Small business market-share strategies and transfer-pricing certainty.

• Author: Hesser, Kirk

Expanding into foreign markets has typically been associated with large businesses that have the capital and resources necessary to accomplish such growth. However, with decreasing communication and transportation costs, many small businesses are also growing internationally. In lieu of independent sales agents or contract manufacturers in foreign markets, expansion plans may include related-party sales offices or manufacturing locations. Further, to penetrate these new markets, small businesses may consider temporarily lowering prices (perhaps incurring losses) on sales of their products relative to prices for otherwise comparable products in the same markets. Or, they may incur temporarily higher marketing costs while penetrating a new foreign market. To the extent that wholly owned or controlled entities are used for such market-share strategies, the transfer-pricing implications are important. In particular, if potential exists for less-than-normal profits or higher-than-normal operating expenses or both for several years, small businesses must determine the allocation of these among parties through transfer-pricing policies.

The final transfer-pricing regulations provide little guidance for implementing market-share strategies. Despite this, taxpayers can expect the transfer-pricing policy behind these types of business strategies to be subject to close scrutiny by taxing authorities in all jurisdictions. For example, in the IRS Guide for International Examiners, examiners are instructed to closely analyze any transfer-pricing arguments that emphasize market penetration. The IRS expects taxpayers to provide contemporaneous documentation substantiating that (1) the time period for the market-share strategy is reasonable (considering the industry and product) and (2) the market-share strategy has economic substance, or a reasonable likelihood exists that it will produce future profits. Further, on audit, the Service's examiners are likely to ask for marketing studies, feasibility studies, etc.

With all of the aforementioned considerations and required documentation, many may consider marketshare strategies to be accessible only to the...