For many multinational companies, transfer pricing becomes a concern only when someone asks for documentation, an auditor raises a question, or the company realizes its intercompany transactions have grown significantly.
By that point, however, the company may already have unnecessary tax exposure.
A Transfer Pricing Study can help a company establish and document how transactions between related entities should be priced. But does every company with international operations need one?
Not necessarily. The better question is whether your company has related-party transactions significant enough to create transfer pricing risk.
What Is Transfer Pricing?
Transfer pricing refers to the pricing of transactions between related companies, such as a U.S. subsidiary and its foreign parent company.
These transactions may include:
- Purchases or sales of products
- Management or administrative services
- Royalties and licensing fees
- Intercompany loans and interest
- Technology or intellectual property
- Cost-sharing arrangements
Tax authorities generally expect these transactions to follow the arm’s-length principle – meaning the pricing should generally resemble what independent companies would agree to under comparable circumstances.
A Transfer Pricing Study analyzes the company’s transactions, functions, risks, and financial information and evaluates whether its pricing is consistent with an arm’s-length result.
Which Companies Typically Need a Transfer Pricing Study?
Transfer pricing becomes particularly important when a company has meaningful transactions with foreign related parties.
A U.S. company may want to consider a study when it:
- Is owned by a foreign parent company
- Owns subsidiaries outside the United States
- Regularly purchases products from related companies
- Provides or receives management services
- Pays royalties or licensing fees to related entities
- Has intercompany loans
- Has significant related-party transactions
- Consistently reports losses or unusually low profitability
The more significant the intercompany activity, the more important transfer pricing compliance generally becomes.
Is There a Revenue Threshold?
One common misconception is that a company doesn’t need to think about transfer pricing until it reaches a specific revenue level.
Several tax jurisdictions have transfer pricing documentation requirements that are based on a set revenue threshold. In the U.S., revenue can be an important indicator, but it isn’t the only factor.
A relatively small U.S. subsidiary could have substantial related-party purchases or service fees. Conversely, a much larger company might have limited international related-party activity.
Rather than focusing exclusively on revenue, management should consider the size, frequency, and nature of related-party transactions, along with applicable tax and documentation requirements.
“Our Parent Company Sets the Price, So We’re Covered.”
This is another common assumption.
A foreign parent may have a global transfer pricing policy, but that does not automatically mean the U.S. subsidiary has sufficient U.S.-focused support for its tax position. Compliance should be considered for both jurisdictions relevant to the intercompany transaction.
A subsidiary should understand how its intercompany pricing policies affect its U.S. taxable income and whether appropriate documentation exists.
What Happens If You Wait?
Waiting until an audit begins can put a company in a difficult position.
Instead of proactively documenting why its pricing is reasonable, management may find itself trying to reconstruct historical decisions, locate old financial information, and explain transactions that occurred years earlier. A proactive Transfer Pricing Study can help management identify issues earlier, document its methodology, and determine whether adjustments should be considered.
The Bottom Line
If your company conducts significant transactions with foreign related parties, transfer pricing deserves attention before an auditor asks about it.
A study isn’t simply about producing a report. It is about understanding whether your intercompany pricing is supportable – and addressing potential exposure while management still has time to act.
If you want to learn if your company needs a Transfer Pricing Study, Contact CDH today for a free consultation.
