Transfer Pricing Compliance Issues & Best Practices

The first thing to take into consideration is the compliance requirement in the local country: are there annual transfer pricing documentation and filing requirements, and if so what do they entail? Secondly, even if documentation requirements are not mandatory, you need to weigh the cost of doing a full analysis of your transfer pricing with the potential exposure associated with not meeting the relevant jurisdictional requirements. Most countries have rules in place dictating that intercompany transfer pricing meet something along the lines of an “arm’s length standard”. In other words, intercompany transfer pricing must generally be representative of what two independent third parties would reach if they were dealing at arm’s length. Testing this standard would generally involve looking at market transactions, engaging in benchmarking exercises, and doing other economic analyses of the intercompany transactions. The time and effort spent analyzing the arm’s length nature of your transfer pricing should be commensurate with the potential exposure associated with an income tax adjustment, as well as any relevant penalties.

I fully endorse Justin's comments and want to elaborate on the range of approaches one can take with a corresponding risk/return tradeoff. In the US and most countries that follow similar OECD transfer pricing standards, the customary approach to protect against the imposition of penalties (20-40% in the US) plus interest on top of a potential transfer pricing tax adjustment is to prepare a full transfer pricing documentation study (aka penalty-protection study), as briefly described by Justin. Such a study would also help in any financial auditor's evaluation of your tax reserves under an ASC 740-10 (aka FIN 48) analysis.

At the other extreme, one could just use some rule of thumb as to the proper service cost markup and take your chances with both the tax authorities and your financial auditors. In between these two extremes, one could prepare only a benchmarking analysis of the proper markup rate to have a firmer idea regarding the arm's length range but this would not provide penalty protection that a full study does.

Additional intricacies that come into consideration are that shareholder or management stewardship costs are not charged. If part of the service provider's costs include third party legal fees, for example, should these pass-through costs be re-charged with or without a markup? Finally, under certain conditions, it may be feasible to charge without a markup, though this is not necessarily beneficial.

In conclusion, advisors like Justin and myself are naturally happy to assist you with fleshing out the approach best suited to your circumstances.

Jake

I mostly agree with both the gentleman's comments before mine, but would like to add that you need to support the transfer pricing agreement to both countries taxing agencies. The IRS has specific guidelines on transfer pricing that were discussed by Jake above.

Determining an arms length transfer price generally starts in the country performing the services. For example, India performs transfer price services for many U.S. corporations. if your company is performing R&D services, those previous transactions can be deemed "comparable" for the pricing of future R&D service contracts, depending on the specifics of each contract. Even if they aren't 100% comparable, they can be a starting point to which adjustments can be made. There is also court law in India regarding transfer pricing. Don't stray too far from past guidelines without adequate support, or the risk of tax adjustment increases. Transfer pricing is very tricky; get some help if you don't have some previous experience with it.