What is transfer pricing?
When a company sells a product or service to an affiliate or subsidiary, it must establish a transfer price that accounts for the profit or loss on the transaction. It must then report the profit or loss on its financial statements and tax returns. The subsidiary must do the same. Tax authorities, including the IRS, believe that some companies have manipulated the system to report lower income in high-tax countries and correspondingly higher income in low-tax countries.
What is the risk to companies without the proper tax position?
Tax authorities around the world are very aware of the effect transfer pricing policies have on tax revenues. Most will attempt to adjust a company’s taxable income if they determine that the income based on the company’s transfer pricing is inconsistent with pricing that would have been charged to an unrelated company. For example, if a foreign parent’s pricing to its U.S. subsidiary is deemed too high resulting in lower profit for the subsidiary, the IRS may increase the subsidiary’s taxable income. The foreign tax authority is under no obligation to reduce the parent’s taxable income. The result? Double taxation.
Under FIN 48, companies must assume that they will be audited by both the IRS and the relevant tax authority of their foreign affiliate. Let’s take the example of a U.S. subsidiary of a foreign parent. The U.S. subsidiary purchases goods from its parent for resale within the United States. Further assume the U.S. subsidiary incurs tax losses as a result of overpaying for goods purchased from its parent. If management cannot provide adequate support that this transfer pricing policy can be sustained under audit, then a FIN 48 liability may need to be provided on its U.S. financial statement. The FIN 48 liability may be a red flag for an IRS auditor should the company be subject to an IRS examination.
How do I protect my company?
Companies with international operations must implement written transfer pricing policies that satisfy an arm’s length standard and the more stringent standards of FIN 48 for all intercompany transfers. The IRS provides several methods for determining the reasonableness of a policy, but other countries typically use different guidelines established by the Organization for Economic Cooperation and Development (OECD). Companies should work with a tax specialists with the knowledge and experience to help them develop a policy that will keep them in compliance and minimize their global tax liability.
The assessment of tax positions will require the review of all relevant aspects of the tax law including case law and rulings. Appropriate documentation of the assessment of each individual tax position must be maintained by the company. Specialized expertise in the tax law will be required to ensure that adequate analysis and appropriate documentation of tax positions analysis are accomplished.
Robert Verzi, CPA, is an international tax partner with Habif, Arogeti & Wynne, LLP with more than 22 years of experience providing international tax solutions to publicly and privately held corporations on an array of international tax matters, such as foreign tax credit management and utilization, structuring foreign and domestic operations, international mergers and acquisitions, and export tax incentives. He also has many years of experience serving foreign-owned U.S. businesses. Reach him at (404) 898-8486 or [email protected].