Transfer Pricing FAQ

We frequently hear and respond to the following questions. If you have a question for Altus Economics, please contact us.

I believe our intercompany transactions are already arm's length. Do I need to prepare a transfer pricing study to document this?

The short answer to this question is: it all depends on your risk profile. The US regulations outline very specific (albeit subjective) criteria to determine what does and does not constitute arm's-length pricing. The regulations also outline various tests to analyze the arm's-length nature of intercompany pricing. If you believe that your transfer pricing is arm's-length, and that it will withstand such testing, then you may or may not want to consider preparing a transfer pricing study.

The US regulations require that all intercompany pricing between related parties in separate tax jurisdictions be at arm's length. The US regulations do not, however, require that a taxpayer prepare documentation that supports this. This is commonly misunderstood and not explained well by many transfer pricing professionals. Documentation, per the US regulations, is entirely optional. Documentation supporting the arm's-length nature of intercompany pricing is required only if a taxpayer wishes to reduce or eliminate the risk of penalties that can result from a transfer pricing adjustment. Penalties can amount to either 20 or 40 percent of the transfer pricing adjustment levied.

If your transfer pricing is deemed arm's length, there will be no adjustment levied, and there will be no penalties. In this situation, there is nothing for documentation to protect. The reality, though, is that the arm's-length nature of intercompany pricing is a highly subjective matter. Different parties frequently reach different conclusions regarding this fact. Two very knowledgeable economists can each look at the exact same facts and circumstances and reach divergent opinions on the subject. Documentation in support of your pricing at least can offer penalty protection in situations where you believe your transfer pricing to be arm's length, but the IRS disagrees and levies an adjustment.

Additionally, contemporaneous documentation (documentation prepared contemporaneously with the filing of a tax return) firmly establishes your case for the arm's-length nature of your transfer pricing before the IRS even has the chance to examine your case. Having a case established in advance can automatically put you at an advantage should the IRS decide to challenge your transfer pricing.

I am not sure that my company can afford a transfer pricing study. Why should we spend money on something that may or may not even be disputed?

Spending money on a transfer pricing study may be a bad investment of your firm's resources! A study is not required by US regulations. As with all company expenditures, you need to weigh the cost of the project with the potential benefit. Please see the answer to "Do I need to prepare a transfer pricing study to document this?"

First of all, you need to assess the exposure associated with your transfer pricing. Experienced eyes might identify exposure or risk that you are not even aware of. Second of all, you need to assess the potential cost associated with a transfer pricing audit and adjustment. The benefit that a transfer pricing study might bring is that it could eliminate an adjustment and possibly the audit altogether. Finally, you need to assess your company's risk tolerance. Are you willing to risk an adjustment, or does your company value certainty?

None of the steps listed above are simple or easy. Most of these steps can be aided by the experiences of a seasoned transfer pricing professional.

Do we need to retain a third-party professional to prepare our transfer pricing study, or can we prepare it ourselves using internal resources?

You can absolutely prepare a transfer pricing study using your own internal resources. Sometimes that is the best option. After all, nobody knows your business like your own people. There are good resources and services in the marketplace that can assist taxpayers in preparing their own documentation. Many larger corporations have entire departments that do nothing but prepare transfer pricing documentation and address compliance with global transfer pricing regulations.

It is important to realize, however, that the US regulations outline very specific criteria for evaluating the arm's-length nature of intercompany pricing. It does not matter that your company tries to act in an arm's-length manner. It does not matter that you believe your transfer pricing to be arm's-length. You must demonstrate this based on economic principles outlined in the US regulations, and you must adhere to certain methodologies and economic valuation techniques.

Enough cannot be said about the subjectivity surrounding the determination of arm's-length pricing. No two people view this determination quite the same. Experienced transfer pricing professionals are adept at analyzing transfer pricing from a variety of perspectives. Such an analysis has the advantage of being prepared to address other parties' perspectives and formulating an appropriate defense in advance.

Finally, an outsider's perspective has a certain quality that an insider can never offer. There is a reason why publicly traded companies are required to have their financial statements audited by an outside party. Even large corporations with dedicated internal transfer pricing resources almost always rely on outside advisors to augment their capabilities.

I know that we need to retain a third party to advise us on our transfer pricing. How do we go about selecting the right professional?

This is never an easy thing to do, no matter the area of specialization. First and foremost, you need to examine the credentials and experience of the people who will actually be advising you . The service provider must be able to tell you the exact names of the people that will be working on your project and what their credentials are. Too often, transfer pricing service providers will have a senior experienced professional work with you during the sales process, but then push the actual work down to junior people with little experience.

The following statement will sound cliché, but it is universally true. Cost is important, but good service is priceless. Any service provider that places all of its emphasis on its pricing is probably not worth your time. A good service provider will offer its expertise at a competitive price. A good service provider, however, is primarily focused on doing exceptional work and helping others.