U.S Internal Revenue Code Section 482 gives tax authorities the power to reconstruct an intracorporate transfer price and tax the calculated profits whenever there is reason to suspect low prices set for tax evasion.
Due to differences in Tax structures among various countries, a firm can obtain meaningful profits by ordering a subsidiary in a country with high corporate taxes to sell at cost to a subsidiary’ in a country where corporate taxes are lower. The profit is earned where less income tax is paid, to give the company as a whole, an overall gain.
Transfer Pricing, in short is the ‘strategic’ pricing between members of the same enterprise that is mostly controlled through corporate policy. The manipulation of transfer prices for the mitigation of income taxes, import duties and other reason has caused many governments to insist on arms-length prices. Arms –length prices are prices considered reasonable, fair, market based or prices charged unrelated customers.
We provide the following services:
1. Transfer Pricing Benchmarking
2. Transfer Pricing Documentation
3. Transfer Pricing Intangibles Valuation (Intercompany Transfers of Intangible Property)
4. M&A Valuation pertaining to the Transfer Pricing
5. Fair Value Financial Reporting Valuation (IFRS & FASB) pertaining to the Transfer Pricing
6. Forensic Economics Litigation Support
The United States Internal Revenue Code Section 482 provides specified methodologies for determining the arm’s length terms for the transfer of tangible property, and capital between tax—payers. The taxpayer is required to use the method that provides the most reliable measure of arm’s length pricing. Although there is no automatic best method for each taxpayer, the regulations indicate under which circumstances each of the methods is likely to be most reliable for finding the appropriate transfer price.
Section 482 provides five transfer pricing methods for tangible property and three for intangible property.
Tangible Property - 5 Transfer Pricing Methods:
Tangible property methods include the following:
1. The comparable uncontrolled price method
2. The resale price method
3. The cost plus method
4. The comparable profits method
5. The profit split method
The three specified methods for the transfer of intangible property include the following:
1. the comparable uncontrolled transaction method
2. the cost plus method
3. the profit split method.
Under the comparable uncontrolled transaction method, an evaluation is made to determine if the amount charged for a controllable transfer of intangible property was arm's length as compared to a comparable uncontrolled transactions must involve either the same intangible property or comparable intangible property.
To be comparable, the two intangibles must be used in connection with similar products or processes within the same general industry or market, and have similar profit potential.
For the Cost Plus Method and Profit Split Method, the same definitions are used as for the transfer of tangible property, described above.
The economic benefits that a multinational enterprise will gain from transfer pricing are their motivations for practicing transfer pricing. Transfer pricing assists an MNE in evaluating the financial performance of different parts of the company.
If the host country of one of the subsidiaries has lower taxes than the other host countries, it would be natural to try to maximize profits in the lower tax country and minimize them in the higher tax country.
In the end transfer pricing may help reduce the consolidated company's tax burden. Other differences between hos countries could dictate the allocation of profit to or from the subsidiaries located there. Such differences could include currency controls, customs duty, tariffs, labor relations, political climate, and social unrest.
It is sensible to allocate as much profit as reasonably possible to subsidiaries in countries with the least currency controls, the best best labor relations, political climate, and the least social unrest.
Adhering to the different requirements of multiple tax regulation among various nations is a complicated process. National tax authorities enforce detailed documentation requirements, transaction transparency, audit/inspection activity, and strict punishments.
To meet the requirements of U.S transfer—pricing regulations, a taxpayer must annually prepare, prior to the filing of the U.S tax return, all of the transfer—pricing documentation. Corporations that utilize transfer pricing must satisfactorily document their adherence to the arm’s length approach.
There are two main motivations for compliance. The first is to reduce the risk of an audit and potential dispute with tax authorities. The second is to maintain transparency with investors and tax authorities.
Transparency with stockholders and potential investors enhances consumer confidence which potentially adds value to the corporation. Over 50 countries, including the United States, are beginning to ask their MNEs to report contemporaneous transfer—pricing documentation.
Transfer—pricing documentation must show each significant process used by the corporation regarding transfer pricing and the arm’s length methodology applied. When an MNE fails to disclose information concerning transfer pricing, the company faces significant penalties from the country’s tax authorities.
For example, in Australia, when an MNE provides inadequate or incomplete information, the country’s transfer—pricing laws permit the taxing authority to assign the transfer price. A second example of the importance of documentation is Mexican’s transfer—pricing rules, in which penalties include denial of deductions for the transfer payments to foreign related parties.
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David Hahn, CVA, ASA, MAFF, CCIM, CM&AA, MBA
CVA - Certified Business Valuation Analyst
ASA - Accredited Senior Appraiser
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CCIM - Certified Commercial Investment Member
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