Stock-based compensation (SBC) is complicated. Transfer pricing is complicated. Together, they are... complicated. Book vs tax. US GAAP vs foreign accounting standards. And the main question: whether and how SBC should be included in the cost base for intercompany transactions.
Transfer pricing has to deal with multiple and often inconsistent sources of authority:
- The OECD Transfer Pricing Guidelines, the basis for dozens of jurisdictions’ TP regulations around the world, do not explicitly address stock-based compensation in depth. However, they emphasize that all relevant costs should be considered in determining arm's length pricing.
- The U.S. Transfer Pricing Rules (IRC Section 482 and accompanying Regulations) contain the most developed regulations on SBC, given the preponderance of US firms’ use of SBC as a compensation mechanism. Reg. §1.482-7(d)(3) stipulates that SBC must be included in the cost base for Cost Sharing Arrangements, and the principle has been extended to intercompany service cost bases as well. SBC is a hotly contested topic in the US; sparking ongoing litigation between taxpayers and the IRS.
- Other jurisdictions around the world have a wide variation of approaches to SBC, ranging from legally mandatory inclusion in the cost base (Israel), to nondeducibility and skepticism of inclusion (Canada).
Unfortunately, this complexity and ambiguity means that multinational enterprise taxpayers with stock-based compensationmust either adopt a tailored approach or accept risk. Best practices for mitigating such risks include:
- Review local TP regulations for explicit (rare) or otherwise relevant guidance.
- Take a position on whether SBC is part of the cost base in each jurisdiction, considering both TP regulations as well as the Company’s approach to accounting for SBC.
- Prepare robust documentation to support the Company’s position.
- If applicable, assess whether comparables used in TP benchmarking studies include SBC, and make adjustments where necessary.
- Be prepared to handle potential audits and disputes, and to manage double taxation risks.
