As you conduct business internationally, one of the things to consider is transfer pricing. This key accounting practice is important to understand, as it impacts various activities—from the day-to-day tasks to the higher-value matters like sales and research.
If you currently do business internationally or are considering it, a basic knowledge of what transfer pricing is and how it can affect your business is vital.
The Definition of Transfer Pricing
Transfer pricing is the price paid in transactions between related parties. This can include:
Transfer pricing is used to attribute a company’s net profit (or loss) on the above transactions. An essential component is the idea of each related entity’s “fair” share of net profit. This term looks at how countries with taxable entities recognize their fair share of operating profit between related entities. “Fairness” is based upon the functions performed, risks assumed and assets utilized by each entity. If this seems unclear, it’s because it is. In order to truly determine fairness, a functional analysis must be conducted.
Functional analyses look at questions such as:
Why is Transfer Pricing Important?
Tax rates and rules vary by country, which may lead to friction between multinational firms and tax authorities across various jurisdictions.
|Multinational firms seek to:|
|Minimize effective tax rate|
|Repatriate cash effectively|
|Avoid double taxation|
|Tax Authorities seek to:|
|Maximize tax revenue|
|Prevent tax avoidance|
|Prevent profit sharing|
|Enforce arm's length intercompany pricing|
The goal of transfer pricing is to proactively address tax confusion happening with companies doing business internationally. It can help reduce the compliance risk and potentially minimize the net effective global tax burden of companies.
There is significant documentation needed for conducting transfer pricing. Trained international tax specialists can help companies with these documentation requirements as well as a transfer pricing analysis.
The Effect of Tax Reform on Transfer Pricing
The impact of the 2017 Tax Cuts and Jobs Act was far-reaching for businesses. Direct impact to the U.S. transfer pricing regulations was minimal, with the one true change being an expanded definition of intangible property.
However, other pieces of the tax reform legislation have a large indirect effect on transfer pricing options, including:
These reforms have led to a lower rate applied to a broader base of taxable income for multinational companies. As a result, companies should strongly consider:
While it does depend on the other country you’re conducting business in, the new tax legislation has given multinational organizations a new opportunity to move key functions and services back into the United States.
Next Steps to Consider
Transfer pricing has always been a key area to consider if you conduct business internationally. The impact of the tax reform legislation has made transfer pricing even more imperative. While the incentives may be vast, it is also important to remember the extensive compliance and documentation required within transfer pricing.
A transfer pricing analysis will allow your business to look at various options to minimize tax burden globally. Utilizing a business advisor who is trained in international tax will enable you to see the impact of transfer pricing while also minimizing compliance burden.
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