Transfer pricing involves the terms and prices at which related parties sell goods or services to each other. When the parties are located in different countries opportunities exist for the movement of income to a lower-taxing jurisdiction. Current U.S regulations as well as the increased efforts of the OECD with regard to preventing base erosion and profit shifting (BEPS) have heighted the need for transfer pricing documentation.
The Transfer Pricing requirements under US tax law include having contemporaneous documentation that contains a financial analysis, risk-functional analysis, as well as an economic analysis. With these three items companies can stay in compliance with the regulations, have comfort during audits, and utilize the analysis for tax planning opportunities. Failure to provide this documentation upon audit can result in potentially costly penalties (up to 40% on the underpayment of tax) and adjustments to your taxable income. It should be further noted that while there is a tax compliance requirement for transfer pricing documentation, it can also be a useful tax planning tool.
Optimizing Your Transfer Pricing Arrangement
Who pays the tax, and where, on international and domestic business transactions can mean millions of dollars to countries, states, and businesses. By taking control of the sometimes complicated transfer pricing process, mid-sized businesses can save thousands of dollars in taxes, better manage their global effective tax rate, and curb the risk of running afoul of tax authorities.
How Transfer Pricing Arrangements Work
With the implementation of the 2015 BEPS action items created by the OECD, virtually all countries now have and enforce transfer pricing laws and documentation requirements. 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.
Transfer Pricing and Tax Reform
On December 22, 2017, the federal Tax Cuts and Jobs Act (“Tax Act”) was signed into law creating one of the largest tax overhauls in history. Though there were no direct changes to the transfer pricing requirements, certain international provisions implemented through the Tax Act may create an impact on transfer pricing. These provision include, but are not limited by, Foreign Derived Intangible Income (FDII), Global Intangible Low-Taxed Income (GILTI), Base Erosion Anti-Abuse Tax (BEAT), and the definition of intangible property. It is important that companies review their existing transfer pricing policies or take these provisions into consideration when creating a new policy to ensure that they are in compliance and maximizing all tax planning opportunities.