Transfer Pricing
Transfer pricing refers to the prices charged between related parties — such as a parent corporation and its subsidiaries — for the transfer of goods, services, intangible property, or financial instruments, with tax authorities scrutinizing whether those prices reflect arm's-length market terms to prevent profit-shifting to low-tax jurisdictions.
Transfer pricing is governed in the United States primarily by IRC Section 482, which grants the IRS authority to reallocate income and deductions among related parties when the arrangement does not reflect what unrelated parties would have agreed to in similar circumstances. Treasury Regulations under Section 482 describe several accepted methods for determining arm's-length prices, including the comparable uncontrolled price method, the resale price method, the cost-plus method, the comparable profits method, and the profit split method.
Multinational corporations use transfer prices on millions of intragroup transactions each year — raw materials shipped from a manufacturing subsidiary to a distribution subsidiary, management fees charged from a parent to affiliates, royalties paid for licensed intellectual property, and intercompany loans. Setting these prices too low in high-tax countries and too high in low-tax countries effectively shifts taxable income to preferred jurisdictions, reducing the global tax burden.
The IRS and foreign tax authorities cooperate through the OECD's Base Erosion and Profit Shifting (BEPS) project, which produced 15 action items to combat aggressive transfer pricing and other international tax planning strategies. BEPS Action 13 introduced country-by-country reporting (CbCR), requiring large multinationals to file reports with their home tax authority showing revenue, profit, taxes paid, and employee headcount for every jurisdiction where they operate.
US corporations with intercompany transactions must maintain contemporaneous transfer pricing documentation to support their pricing positions and avoid a 20 percent accuracy-related penalty (rising to 40 percent for gross valuation misstatements). Advance pricing agreements (APAs) between taxpayers and the IRS offer certainty on transfer pricing methodology prospectively, avoiding costly audits.