Transfer Pricing Between Related Parties

By John M. Tate

Transfer Pricing-these two words should be familiar if your company is involved with international commerce using related parties, such as a subsidiary, a branch office or even a relative’s business.  There has been increasing scrutiny of prices charged between members of a commonly controlled group located in different countries by the United States Internal Revenue Service (IRS) as well as the foreign jurisdiction tax authorities in recent years. The United States Internal Revenue Code (IRC) section 482 requires that related parties charge each other the same prices that unrelated parties would have charged, using the so-called “arms-length” pricing rule.  This rule applies to sales of inventory, fixed assets, services, intellectual property and interest on intercompany loans.  Foreign tax laws generally have similar, but not identical, requirements for the pricing of transactions between related entities.  

The IRS regulations related to IRC section 482 are quite lengthy.  These regulations permit a taxpayer to use any of several specifically described methods to demonstrate that, in fact, the related parties are using arms-length prices for their transactions. The rules for transfers of tangible property and inventory and those for intellectual property and services use similar concepts, but must be separately documented.  Interest must be charged at market rates applicable to the currency of the loan but with several “safe harbor” options available.  The IRS has made extensive amendments to transfer pricing regulations in the last ten years. The most recent change related to intercompany services and became effective for tax year 2007.  More changes to the regulations are anticipated in 2008 and in subsequent years.  

In addition to having the authority to revise the tax due where transfer pricing is deemed to be other than at arm's length, the United States tax law also allows for accuracy related penalties that are punitive and specific to transfer pricing issues. To avoid these penalties, a taxpayer must document through detailed comparisons and analyses that related party transactions are priced under acceptable arms-length principles and must prepare their tax returns using these arms-length prices. Further the taxpayer must have completed their written report documenting that arms-length prices were used by the time the tax return is filed each year.  Again, many foreign counties have similar requirements for documentation of the appropriateness of the pricing used between related parties.

Now, more than ever, it is important to address transfer pricing issues and complete the supporting documentation before a tax return is filed.  In the event of an audit, it allows the taxpayer to effectively present their transfer pricing methodology and thus possibly avoiding severe penalties and costly confrontations with the tax auditors.


About Joseph Decosimo and Company, PLLC
Decosimo has significant experience with international business affairs and has committed a team of professionals to work in this area exclusively. From transfer pricing to captive insurance design, Decosimo provides a full range of advisory services for both international companies conducting business in the United States and domestic companies conducting business abroad.

The nationally recognized Decosimo CPA firm provides Assurance, Litigation Support and Corporate Finance, as well as international and domestic Tax services to public and private corporations. Decosimo is a leading regional CPA firm with nearly 250 professionals and staff. The firm has offices in Chattanooga, Knoxville, Memphis and Nashville, Tenn.; Atlanta and Dalton, Ga.; Cincinnati, Ohio; and the Cayman Islands.