How to Develop the Right Transfer Pricing Strategy for Your Business
April 28, 2022
At a glance
- Take action before you do business abroad: From startups interested in expanding internationally to established multinational enterprises, transfer pricing planning is a necessity for every business with cross-border transactions.
- Impact on your business: Not only can transfer pricing planning help you meet the IRS’s regulatory requirements, but it can also help you better manage cash flow, profitability and tax efficiency.
- Next steps: It’s smart to have your policy reviewed by a qualified transfer pricing specialist — and Aprio can help.
Schedule a consultation with one of Aprio’s Transfer Pricing advisors.
The full story:
Is the volume of your business’s intercompany transactions increasing? Are you considering expanding internationally in the future? Are you having difficulty managing your foreign cash flow? If you answered “yes” to any of these questions, then now is the time to engage in transfer pricing planning.
What is a transfer pricing policy?
Unfortunately, many companies, regardless of their stage in the lifecycle, are unaware they need a transfer pricing policy. Transfer pricing refers to the intercompany price a company charges a related entity for goods, services, intangible property or financing. This price should reflect the price paid by third parties for similar activities in order to avoid the narrative of profit-shifting and tax avoidance.
Moreover, having proper transfer pricing in place is a tax requirement in most countries. Documenting your transfer pricing policy can take many forms; your policy must outline the appropriate methods you used to support that pricing in order to meet the required “arm’s length standard” per most established transfer pricing regulations. Having the right transfer pricing policy in place can make a big difference not only for the financial and tax position of the business, but in the eyes of the IRS or any other tax authority.
Fulfill compliance and regulatory requirements
When your business engages in transactions with foreign related parties, the IRS looks for what we call the “three-legged stool”: an intercompany agreement, transfer pricing documentation and evidence that you’re following such practices. In other words, the IRS wants to know that what you’re saying is occurring is reality and that your documentation supports this
Your intercompany agreement is a legal, commercial agreement that you have entered into with a related entity, outlining the parameters of the intercompany transactions occurring. This agreement should include terms such as compensation, scope of interaction, effective date and tenor.
Transfer pricing documentation refers to the formal tax compliance document outlining the transfer pricing policies — as well as their supporting methodologies — associated with the intercompany transactions. US transfer pricing documentation must follow the 10 principal documents format specified by the IRS in order to meet the US transfer pricing requirements and qualify for penalty protection in the event of an IRS audit. All US taxpayers that have intercompany transactions with foreign related parties are required to have up-to-date transfer pricing documentation contemporaneous with their US tax return filing.
When is the right time to develop a transfer pricing policy with appropriate documentation? As soon as possible. In our conversations with businesses, we often stress that even if a company is starting up operations in the US or another country, it’s important that they take transfer pricing seriously from the very beginning. Flesh out your transfer pricing structure on day one and document the process in your intercompany agreements and formal transfer pricing documentation.
Avoid IRS penalties
Most multinational companies believe the only value of effective transfer pricing planning is ensuring compliance and penalty protection. While this is untrue given the ample tax planning opportunities available using transfer pricing, US companies with foreign affiliates are required by the IRS to report intercompany activity via Forms 5471 or 5472 filed with the US tax return. The IRS uses these forms to identify candidates for potential transfer pricing audits. If the IRS flags your company for a transfer pricing audit, the first item they will ask for in their information request is your US transfer pricing documentation for the applicable tax year. From this point, your company has 30 days to provide the appropriate documentation to the IRS — an incredibly short window for those who don’t have any documentation in place.
As mentioned, according to the US tax code rules, your transfer pricing documentation must be contemporaneous with the filing of your annual tax return. By adhering to these rules, your business is protected from any penalties associated with potential transfer pricing adjustments that may occur as a result of the audit.
Boost cash flow, manage profitability and increase tax efficiency
Beyond the regulatory perspective, transfer pricing is the number-one international tax planning tool multinational companies have at their disposal. The process presents a major opportunity for businesses to control cash via effective tax planning.
The more complex your company is — in other words, the more functions it performs and the more business risks it assumes — the more profit your company should theoretically earn in the long run. Let’s say that your home country is Ireland, in which you are subject to a 12.5% corporate income tax rate; the US business is subject to a 21% corporate income tax rate, plus the applicable state taxes. From a transfer pricing perspective, you will likely want to move as many functions and responsibilities to the Irish parent company as possible in order to maximize Irish profitability and benefit from the lower Irish tax rate. By setting up the appropriate transfer pricing policy and documenting accordingly via transfer pricing documentation and an intercompany agreement, you can shift business risks and functions, therefore optimizing your overall tax structure.
Another key element to transfer pricing planning is managing intellectual property (IP). Though IP is exceedingly complex and requires an in-depth analysis, there are some best practices to consider. First, if you are a startup with newer IP, you may consider having it developed in a jurisdiction that would incur less tax from the beginning. Conversely, if you have existing IP and are engaging in transfer pricing planning, you may explore strategies for potentially moving your IP to a lower tax area. Tax authorities will look for a significant share of profits to follow the IP; of course, the proper transfer pricing strategy must coincide with that, as economic substance in IP-owning jurisdictions is becoming increasingly important. Consult with Aprio’s International Tax and Transfer Pricing Teams to fully assess your unique situation.
The bottom line
To fully leverage the benefits associated with transfer pricing planning while complying with transfer pricing regulations, it’s smart to seek professional expertise. Aprio’s Transfer Pricing Team can provide the technical knowledge and breadth of experience you need to ensure your policy is compliant and positioned to help you succeed.
Schedule a consultation with us today.
About the Author
Robert is an international tax partner with more than 27 years of experience providing international tax solutions to publicly and privately-held corporations on an array of international tax matters, such as foreign tax credit management and utilization, structuring foreign and domestic operations, international mergers and acquisitions, and export tax incentives. He also has many years of experience serving foreign-owned U.S. businesses.