Transfer Pricing

Multinational operations engage in a variety of intercompany transactions. For example, a US parent company may sell components or provide marketing, managerial, technical and or administrative services to its foreign subsidiaries. Some companies use these related party transactions as a means to shift profits to lower tax jurisdictions. As a consequence, a “transfer price” must be computed for these types of related party transactions to confirm that the payments are made on an arm’s-length basis as defined in the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations published by the OECD in 1995 and supplemented in 1996 and 1997, and under the general rules and provisions of Internal Revenue Code (IRC) Section 482.

The IRS Large and Mid-Size Business (LMSB) Division, serving corporations, subchapter S corporations, and partnerships with assets greater than $10 million, issued a directive on January 22, 2003 stating that it will more actively enforce transfer pricing reporting and documentation requirements. Violations of these requirements result in IRC Section 6662 penalties.

In mid-September 2010, the IRS announced that it was reorganizing LMSB to focus more on international tax compliance. The new division, Large Business and International (LB&I) will have a team dedicated to transfer pricing audits, led by the IRS’ newly-appointed transfer pricing director – a position that never previously existed within the agency. Additionally, the Obama Administration has identified transfer pricing as a perceived tax abuse area and has proposed legislation to substantially impact current planning and reporting requirements. 

IRC §6662 provides for the assessment of penalties on an entity that fails to analyze and identify material deficiencies and weaknesses. IRC §6662(e)(1)(A) assesses a 20% penalty for a substantial valuation misstatement. A substantial valuation misstatement exists if the value or adjusted basis of any property claimed is 200% or more of the amount determined to be the correct amount of such value or adjusted basis. §6662(h)(2)(A) assesses a 40% penalty for a gross valuation misstatement. A gross valuation misstatement exists if the value or adjusted basis of any property is 400% or more of the amount determined to be the correct amount of such value or adjusted basis. Failure to obtain an accurate arm’s length pricing agreement may constitute a substantial or gross valuation misstatement under §6662.

A transfer pricing study can be conducted to analyze a company’s related party operations with its subsidiaries and compare its operating results to results of other corporations with similar operations and ensure that the studied corporation’s activities are conducted within an acceptable arm’s-length range of pricing. An accurate transfer pricing study report provides sufficient evidence to eliminate IRC §6662 penalties mentioned above in the event that the IRS adjusts the intercompany transaction amounts.

A full study should be prepared in the initial year and every third year thereafter. Updates to the study are prepared in the interim years to remain in compliance with the contemporaneous document requirements of §482.

For more information, please contact Amy Preston , 954-491-1950, ext. 236 or Adam Small, CPA, ext. 216.