How can I ensure cross-border deals meet transfer-pricing standards?June 07, 2012
Avoiding the transfer pricing trap to limit your exposure for an IRS audit.
The IRS and other tax authorities worldwide pay particular attention to how businesses allocate income and expenses among related entities abroad, known as transfer pricing, because of the potential to shift income to lower-tax jurisdictions.
In general, transfer pricing must meet an “arm’s length” standard where the prices charged in an intercompany transaction must be similar to those charged by unrelated companies for the same transaction under the same circumstances. Over the years, global tax agencies have gained increased powers to help enforce the arm’s length principle, resulting in stricter penalties, additional documentation, and increased exchange of information between jurisdictions. Transfer pricing is a trap your company must work diligently to avoid, but with careful planning it can limit its exposure to an IRS audit and minimize its tax liability. Here are two considerations:
Pay special attention to intangible assets. Transfer pricing of such intangible assets as intellectual property is a major audit priority that spans all industries but is particularly prevalent among high-tech enterprises. Much of today’s global economy revolves around intangible assets, which are inherently difficult to value. Given their increasing importance and the scrutiny of tax authorities worldwide, companies need a strategy to defend their transfer pricing methods.
Let’s say your US-based company transfers patents, or other intangibles, to an overseas subsidiary. The unit must pay a fair market price or buy-in payment to your business. Buy-in disputes with tax authorities often involve such issues as:
- The up-front valuation of intangibles.
- The definition and scope of intangible items (for example, technology, goodwill, workforce in place, etc.).
- Determination of the useful life of pre-existing intangibles.
- The type of payment (royalty, lump sum or instilment) and when it was made.
- In-process R&D, as well as the rights to further research versus manufacturing and selling rights.
- Third party acquisition buy-in (stock or asset purchase of a company) or license of intangibles from third party.
- Documentation to prove the payment amounts are correct.
Prepare a transfer pricing study. Contemporaneous documentation is a critical step in complying with laws worldwide and avoiding severe penalties imposed on transfer pricing tax underpayments. A comprehensive study prepared by your accounting firm should detail and justify the pricing methodology used in intercompany transactions. It can help a company withstand scrutiny from tax authorities, as well as reveal tax planning opportunities.
Transfer pricing is a complex issue. Contact a member of our Tax Services Group for more information.