TRANSFER PRICING: A Truly Global Concern.

• Author: Felgran, Steven D.
• Position: Multinational corporations

As business continue globalization efforts and fiscal authorities become increasingly concerned with claiming their fair share of tax revenues transfer pricing has evolved from primarily a United States' concern to a truly global one.

Numerous tax authorities have followed the lead of the Internal Revenue Service (IRS), enforcing the "arm's length standard" for transfer pricing by means of documentation requirements with penalties for noncompliance.

This heightened scrutiny has caused multinational corporations to face increased risk of transfer pricing audits and income adjustments, particularly in the U.S., Canada, the United Kingdom, Germany, France and Japan. The introduction of the euro has further increased exposure, due to the greater pricing transparency caused by a single European currency.

Global transfer pricing documentation has become increasingly important as multinational corporations need to document that their multiple transfer prices are consistent with the arm's length standard. Taxpayers perform detailed documentation studies in order to show compliance with rules and to avoid penalties in numerous jurisdictions. As the arm's length principle underlies the transfer pricing regulations of most tax jurisdictions, global documentation provides a consistent and effective solution that can be efficiently prepared.

Taxpayers now have the option of using state-of-the-art software programs as a management tool to manage transfer pricing systems and possibly reduce their company's effective tax rate. Software can be used to analyze complex transfer prices quickly and generate country specific or global documentation.

U.S. and OECD Requirements

The U.S. government was the first to enforce the arm's length standard as the overarching principle in setting transfer prices when, in 1994, the IRS issued final regulations accompanying section 482 of the Internal Revenue Code requiring that related party transactions meet the standard. A transaction meets the standard if its results are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in a comparable transaction under comparable circumstances.

The final penalty regulations accompanying section 6662 became effective in 1995 and provide that valuation misstatement penalties can be imposed for failure to comply with the section 482 regulations. The IRS has authority, in certain circumstances, to reallocate income among related parties if it determines that such reallocation is necessary to clearly reflect income. Such penalties may be up to 40 percent of the additional taxes that result from income adjustments. Taxpayers can avoid penalties for transfer pricing adjustments by complying with the standard, reporting arm's length results on their income tax returns, contemporaneously documenting their transfer pricing using methods described in the section 482 regulations...