A transfer price is the price charged for goods, services or intangibles that are sold or transferred between related legal entities within a multinational enterprise. Transfer pricing regulations require that a transfer price be arm’s length, meaning that the transfer price must be consistent with the price that would have been charged to an unrelated party.
Though transfer pricing regulations have long been in place across the globe, there have been several recent developments that have made transfer pricing one of the riskiest areas for multinational companies from a compliance and tax planning standpoint.
Within the past five years, the IRS has created the leadership position of Transfer Pricing Director. The Transfer Pricing Director sets transfer pricing policy in IRS audits and works with Chief Counsel to develop transfer pricing litigation strategy. A Chief Economist position was also created to assist the Transfer Pricing Director in setting IRS-wide transfer pricing policy. The IRS has also added staff to expand its international audit coverage and transfer pricing specialists. As a result, the IRS is increasing its audits of transfer pricing of multinational companies, both large and small.
The U.S. Treasury Department was also actively engaged in the OECD’s Base Erosion and Profit Shifting (“BEPS”) project. BEPS is the practice of artificially shifting income into tax-advantaged environments, generally through the abuse of transfer pricing. A coherent BEPS Action Plan was approved by the G20 Finance Ministers in November 2015. The BEPS Action Plan identified 15 key areas to combat multinational corporation tax avoidance.
Legislation around the BEPS Action Plan has been taking shape. Specifically, Action 13 provides guidance on transfer pricing documentation that includes a master file, a local file, and a country-by-country report. The US Senate Finance Committee and the House Ways and Means Subcommittee on Tax Policy held separate hearings on BEPS in early December 2015. On December 21, 2015, the IRS released proposed regulations requiring annual country-by-country reporting by US parents of multinationals. The regulations require multinational enterprises to provide information on a country-by-country basis related to the multinational group’s income and taxes paid, as well as indicators of the location of economic activity within the group.
Even if the US does not implement the country-by-country reporting, or delays implementation, US multinational companies will be required to file reports if the group includes entities with operations in a foreign country in which country-by-country requirements have been implemented. Countries within the European Union are taking the lead on instituting reporting requirements. The Netherlands, Belgium, Spain, France Poland and Germany have already introduced or passed legislation that increases the transfer pricing reporting requirements. Mexico and Brazil have also introduced legislation related to the BEPS Action Plan, with more countries likely to follow suit.
Though large companies, such as Coca-Cola, Glaxo-SmithKline, Microsoft, Apple, Amazon, and Starbucks have made headlines related to transfer pricing disputes, the increased scrutiny by global tax authorities will also have an impact on smaller companies that have multinational operations.
The OECD BEPS Action Plan and subsequent legislation marks a defining moment for transfer pricing compliance. Multinational companies will have to make significant changes to manage the additional compliance requirements. Tax executives should work with their advisors to get out in front of the reporting requirements, which include increased audit scrutiny, country-by-country reporting and new anti-avoidance legislation.
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