Transfer pricing — the pricing of transactions between related entities within a multinational enterprise — plays a critical role in global tax compliance and financial strategy. Selecting, documenting, and regularly reviewing the appropriateness of your transfer pricing method is not just a technical exercise, but a cornerstone of tax risk management and regulatory compliance.
Transfer Pricing Methods
Transfer pricing methods are approaches used to determine the price for transactions between related entities within a multinational enterprise, or MNE. An appropriate method is required to demonstrate compliance with the arm’s length principle, which states that intercompany pricing must reflect what independent parties would agree to under similar circumstances.
The most common transfer pricing methods are indirect, profit-based methods which examine the net profit margin relative to an appropriate base (e.g., costs or sales) that a taxpayer earns from a controlled transaction. In my experience, these methods, which benchmark net margins vs. comparable independent companies, comprise at least 75% of transfer pricing methods adopted by taxpayers because they require less granular comparability data are relatively simply to apply and interpret.
In a distant second place are direct, transactional methods which compare the prices or rates charged in a controlled transaction to those charged in a comparable uncontrolled transaction. These are best applied when highly comparable transactions (e.g., commodity sales or licensing agreements) are identifiable and have data readily available.
Selecting a Method
Transfer pricing method selection is typically done prospectively when a new controlled transaction is initiated or identified. It involves evaluating the available methods, considering their comparability and feasibility, and selecting the best or most appropriate one available.
Method Monitoring
A significant majority of taxpayers have a "set it and forget it" approach to transfer pricing methods. While many update the factual and financial information in their transfer pricing documentation each year, the method itself is rarely revisited. This is fine as long as the facts and circumstances of the transaction remain unchanged, but it can land a taxpayer in hot water when changes happen - and changes happen.
MNEs can avoid this trap by answering a set of questions at least annually:
- Has the MNE's business or supply chain changed in ways that affect the characterization and analysis of the controlled transaction?
- Have external economic factors in the industry or broader economy (e.g., tariffs, downturns) affected the comparability of the companies or agreements used in the legacy transfer pricing method?
- Is new external or internal data available that might make a new method more appropriate? For example, has the company entered into substantially similar arrangements with third parties that could be viewed by tax administrations as direct internal comparables?
- Does the existing transfer pricing method "pass the smell test" when the overall allocation of income between taxing jurisdictions is considered? Does it remain in line with the company's business and cash management realities and objectives
What Eide Bailly Can Do for You
Eide Bailly supports our clients with regular transfer pricing method risk assessments and reviews. If you or your current advisor have not considered the appropriateness of your transfer pricing method this year, reach out to us today for a no-cost diagnostic conversation!
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