Does your company have intercompany transactions? Do the transactions cross over multiple foreign local jurisdictions?
If you answered yes to either of these questions, you may be at risk for a transfer pricing adjustment from the IRS, foreign jurisdiction, or even a state jurisdiction. In addition, with the current OECD base erosion and profit shifting (BEPS) action items coming into the spotlight, transfer pricing should be at the forefront of all companies. Each entity should be analyzing their intercompany transactions to ensure they can be supported as arm's length transactions. This analysis can provide support that the taxpayer is not intentionally shifting profits into a lower tax jurisdiction at a rate that is unreasonable, and also provide excellent tax planning opportunities.
Intercompany transactions cover many different types of transactions. Some examples are as follows:
- Tangible transactions from a manufacturer to a related-party distributor
- Intangible transactions of know-how from one related-party to another
- Fees for services of one related-party to another
- Management fees for centralized corporate offices for services such as admin, HR, and finance
The key phrase to all transfer pricing is “arm's length.” Arm's length means that the transaction should be executed as if it were being done with a third-party. There should be no advantage to the transaction due to the intercompany nature. According to the U.S. and many foreign jurisdictions regulations, each intercompany transaction must support that their transactions are at arm’s length and the company is not trying to erroneously shift profits to lower tax jurisdictions.
Do you have support that shows the intercompany transactions are at arm’s length? Do you have intercompany agreements in place that are followed for these intercompany transactions?
If you answered no to either of these questions, you may not have the adequate support that the IRS deems necessary according to the transfer pricing regulations in Section 482. These documents are meant to be contemporaneous in nature, which means that they should exist as the intercompany transactions exist. As part of the increasing scrutiny on transfer pricing, a company that faces an IRS audit will most likely be asked for their contemporaneous transfer pricing documentation.
The documentation required by the IRS is known as the following 10 principal documents:
1. Overview of your company’s business
2. Description of your company’s organizational structure
3. Any document explicitly required by the §482 regulations
4. Description of the method selected and the reason why the method was selected
5. Description of the alternative methods considered and rejected
6. Description of the controlled transactions and internal data used to analyze them
7. Description of the comparables used, how comparability was evaluated, and what adjustments were made
8. Explanation of the economic analysis and projections relied on
9. Summary of any relevant data that your company obtains after the end of the tax year and before filing a tax return
10. General index of the principal and background documents, and a description of your record-keeping system
While these are the documents the IRS requests, companies should continue to be cognizant of the level of risk in their intercompany transactions and whether or not an entire transfer pricing study is deemed necessary according to the company’s appropriate level of risk. A more practical approach may be available if the company decides that the risk level of their transactions is minor.
What Should Companies Do?
With transfer pricing being a hot topic in the tax world, companies should have documentation on the intercompany transactions that cross over multiple jurisdictions. Taxpayers should be able to support that their intercompany transactions are being transacted at an arm's length standard to the IRS if an audit were to occur. This documentation is important as protection for the company should an audit occur and could be used as a tax planning tool to be able to reasonably, within an arm's length standard, shift profits to a lower tax jurisdiction. For expert guidance in compiling and reviewing your documentation, please contact us.