Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. Because of the potential for cross-border controlled transactions to distort taxable income, tax authorities in many countries can adjust intragroup transfer prices that differ from what would have been charged by unrelated enterprises dealing at arm’s length (the arm’s-length principle). The OECD and World Bank recommend intragroup pricing rules based on the arm’s-length principle, and 19 of the 20 members of the G20 have adopted similar measures through bilateral treaties and domestic legislation, regulations, or administrative practice.World Bank pp. 35-51OECD Guidelines 0.15 Countries with transfer pricing legislation generally follow the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations in most respects, although their rules can differ on some important details.
Where adopted, transfer pricing rules allow tax authorities to adjust prices for most cross-border intragroup transactions, including transfers of tangible or intangible property, services, and loans.OECD Guidelines 0.11 For example, a tax authority may increase a company’s taxable income by reducing the price of goods purchased from an affiliated foreign manufacturerOECD Guidelines 1.47-1.48 or raising the royalty the company must charge its foreign subsidiaries for rights to use a proprietary technology or brand name.OECD Guidelines 6.1-6.39 These adjustments are generally calculated using one or more of the transfer pricing methods specified in the OECD guidelinesOECD Guidelines 2.9 and are subject to judicial review or other dispute resolution mechanisms.OECD Guidelines 0.18, 4.1-4.168
Although transfer pricing is sometimes inaccurately presented by commentators as a tax avoidance practice or technique (transfer mispricing), the term refers to a set of substantive and administrative regulatory requirements imposed by governments on certain taxpayers.Falk, Daniel, “Transfer Pricing: Alternative Practical Strategies,” 19 Tax Mgmt. (BNA) Transfer Pricing Report, at 829 (Nov. 18, 2010) However, aggressive intragroup pricing – especially for debt and intangibles – has played a major role in corporate tax avoidance, and it was one of the issues identified when the OECD released its base erosion and profit shifting (BEPS) action plan in 2013. The OECD’s 2015 final BEPS reports called for country-by-country reporting and stricter rules for transfers of risk and intangibles but recommended continued adherence to the arm’s-length principle. These recommendations have been criticized by many taxpayers and professional service firms for departing from established principles and by some academics and advocacy groups for failing to make adequate changes.
Transfer pricing should not be conflated with fraudulent trade mis-invoicing, which is a technique for concealing illicit transfers by reporting falsified prices on invoices submitted to customs officials. “Because they often both involve mispricing, many aggressive tax avoidance schemes by multinational corporations can easily be confused with trade misinvoicing. However, they should be regarded as separate policy problems with separate solutions,” according to Global Financial Integrity, a non-profit research and advocacy group focused on countering illicit financial flows.
In general
Over sixty governments have adopted transfer pricing rules,Several websites provide overviews of transfer pricing regulations by country, such as the Country References on the TP analytics website. which in almost all cases (with the notable exception of Kazakhstan) are based on the arm's-length principle.See, e.g., OECD Guidelines 1.1 et seq., 26 CFR 1.482-1(b) . The rules of nearly all countries permit related parties to set prices in any manner, but permit the tax authorities to adjust those prices (for purposes of computing tax liability) where the prices charged are outside an arm's length range. Most, if not all, governments permit adjustments by the tax authority even where there is no intent to avoid or evade tax.See, e.g., 26 CFR 1.482-1(f)(1)(i). The rules generally require that market level, functions, risks, and terms of sale of unrelated party transactions or activities be reasonably comparable to such items with respect to the related party transactions or profitability being tested.
Adjustment of prices is generally made by adjusting taxable income of all involved related parties within the jurisdiction, as well as adjusting any withholding or other taxes imposed on parties outside the jurisdiction. Such adjustments are generally made after filing of tax returns. For example, if Bigco US charges Bigco Germany for a machine, either the U.S. or German tax authorities may adjust the price upon examination of the respective tax return. Following an adjustment, the taxpayer generally is allowed (at least by the adjusting government) to make payments to reflect the adjusted prices.
Most systems allow use of transfer pricing multiple methods, where such methods are appropriate and are supported by reliable data, to test related party prices. Among the commonly used methods are comparable uncontrolled prices, cost-plus, resale price or markup, and profitability based methods. Many systems differentiate methods of testing goods from those for services or use of property due to inherent differences in business aspects of such broad types of transactions. Some systems provide mechanisms for sharing or allocation of costs of acquiring assets (including intangible assets) among related parties in a manner designed to reduce tax controversy. Most governments have granted authorization to their tax authorities to adjust prices charged between related parties.See, e.g., law of the U.S. at 26 USC 482, UK at ICTA88/s770, Canada. Note that OECD Guidelines leave this issue to member governments. Many such authorizations, including those of the United States, United Kingdom, Canada, and Germany, allow domestic as well as international adjustments. Some authorizations apply only internationally.
In addition, most systems recognize that an arm's length price may not be a particular price point but rather a range of prices. Some systems provide measures for evaluating whether a price within such range is considered arm's length, such as the interquartile range used in U.S. regulations. Significant deviation among points in the range may indicate lack of reliability of data.OECD Guidelines 1.45, 41; 26 CFR 1.482-1(e). Reliability is generally considered to be improved by use of multiple year data.OECD Guidelines 1.49-1.51; 26 CFR 1.482-1(f)(2)(iii).
Most rules require that the tax authorities consider actual transactions between parties, and permit adjustment only to actual transactions.OECD Guidelines 1.36-1.41. and 26 CFR 1.482-1(f)(2)(ii). Multiple transactions may be aggregated or tested separately, and testing may use multiple year data. In addition, transactions whose economic substance differs materially from their form may be recharacterized under the laws of many systems to follow the economic substance.
Transfer pricing adjustments have been a feature of many tax systems since the 1930s. The United States led the development of detailed, comprehensive transfer pricing guidelines with a White Paper in 1988 and proposals in 1990–1992, which ultimately became regulations in 1994.TD 8552, 1994-2 C.B. 93. In 1995, the OECD issued its transfer pricing guidelines which it expanded in 1996 and 2010.For a history of the earlier OECD efforts, see paper presented to the United Nations in 2001. The two sets of guidelines are broadly similar and contain certain principles followed by many countries. The OECD guidelines have been formally adopted by many European Union countries with little or no modification.
Comparability
Most rules provide standards for when unrelated party prices, transactions, profitability or other items are considered sufficiently comparable in testing related party items.OECD Guidelines 1.15, et seq., 26 CFR 1.482-1(d). Such standards typically require that data used in comparisons be reliable and that the means used to compare produce a reliable result. The U.S. and OECD rules require that reliable adjustments must be made for all differences (if any) between related party items and purported comparables that could materially affect the condition being examined.OECD Guidelines 1.15, 26 CFR 1.482-1(d)(2). Where such reliable adjustments cannot be made, the reliability of the comparison is in doubt. Comparability of tested prices with uncontrolled prices is generally considered enhanced by use of multiple data. Transactions not undertaken in the ordinary course of business generally are not considered to be comparable to those taken in the ordinary course of business. Among the factors that must be considered in determining comparability are:OECD Guidelines 2022 1.33-1.36; 26 CFR 1.482-1(d). the contractual terms of the transaction, either formalized in written contract or not; the functions performed by each of the parties to the transaction taking into account assets used and risks assumed (so-called Functions, Assets, and Risks Analysis or FAR Analysis); the characteristics of property transferred or services provided, as difference in quality or the extent of service may affect price; the economic circumstances of the parties and of the market in which the parties operate, e.g. the geographic location, the extent of competition, and consumer purchasing power may result in different pricing even for the same goods and services; and the business strategies pursued by the parties, e.g. start-ups and mature businesses may have different pricing strategy, whether to focus on customer acquisition or profitability.
Nature of property or services
Comparability is best achieved where identical items are compared. However, in some cases it is possible to make reliable adjustments for differences in the particular items, such as differences in features or quality.OECD Guidelines 1.19, 2.7, 26 CFR 1.482-3(b)(2)(ii)(A), 26 CFR 1.482-9(c)(2)(ii)(A). For example, gold prices might be adjusted based on the weight of the actual gold (one ounce of 10 carat gold would be half the price of one ounce of 20 carat gold).
Functions and risks
Buyers and sellers may perform different functions related to the exchange and undertake different risks. For example, a seller of a machine may or may not provide a warranty. The price a buyer would pay will be affected by this difference. Among the functions and risks that may impact prices are:OECD Guidelines 1.20-1.27, 26 CFR 1.482-1(d)(3)(i) and (iii). Product development Manufacturing and assembly Marketing and advertising Transportation and warehousing Credit risk Product obsolescence risk Market and entrepreneurial risks Collection risk Financial and currency risks Company- or industry-specific items
Terms of sale
Manner and terms of sale may have a material impact on price.OECD Guidelines 1.28, 1.29, 26 CFR 1.482-1(d)(3)(ii). For example, buyers will pay more if they can defer payment and buy in smaller quantities. Terms that may impact price include payment timing, warranty, volume discounts, duration of rights to use of the product, form of consideration, etc.
Market level, economic conditions and geography