parent company, located in country B, at a selling price of $200. The parent company sells the goods for $300. Both entities have a $100 profit. But the tax rate in country A is 20 percent, and the tax rate is 60 percent in country B, or $60 on a $100 profit. After taxes, the multinational company's overall profit is $120. (See Case 1 in Chart below)

But if the subsidiary sells the goods for $280, and the parent sells them for $300, the multinational's profit increases because more of the pre-tax profits are shifted to the subsidiary in country A, where the tax rate is lower. The subsidiary now makes $180 profit, with 20 percent of that paid in tax. But the parent company earns just $20 on the transaction. With the tax rate of 60 percent in country B, it pays just $12 in tax. The overall after-tax profit rises from $120 to $152. (See Case 2 in Chart Below)

This chart summarizes how after-tax profits result under these transfer pricing scenarios.

	Case 1		Price of Goods		Transfer Price		Selling Price
			$100		$200		$300
			Subsidiary Company				Parent Company
	Pre-tax profit		$100		$100		$200
	Tax rate		20%		60%
	Tax paid		$20		$60		$80
	After-tax profit		$80		$40		$120
	Case 2		Price of Goods		Transfer Price		Selling Price
			$100		$280		$300
			Subsidiary Company				Parent Company
	Pre-tax profit		$180		$20		$200
	Tax rate		20%		60%
	Tax paid		$36		$12		$48
	After-tax profit		$144		$8		$152

In theory that's how a beneficial transfer pricing arrangement works. Here's how it would work in the real world. Take the case of a company that produces and exports blue jeans. Tax professionals would likely determine whether a transfer pricing arrangement is at arm's length by using one of the methodologies prescribed by the IRS such as the comparable profits method (CPM), which examines publicly traded companies that manufacture and export blue jeans or a similar product. Publicly traded companies are used as a yardstick because, unlike privately held companies, their financial data is readily available to the public.

If the profits from a multinational's related party fall within the profitability range of comparable companies, the multinational is deemed to be dealing at arm's length with its related party and in compliance.

But, by planning ahead, if you find that your transfer pricing falls outside the profitability range of comparable companies, you can make adjustments so your operation is in compliance. For example, pricing can be adjusted to ensure that the optimum amount of profit occurs in lower tax jurisdictions. Perhaps a handling charge would be appropriate to raise the cost in one jurisdiction. The time a vice president devotes to a project, for example, can be assessed in one jurisdiction to reduce the profit that is taxable in another.

One area of transfer pricing that is receiving more attention is in assigning the value of intellectual property (IP). Tax professionals say it's critical to first identify a company's intellectual property — even something as basic as managerial know-how. Not only does this help a company understand the importance of its IP, but can also help it identify what leads to the creation of its IP.

And by determining where and what intellectual property is being created, tax professionals can use this information to maximize your company's tax savings when planning a transfer pricing approach. Tax professionals recommend that you take the following steps when preparing a successful transfer pricing strategy:

• Plan ahead. By incorporating transfer pricing into your planning process, you can help structure your operations to ensure that they remain in compliance with applicable laws and that you maximize your possible tax savings. Do not view transfer pricing requirements as simply another compliance issue, but as a valuable planning tool.
  
• Prepare a transfer pricing report. A transfer pricing report provides a corporate overview and explains the rationale for how you calculated the arm's-length pricing of your inter-company transactions. This document can help you if your company is audited.
  
• Consider an advance pricing agreement (APA). An APA is an agreement between your company and the IRS that is designed to reduce your risk of an audit. The agreement between the taxpayer and the IRS comprises the parameters of prospective inter-company transactions and the transfer pricing methodology that is appropriate in determining the pricing of such transactions. Once the agreement has been reached — and provided its terms are met — the taxpayer is protected from transfer pricing adjustments during the term of the agreement. On behalf of your company, a tax professional can contact the IRS and outline facts and details anonymously before proceeding with an APA.

By following these basic steps, you can make the most of transfer pricing arrangements — transforming them into money-saving opportunities instead of a compliance issue.

How Freed Maxick & Battaglia, CPAs can help.

Freed Maxick & Battaglia's experienced international tax professionals can help ensure your company has the necessary documentation to withstand inquiries from the IRS and tax authorities throughout the world. Because we are a Top 100 public accounting firm in the U.S. and the largest in Western New York, we have the expertise and resources of a dedicated International Tax Group to ensure your company fully complies with the requirements necessary to avoid penalties, while minimizing your total tax on a global basis.

Our international tax team works with companies nationwide to provide consulting, analyze comparable company data, perform functional analysis, and prepare comprehensive transfer pricing studies. Our approach looks at each company’s particular situation and emphasizes the documentation process, risk assessment and planning opportunities — not just regulatory compliance. At Freed Maxick & Battaglia, CPAs, we believe that transfer pricing can be a tool that helps you minimize your global tax liabilities, maximize business opportunities and, where appropriate, identify your optimal tax structure.

Our Four-Step Transfer Pricing Process

Freed Maxick utilizes a four-step transfer pricing review process. Our four-step process delivers three vital benefits: peace of mind, proof of compliance and an assessment of strategic potential.

The results of our four-step review can provide you with:

• Minimized risk of double taxation
• Reduction of worldwide effective tax rate
• Enhanced shareholder value
• Support documentation

During our transfer pricing review, we will evaluate the tax structure of the entire group to ensure that the most tax-efficient model is being pursued. We aim at identifying opportunities to reduce your global tax liabilities.

1. Understand your business.
   We perform an in-depth assessment of related-parties and related-party transactions in order to define the products and/or services transferred. We analyze how each product-service was developed, the parties involved, their business characterization, the functions performed and the risks assumed by each party.
   
   
2. Identify best transfer pricing method.
   Not all transfer pricing methodologies work for all companies. Based on our understanding of your business model we select the most appropriate method for your company’s related party transactions to test their arm’s length nature.
   
   
3. Determine arm’s length pricing ranges.
   Using the transfer pricing method identifi ed as most suitable for your company we determine the arms length price ranges. We test the company’s current position within such price ranges and make recommendations on any necessary modifi cations. During this exercise we take full account of your business objectives.
   
   
4. Document results.
   Once the arm’s length pricing range has been quantifi ed and the company’s position is tested within this range, we prepare a report in order to document the review process undertaken and the conclusions reached.

The final report will:

• confirm the propriety of your company’s transfer pricing methodology
• Deliver required documentation
• Minimize the risk of double taxation and tax audit adjustments
• Identify new opportunities and recommend new solutions for global tax minimization

Following a proven four-step process, we thoroughly analyze, evaluate and document your methodology for determining the pricing for the products, services and intangibles (trademarks, patents and copyrights) transferred between related companies.

Download our Transfer Pricing Overview "White Paper"

• Transfer Pricing - Used as an International Tax Strategy 

Related International Tax Links:

International Tax Services

• IC-DISC
• Canadian Services
• Expatriate Tax Planning
• International Tax Structuring
• International Tax Compliance

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Contact Our International Tax Management Team:

Freed Maxick & Battaglia, CPAs provides Transfer Pricing services to companies nationwide. No matter where your company is located, Freed Maxick can assist with your international tax needs. Freed Maxick is a Top 100 public accounting firm in the U.S. and the largest in Western & Upstate New York (NY). Each member of Freed Maxick’s International Tax Group and has extensive experience (including Big Four experience) working with U.S. based companies doing business abroad as well as foreign-owned companies doing business in the U.S. The group provides tax and consulting services to privately held and public (SEC) companies. Affiliated with RSM McGladrey, the 5th largest accounting firm in the U.S., Freed Maxick has vast national and international resources to help your business expand nationally and internationally. Additionally, through the international network of RSM McGladrey (RSM International) we have immediate access to one of the highest levels of international tax expertise in the world.

Contact us Via the Web or Toll Free: 1-800-777-4885

Howard Epstein, CPA	Mark Stebbins, CPA	Sally Wisnoski, CPA	Bill Iannarelli, CPA	Jeff Zawada, CPA
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