Blockchain technology firms' transfer-pricing issues.

• Author: Amini, Farnaz

Businesses increasingly recognize the value of blockchain technology. Software applications based on blockchain are being offered to serve industries spanning from supply chain management, logistics, and manufacturing to insurance, financial services, and health care. As block-chain technology companies grow and expand globally, their intercompany (i.e., related-party) group dealings will increase and they will need to carefully consider transfer-pricing issues.

Like other software companies, blockchain companies may seek to vertically integrate in order to reduce costs, implement more effective supply chains, and increase market share. As such, some blockchain companies may develop into global groups with recurring intercompany arrangements/transactions, which will have transfer-pricing implications. The following discussion presents some of the transfer-pricing considerations for blockchain companies (and other software firms) to consider as they grow and expand across jurisdictions.

Blockchain basics

Blockchain, an open-source technology, was introduced by Satoshi Nakamoto in the 2008 bitcoin white paper. (1) A block-chain is a distributed ledger system that allows for the creation of an unalterable record of information from transactions, which provides greater transparency, traceability, and security in executing transactions. A blockchain is managed by a peer-to-peer network of computers that simultaneously verify and record transactions and maintain a copy of the distributed ledger. Since its introduction as bitcoin's underlying platform, blockchain has proved to have applications for the maintenance of digital records well beyond the cryptocurrency space for the broader financial services industry, for technology companies, and for companies seeking to increase competitiveness through implementing more efficient supply chains.

Given the widespread applicability of blockchain technologies for improving business operations and supply chain management, there has been a growth in blockchain development companies, and the number of patents related to new blockchain technologies has risen dramatically since 2016. Software applications may include blockchain developer tools, enterprise solutions, custom blockchain development services, token development, and blockchain ecosystems, to name a few. The demand for blockchain platform solutions is anticipated to increase as the applicability of the blockchain platform for businesses becomes more widely known and accepted.

Transfer pricing

The valuation, for income tax purposes, of cross-border transactions between associated enterprises is based on the "arm's-length principle" under both the Sec. 482 regulations (commonly referred to as the transfer-pricing rules) and the Organisation for Economic Co-operation and Development's 2017 Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations (OECD Guidelines). (2) A controlled (i.e., related-party) transaction meets the arm's-length principle if the transaction's results are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances. (3) (The arm's-length principle has been the subject of much discussion in recent years, and the OECD is leading a global tax reform effort hoping to transform the applicable international taxation framework.)

Key to the application of the arm's-length principle in determining the valuation of transfers of physical and intangible goods and the provision of services between related parties is the determination of the transfer prices of the transactions. Transfer prices are significant because they determine the taxable income of related parties in different tax jurisdictions.

To determine transfer prices for a transaction, a transfer-pricing method appropriate to the transaction is used. To decide which method is appropriate, a functional analysis should be performed that includes studies of the functions performed, assets used, and risks borne by each...