We recently received a new client to perform a transfer pricing study; and the reasons that the client engaged us for provided a comprehensive explanation for such studies, so I am sharing it here. Marina Gentile is our market leader for Withum’s Global Transfer Pricing Strategies practice and she was involved with that client and assisted with this blog.
Background
The client is an international company that is growing exponentially and is a Big 4 audit client that was being pressured by them to obtain an independent transfer pricing study.
What Is Transfer Pricing?
A transfer pricing study assures that arm’s length pricing is incorporated in intercompany pricing and transactions. At the end of the day, the company-wide transactions are consolidated in one audited financial statement and any differences or inconsistencies are eliminated so this would have no effect on the overall financial statements. However, United States and foreign tax authorities focus on pre-consolidated results for the entities and operations within their jurisdictions. Related companies are expected to operate as if they were independent parties. That means pricing should be done at market rates with reasonable profits included in the transactions. The reason for this concern is that international companies (and even domestic companies operating in multi-states) might try to shift profits into lower-taxed jurisdictions from higher-taxed countries and states. If this is done flagrantly, then significant tax liabilities could result. Further, there is a concern that intercompany balances could be accruing indefinitely rather than being settled annually.
What the Study Does
The study examines the cost and overhead structure of the company and its many subsidiaries. It develops a “FAR” analysis, assessing the Functions performed, Assets employed (especially intangibles), and Risks incurred by one affiliated entity relative to the others. The study then provides the market benchmark companies or transactions – comparables – that are used to determine what would be appropriate pricing when considering the local market conditions. If done properly these studies provide strong and credible support should an audit arise, and protects the taxpayer against IRS penalties that could be 20% or 40% of the income adjustment. It also provides assurance to the financial auditor that the liability from any audit would not be material to the financial statements as a whole, and that there is no uncertain tax position in that regard.
Added Studies
Because of the nature of the thoroughness of the study, many clients expand the study to include cost and overhead allocation studies for specific segments of the company. This ensures that affiliated companies are allocating their costs properly based on key drivers of the business before applying the recommended arm’s length profit element to the transaction.
How the Study is Done
After a preliminary kick-off call for a discovery phase, the transfer pricing professionals determine the best transfer pricing strategy and begin implementation. Much of the work is done virtually using data mining and artificial intelligence software. Also, sophisticated sampling models are prepared so most of the testing and review is performed on a test basis.
Frequency of the Studies
Large companies usually have these done annually. Very small companies usually would have the follow-up studies done every few years or would opt to have an analyses-only approach so they have arm’s length pricing to include in their accounting systems, without the higher cost that comes with the bells and whistles of a full study. Some companies want it initially to provide comfort that their systems and procedures are proper and forgo follow-ups. Fees for small companies can be quite low, and the fees for large companies are very competitive and do not seem to present a barrier to the studies.
Call us
If you have any questions, or think you might need such a study or just want to ask about it, you can contact Marina directly or contact me with more general questions. For some added information, here is a link to a previous blog on Transfer Pricing.
If you have any business or financial issues you want to discuss please do not hesitate to contact me at [email protected].
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