Transfer Pricing Issues

Cfo.com has a new article about Internal Revenue Service regulations on transfer pricing. Transfer pricing is a complicated issue, but worth understanding on at least a basic level if you work at all with multinational corporations.

Here's my understanding -- in baby talk -- of what the transfer pricing issue is all about. Revenue agencies want to assure that companies based in their country are not engaged in complicated transactions by which expenses are shifted to high-tax countries, while income is shifted to lower tax countries. Companies that do so have minimized taxable income, while maximizing deductions on an aggregated basis. What this means is that some companies may have failed to charge an arm's length price for transactions with a related entity in another country.

Companies -- at least those in the U.S. -- typically have one of the final four international accounting firms do a transfer pricing study every few years. This helps those companies document the amounts charged between these related entities. If companies charge prices that are not at arm's length, then they will nevertheless be taxed as if the transactions had been at arm's length.

According to the article cited above, the IRS and U.S. Treasury Department have issued new transfer pricing rules that will be effective in January of 2007. The new rules are here. The new rules will likely require more -- and more frequent -- documentation.