Are you aware of the tax requirements involved with transfer pricing? If you’re a global company that exchanges goods, services or intangible assets with related entities, in cross-border transactions, you should be. Transfer pricing is one of the top audit issues for the IRS and other revenue-strapped tax authorities, and you don’t want to incur steep penalties for failure to determine and document arm’slength pricing.
Transfer pricing generally refers to the prices for which related parties, such as a U.S. corporation and its foreign subsidiary, exchange goods, services or intangible assets in cross-border transactions. For example, if a U.S. parent company has a subsidiary that manufactures in Mexico, and that subsidiary sells the goods back to the U.S. parent company, the IRS looks at what that price between the related entities. Contrary to popular belief, transfer pricing restrictions aren’t limited to international transactions. They also apply to domestic companies that do business with related parties across state lines.
The government is concerned that companies will manipulate these prices to shift profits to lower tax jurisdictions. If you don’t want the IRS to tell you what that the standard should be, it’s best to determine your own transfer standard with the proper documentation.
What to Do
To deter tax avoidance, transfer pricing rules require related businesses to set prices that are comparable to those charged in arm’s-length transactions using one of several accepted methods. If you want to avoid penalties, it’s recommended to document intercompany pricing decisions contemporaneously to ensure compliance with tax rules. Keep in mind, your documentation needs to be prepared with your tax return each year to avoid penalties and interest on transfer pricing audit adjustments.