Why is it important to have proper transfer pricing documentation?
The IRS’s transfer pricing rules are designed to ensure that prices charged by related entities for goods or services net the same results as what would have been realized if unrelated entities were involved in that same transaction under the same circumstances. These transactions need to be well documented because the IRS and more than 70 other foreign tax authorities want to make sure that your intercompany transactions are arm’s length in nature, so you cannot shift income among different entities of the same group or from one country to another. Therefore, you need to have contemporaneous documentation, including a functional and economic analysis to support your transfer pricing policies. Without such documentation, many countries’ tax authorities, including the IRS, may make transfer pricing income adjustments and impose penalties. U.S. penalties can range from 20 percent to 40 percent of the adjustment amount.
On the other hand, a fiscally responsible and well-tested transfer pricing study could contribute to long-term sustainability of your effective tax rate and provide planning opportunities for future expansion. It also became more important after the adoption of the FIN48 by most entities because of the potential uncertain tax positions of your foreign operations.
What forms are critical for U.S. corporations to file when doing business overseas?
Depending on the type of your foreign operations, many forms may be required to disclose with the IRS. The most common one is Form 5471, which requires certain U.S. owners to disclose their foreign corporation’s operations, and it must be filed annually. Depending on which category filer the taxpayer may be, there are different schedules that need to be filed. Because it requires detailed foreign financial information, it usually takes time to get it right. So it’s recommended to start planning right after the year-end and work with your overseas staff to get that as soon as possible. If you are required to file the form but fail to do so, the IRS would assess a $10,000 penalty on each occurrence.
Another common and important form is the Report of Foreign Bank and Financial Accounts (FBAR) form TD F 90-22.1. The form requires you to disclose your financial accounts in foreign countries if the aggregate value exceeds $10,000 at any time during the calendar year. Please be aware that you may have filing requirements not only if you own, directly or indirectly, those accounts, but also if you just have signature authority. Similar to Form 5471, failing to file a required FBAR is costly.
What do U.S. taxpayers need to be aware of on a personal level when working overseas?
First of all, don’t think that just because you’re working overseas you don’t need to file a U.S. tax return. As a U.S. taxpayer, your worldwide incomes are still subject to the U.S. tax. How you report the foreign source earned income depends on whether you qualify for a special foreign earned income exclusion rule and whether you want to make such election. If you do, you may exclude certain foreign earned income from U.S. tax, but the related foreign tax credit must be reduced accordingly. Therefore, you need to compare and take the most beneficial way of filing.
Additionally, because you stay and work in a foreign country, don’t overlook the potential local tax authorities’ filing requirements and withholding rules. You may have a foreign tax liability because you performed services there.
Barry Wen is tax senior manager at Burr Pilger Mayer. Reach him at (408) 961-6316 or [email protected].
