RSM Resources

Just as most nations patrol their borders to deter people and goods from crossing illegally, many countries also conduct a different sort of border patrol: They ensure multinational companies charge a fair fee for business transactions with foreign affiliates and other related business entities.

Two decades ago, only two countries actively governed these kinds of intercompany transactions and their associated "transfer prices." Today, however, 40 countries have adopted their own transfer pricing regulations, and that number is constantly rising.

Transfer pricing rules apply to all companies that do business with related parties, both domestically and internationally. However, most experts agree that increased globalization is the clear culprit in turning transfer pricing into a hot issue — one that business owners ignore at their own peril.

Consider the following illustration of transfer pricing in action. A U.S.-owned telecommunications company purchases some electronics parts from its own subsidiary in India. The amount the U.S.-based parent company pays for these parts is the transfer price. The tax authorities of both countries may take a keen interest in that transfer price, because the amount charged directly affects many complex financial variables,including the total income and profit margin each unit of the company declares, as well as the amount of tax the transaction triggers for each government.

Arms-length requirements

Transfer pricing rules require that companies deal at "arm’s length" with related parties when transferring goods or services between divisions. When it comes to transfer pricing, "arm’s length" means a company must be able to prove that it charges a fair-market price for all of its related-party transactions.

According to U.S. transfer pricing rules, if your company does not have the proper documentation to justify a transfer price, the Internal Revenue Service can dictate a different transfer price for your transactions and then assess a penalty of up to 40 percent on that adjusted amount. And depending on the country where your affiliate is located, you could face additional taxes and substantial penalties from that country’s government.

While rules and enforcement policies can vary greatly from country to country, experts advise that assuming any government will turn a blind eye to your company’s transfer pricing practices can be a costly mistake.

So, how can you keep your midsized company from running afoul of transfer pricing police on both sides of the border? Forewarned is forearmed, the experts say. Use the following information to learn more about the rules and risks associated with transfer pricing and what you can do to protect your company’s interests.

Who is at risk?

Is your midsized company at risk of being in conflict with transfer pricing rules and regulations? Experts say it’s in your best interest to find out well before the auditing agents come knocking. To determine whether your business invites regulatory scrutiny, ask yourself the following questions:

• Does your midsized business have a foreign subsidiary?
• Is your business foreign-owned?
• Is your company conducting any transactions with related-parties, either through direct ownership or common ownership?

If you answered yes to any of the above questions, transfer pricing regulations most likely affect your company. U.S. regulations require that all companies engaging in related-party transactions produce a transfer pricing report to justify their related-party transfer prices.

Timeliness is key

A proper transfer pricing report combines comprehensive benchmarking data and analysis to illustrate that the transfer prices your company uses are in line with what other companies in your industry would charge an unrelated party for the same goods or services.

In the past, many U.S.-based companies could put off creating a transfer pricing report until after receiving a letter from the IRS requesting the information. Then,company officials had 30 days to report the requested documentation.

Recent changes to the transfer pricing enforcement guidelines have rendered that practice — playing transfer pricing catch-up — dangerous in the extreme, experts say. IRS auditors also may require you to submit accounting and consulting invoices or other forms of documentation to prove that you produced your transfer pricing report in the year the transactions occurred. And, if you can’t? Then, the IRS may refuse to accept your report and adjust your transfer prices.

Even companies that have their transfer pricing documentation in place risk the IRS or other government bodies second-guessing them. Recently the IRS settled the largest transfer pricing dispute — the largest tax dispute of any kind in its history — with pharmaceutical giant GlaxoSmithKline Holdings (GSK). GSK agreed to pay $3.4 billion to resolve a transfer pricing dispute for the tax years 1989 through 2000as well as tax issues for the 2001 to 2005 period. The dispute involved transactions between GSK, which has its U.S. headquarters in Research Triangle Park, N.C., and Philadelphia, and several of its foreign affiliates.

Transfer pricing report basics

Even if authorities call your transfer pricing report into question, experts say it’s always better to have one than not.

Although some midsized companies create their own transfer pricing reports, many look to external specialists who have access to benchmarking data.

Experts say you can expect a vendor to provide a report that will stay current for up to three years. It’s important to make sure the company you select is familiar with the unique aspects of your industry as well as the rules and regulations that govern all the countries where you operate.

Also look for support beyond simply producing atransfer pricing report. Seek help adjusting your transfer pricing methods to maximize profit and minimize risk. A good defense is alwaysthe best offense in protecting your midsized company’s interests in related-party transactions.