Transfer Pricing and Cross-Border Transactions

Transfer pricing rules

The U.S. transfer pricing regulations under §482 seek to ensure that appropriate amounts of income of a multinational enterprise are subject to U.S. taxation. The Organization for Economic Cooperation and Development (OECD) also maintains its own transfer pricing guidelines. Collectively these regulations aim to prevent profit shifting to lower tax jurisdictions and avoid international double taxation.

U.S. transfer pricing regulations

The IRS employs the arm’s length standard in administering transfer pricing. The transfer pricing regulations try to determine the price that the related parties would have agreed to if they had dealt with each other at arm’s length as unrelated parties.

According to the IRS:

“A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result). However, because identical transactions can rarely be located, whether a transaction produces an arm’s length result generally will be determined by reference to the results of comparable transactions under comparable circumstances.”

The IRS can make transfer pricing adjustments to transactions between “two or more organizations, trades, or businesses” that are owned or controlled by the same interests.

OECD transfer pricing guidelines

The OECD first published its Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in 1995. The OECD has since continuously revised and supplemented the guidelines, reflecting an ongoing focus on international tax challenges, including transfer pricing issues.

The most recent edition went into effect in 2018, following a substantial revision and expansion as part of the OECD’s Base Erosion and Profit Shifting (BEPS) initiative.

Like the IRS, the OECD employs the arm’s length principle because it “provides broad parity of tax treatment for members of [multinational enterprise] groups and independent enterprises,” avoiding the creation of “tax advantages or disadvantages that would otherwise distort the relative competitive positions of either type of entity.” The guidelines state that the arm’s length principle “has also been found to work effectively in the vast majority of cases.”

Transfer pricing methods and documentation requirements to avoid adjustment penalties

Taxpayers can generally avoid incurring a penalty with respect to a transfer pricing adjustment if:

• The taxpayer established that the transfer price was determined in accordance with a specified method under the §482 regulations and the taxpayer’s use of the method is reasonable
• The taxpayer has documentation that sets out the determination of the transfer price in accordance with such method and that its use of the method was reasonable
• The documentation is contemporaneous to the time that the return was filed and is provided to the IRS within 30 days of its request
• The taxpayer determined its transfer price using either:
  • A specified method under the regulations (the use of which was reasonable)
  • An unspecified method when none of the specified methods was likely to result in a price that clearly reflected income and the method used was likely to result in a price that clearly reflected income
• The taxpayer has documentation (in existence when its return was filed) establishing its use of the particular transfer pricing method and that the use of that method was reasonable
• The documentation is provided to the IRS within 30 days of request

[Download our Transfer Pricing Forum comparative study of the typical transfer pricing issues by country panelists in major and emerging industrial countries.]