What is transfer pricing?

Definition of Transfer Pricing in International Taxation

Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. In the context of international taxation, transfer pricing involves setting, analyzing, and adjusting charges made between related parties for goods, services, or use of property (including intangible property).

Key Aspects of Transfer Pricing:

Arm's Length Principle:

The fundamental concept in transfer pricing is the arm's length principle, which suggests that the amount charged in a controlled transaction between related parties should be the same as if the transaction had been between unrelated parties under similar circumstances.

Transfer Pricing Guidelines:

The OECD Transfer Pricing Guidelines provide guidance on the application of the arm's length principle. These guidelines are widely accepted and followed by many countries in developing their own transfer pricing rules.

Documentation and Compliance:

Taxpayers are required to maintain and provide documentation that substantiates their transfer pricing policies align with the arm's length principle. The IRS provides best practices for transfer pricing documentation to avoid penalties under Internal Revenue Code § 6662(e).

Penalties and Adjustments:

If transfer prices are not set in accordance with the arm's length principle, tax authorities may impose adjustments, resulting in additional tax, interest, and penalties. The IRS outlines penalties for substantial or gross valuation misstatements due to transfer pricing adjustments.

Global Developments:

The OECD's Base Erosion and Profit Shifting (BEPS) project, including Actions 8-10 and Action 13, has led to significant changes in transfer pricing documentation and reporting requirements, emphasizing the alignment of transfer pricing outcomes with value creation.

Country-Specific Regulations:

Countries may have specific transfer pricing regulations that align with the OECD guidelines but also reflect local legislative and economic considerations. For example, Brazil's adoption of OECD transfer pricing rules will impact international businesses and their compliance practices.

Importance of Transfer Pricing:

• Tax Revenue Protection: Ensures that countries receive their fair share of tax revenues from multinational enterprises.
• Prevention of Tax Evasion: Discourages tax evasion through manipulation of intercompany pricing.
• Risk Management: Helps companies manage tax risks and avoid costly audits and disputes with tax authorities.

Transfer pricing is a complex area of tax law, requiring multinational enterprises to carefully consider their intercompany transactions and comply with both domestic and international rules and guidelines.