Transfer pricing, the first thing that comes to mind is a large multi-national organization, such as
Apple or Google, that can shift profits to lower taxed jurisdictions. a They can do this because the
parent entity has control over its subsidiaries in multiple countries and can dictate the price of
transferring goods, services, or intellectual property (IP), and thus limit their tax liability by ensuring
that the profits earned from the transfers are taxed at the lowest rates (Seth, 2023). a I believe that
it is important for governments such as the US to continue to maintain rules on the fair valuation of
goods, services and IP being transferred between subsidiaries of an organization, because of the
economic and social impact of unfair transfer pricing practices. a At the same time, I feel that this
practice should provide countries with an incentive to make their tax policies competitive in order
to attract multi-national organizations to do business in their jurisdictions.
I currently live in East Stroudsburg, Pennsylvania with my husband, four children and two dogs. I
also work full-time for a major bank and have been with the company for over 22 years.
This week’s discussion gives us the opportunity to review transfer pricing. Transfer pricing, put in
simplest terms, is a common practice used by companies to transfer goods and services between
subsidiaries, affiliates, or related entities for a set price. This price can be above or below the
market price. Higher prices are used in high-tax jurisdictions to reduce profit, while lower prices are
used in low-tax jurisdictions to increase profit. In other words, companies use transfer pricing to
reduce tax liability.
Section 482 states that the prices charged by one affiliate to another for the exchange of goods and
services should be consistent with what would have been charged if the exchange was made with a
non-affiliate. In the article we read this week, What Facebook and Apple Can Teach You About
Transfer Pricing, we are given an example of what happens when a company is investigated by the
IRS for potentially not pricing a good or service transferred to its affiliate at a fair price. In the
article, Facebook could potentially owe billions for an investigation brought on by the IRS for the
way it moved assets to its Irish subsidiary to reduce the company’s tax liability (Worstall, 2016).
I do not agree with transfer pricing although I understand why companies engage in this practice.
Although transfer pricing creates tax reduction for the companies that engage in it, it creates a
negative economic impact on the countries and societies where these businesses do business.
A transfer price is the price charged between related parties (e.g., a parent company and its
controlled foreign corporation) in an intercompany transaction (McKinley and Owsley, 2013). While
it’s absolutely legal to use the transfer pricing method if it meets the requirements of Regs. Sec. §
1.482-1(b), it often leads to litigation since multinational companies have different judgement and
interpretation of facts when they determine a range of arm’s-length prices (or profits). A great
example would be a tax court case 3M Co. v. Commissioner, in which 3M Company and its Brazilian
subsidiary tried to enter into a license agreement with similar conditions to the other related-party
manufacturing arrangements. However, the Brazilian Patent and Trademark Office, disallowed it by
saying that the royalty rate 3M had offered was too high and not in line with local regulations. As a
result, a much lower royalty was accepted by the parties. In 2006, 3M Brazil paid $5.1 million in
royalties to 3M, in addition to $64.5 million in dividends. There were two primary issues litigated in
the case. The first was whether the IRS could use Section 482 to allocate additional royalty income
to 3M. The second was whether Treas. Reg. Sec. 1.482-1(h)(2), which specifies when and how
foreign legal restrictions will be considered for purposes of a Section 482 adjustment, was invalid.
The Tax Court ruled in Favor of the IRS in a narrow 9-8 decision. The IRS claimed that the arm’s
length standard applies in every case, citing Treasury Regulation Sec. 1.482-1(b). The IRS also
claimed that Treas. Reg. Sec. 1.482-1(h)(2) is a reasonable construction of Section 482, within the
authority Congress delegated to Treasury.
While I see the benefits of the transfer pricing policy, such as cost savings between different
departments of the company, protection from uncertain supply from the vendors, reduction in
income taxes, reductions in custom fees, I also think that transfer pricing opens doors for tax
evasion.
References
3M Co. v. Commissioner, 160 T.C. 3
IRC § 482
McKinley, J., Owsley, J. (2013). Transfer pricing and its effect on financial reporting. Journal of
Accountancy. Retrieved from
https://www.journalofaccountancy.com/issues/2013/oct/20137721.html
Regs. Sec. 1.482-1(b)
Seth, S. (2023). Transfer Pricing: What It Is and How It Works, With Examples. Transfer Pricing: What
It Is and How It Works, With Examples (investopedia.com)
Worstall, T. (2016). What Facebook and Apple Can Teach You About Transfer Pricing. What Facebook
And Apple Can Teach You About Transfer Pricing (forbes.com)
Seth, S. (2023, May 28). Transfer pricing: what is it, how it works, with examples. Retrieved from
Investopedia.com: https://www.investopedia.com/terms/t/transfer-pricing.asp
