As U.S. manufacturers increasingly conduct business overseas, the way in which related parties of a company charge one another for goods and services continues to be a top audit issue for the IRS and other tax authorities. It should also be a priority for all multinational companies to follow transfer pricing rules to avoid being subject to steep penalties. In 2018, the IRS issued new guidance which governs the transfer pricing examination or audit process.
Transfer pricing refers to the price that related parties (entities under common control), such as divisions of a company, charge one another for goods or services. These include tangible goods, services, intangible property, interest on loans and other financial transactions.
The government pays particular attention to transfer pricing because the taxable profits for each division of the company come into play. The reason? Many companies seek to reduce their tax burden by shifting costs to another country, that is to say, a jurisdiction with lower taxes.
IRS Testing and Audits
Even those manufacturers who strictly follow transfer pricing rules may be subject to an audit. The mere fact that you are required to disclose transactions with foreign related parties on U.S. federal tax returns could trigger an audit. And, of course, if you have a large volume of transactions with related parties in lower-tax countries, you could have an even higher chance of being subject to an audit.
The goal of a transfer pricing examination is to “determine the arm’s-length result under the facts and circumstances of the case.” The “arm’s length” standard is used to determine whether the pricing of transactions between related parties is similar to what it would be if the parties involved are unrelated. In 2018, the IRS issued new guidance on the conduct of transfer pricing audits. Taxpayers can use this new Transfer Pricing Examination Process (TPEP) to know what to expect from a transfer pricing audit, specifically with respect to planning, execution, and resolution. The TPEP also provides best practices to assist with the execution of transfer pricing examinations.
Transfer Pricing Studies
To avoid IRS penalties, manufacturers should provide the IRS with documentation that supports the factual relationship between your company and another entity and pricing decisions in the form of its own transfer pricing study. A transfer pricing study will examine the relationship between your company and other related parties, the different types of controlled transactions between the entities, and the way in which pricing was determined. Particularly, the study will determine whether you are meeting the arms-length standard. IRS regulations specify using the testing method that provides the most reliable measure of an arm’s length result under the facts and circumstances of the controlled transaction under review.
Once manufacturers prepare their studies, they must adhere to them. Tax authorities will penalize companies whose actual pricing for transactions differs substantially from the pricing included in their studies.
Penalties for Noncompliance
Noncompliance with transfer pricing rules can have costly effects for multinational companies. Consequences include penalties, interest on underpayment, double taxation and, sometimes, lingering disputes with tax authorities. If the government determines that your pricing is incorrect, it will tax you on the difference and include interest and penalties.
That’s where having a transfer pricing study can protect you. As a bonus, a transfer pricing study can identify opportunities to reduce costs and improve your operations.
Transfer pricing is a complex and specialized international tax discipline. If your company has multiple entities that have any transactions with one another and that reside in different tax jurisdictions, it’s imperative that you review your documentations policies. An experienced accountant can help ensure that your company is in compliance with transfer pricing requirements.
Goldin Peiser & Peiser can help you with transfer pricing studies and tax strategy for your multinational company. For more information, please contact Aaron Harris, CPA, at 972-818-5300. Learn more about how we can help with transfer pricing or the Manufacturing and Distribution Services Group at Goldin Peiser & Peiser.
Note: This content is accurate as of the date published above and is subject to change. Please seek professional advice before acting on any matter contained in this article.