Transfer pricing rules
The US transfer pricing (TP) statute is expressed in the Internal Revenue Code in Section (IRC) 482.
The US TP rules apply to all taxpayers, including US branches of overseas companies.
The US TP rules generally authorize the Internal Revenue Service (‘IRS’) to allocate income, deductions, credits, and allowances among related business entities; limited opportunities exist for taxpayer application of IRC 482 to report an arm’s length result after the filing if its tax return.
The regulations under IRC section 482 are based on the arm’s length principle and are consistent with the OECD Guidelines.
The regulations are principles-based rather than formulaic in approach.
The preparation of transfer pricing documentation is not mandatory, but the preparation of documentation may be advisable to protect against penalties. If the IRS requests transfer pricing documentation, the taxpayer has 30 days to respond.
The US has not adopted the OECD’s Master File and Local File concept. However, for larger taxpayer groups (over €750m) the US has implemented Country by Country Reporting (CbCR).
OECD guidance
IRC 482 does not explicitly incorporate the OECD Guidelines, but IRC 482 is consistent with the OECD Guidelines.
Transfer pricing methods
There is no hierarchy of methods, but the method used must be applied in a manner consistent with the functional and risk profile of the tested entity.
For transfers of tangible property, the most appropriate pricing method should be selected to provide the most reliable measure of an arm’s length result in each case. The comparable uncontrolled price, resale price, cost plus, comparable profits method, and profit split methods are all acceptable. Other methods can also be used for tangible property transactions if justifiable and appropriate.
For transfers of intangible property, the comparable uncontrolled transactions, comparable profits method, and profit split methods are acceptable. Other methods can also be used if justifiable and appropriate.
For controlled services transactions, the comparable uncontrolled services price, gross services margin method, services cost plus method, comparable profits method, services cost method, and profit split methods are all acceptable. Other methods can also be used if justifiable and appropriate.
For cost-sharing platform contribution transactions, the comparable uncontrolled transaction method, income method, residual profit split method, acquisition price method, and market capitalization method are all acceptable. Other methods can be used if justifiable and appropriate.
Transfer pricing documentation
Preparation of transfer pricing documentation
Transfer pricing documentation is not specifically required under US TP rules. However, documentation created by the time the taxpayer files its tax return that shows that a taxpayer reasonably used a specified or unspecified method to determine its transfer price can obviate the imposition of the transfer pricing penalty.
Documentation is an annual concept, and each tax year stands on its own. Taxpayers must maintain two categories of documentation — principal documents and background documents. The principal documents include:
- an overview of the taxpayer’s business, including an analysis of the economic and legal factors affecting pricing;
- a description of the taxpayer’s organizational structure covering all related parties engaged in transactions potentially relevant under IRC 482;
- any documentation specifically required by the 482 regulations (e.g., documents related to a qualified cost-sharing arrangement);
- a description of the method selected and an explanation of why that method was selected;
- a description of the alternative methods that were considered and an explanation of why they were not selected;
- a description of controlled transactions and any internal data used to analyze those transactions;
- a description of the comparables that were used, how comparability was evaluated, and what adjustments (if any) were made;
- an explanation of the economic analysis and projections relied upon in developing the method;
- a description or summary of any relevant data obtained after the end of the tax year and before filing a tax return; and
- a general index of the principal and background documents and a description of the record-keeping system used for cataloging and accessing those documents.
All principal documents must be furnished to the IRS within 30 days of a request.
Background documents support the assumptions, conclusions, and positions contained in the principal documents and demonstrate how the taxpayer’s method was selected and applied to provide the most reliable measure of an arm’s length result. They include original entry books and records, profit and loss statements, and other documents not specifically listed. Background documents need not be provided to the IRS unless they are specifically requested.
The US has also introduced CbCR (Country by Country Reporting) regulations for groups with revenues over €750m
Master and local file
The US does not require the taxpayers to prepare Master and Local files.
Penalties
IRC 6662(e) and (h) sets forth penalties of 20% and 40% for certain increases in US corporate income tax attributable to IRC 482 adjustments.
Adjustments are excluded from the net IRC 482 adjustment calculation if the taxpayer applies a specified or unspecified method under the best method rule and satisfies the documentation requirement.
In addition to showing that a specified or unspecified method was reasonably applied to determine the transfer price, a taxpayer can avoid the imposition of the transfer pricing penalty only if documentation is created by the time the taxpayer files its return for each specific year.
All principal documents must be furnished to the IRS within 30 days of a request.
IRC 6038A imposes an obligation on US corporations that are at least 25 percent foreign-owned to file an annual information return to report transactions with related parties. A $25,000 penalty applies to each failure to file.
Non-compliance with CbCR and notification requirements may attract penalties of $25,000 or more as a failure to provide information about a foreign business entity.
Economic analysis and how to demonstrate an arm’s length result
Whether the taxpayer’s use of a particular method was reasonable is determined by all facts and circumstances. Factors relevant to this determination include:
- the experience and knowledge of the taxpayer;
- the extent to which the taxpayer obtained accurate data and analyzed it reasonably;
- the extent to which the taxpayer used the most current reliable data available before the end of the tax year in question;
- the extent to which the taxpayer followed relevant requirements in the section 482 regulations concerning the application of the methods;
- the extent to which the taxpayer reasonably relied on a study or other analysis prepared by a qualified professional;
- if the taxpayer used more than one uncontrolled comparable, whether the taxpayer arbitrarily selected a result that corresponds to an extreme point in the range;
- the extent to which the taxpayer relied on a transfer pricing methodology developed and applied under an advance pricing agreement for a prior year, provided that the facts and circumstances have not materially changed; and
- the size of the net transfer pricing adjustment about the size of the controlled transaction out of which the adjustment arose.
Advance Pricing Agreements (APAs), dispute avoidance and resolution
An advance pricing agreement (APA) is an agreement negotiated between the taxpayer and one or more tax authorities about the taxpayer’s facts, methodology, and arm’s length range over a specified prospective period. US APAs generally cover a term of five prospective years, but ‘rollback’ can be used to address the same issue in previous tax years and additional prospective years can be added, as appropriate.
The US has negotiated over 2,200 APAs since 1991. On average, the IRS has closed over 100 APA cases annually for the last five years. The average time to complete an APA in 2021 was 39 months.
IRS strongly prefers bilateral APAs over unilateral APAs.
The user fee for APAs is $113,500 for a regular APA request, $62,000 for a renewal APA, or $54,000 for a small case APA.
The US has an extensive treaty network, and the Mutual Agreement Procedure (MAP) is generally available when double tax occurs. There is no user fee for MAP.
The US allows for arbitration if an agreement cannot be achieved. The US has included a binding arbitration clause in its treaties with Germany, Belgium, Canada, France, Japan, Spain, and Switzerland. The US has not ratified the OECD Multilateral Instrument (MLI) that includes support for arbitration.
After making a transfer pricing allocation, the IRS will take into account appropriate collateral adjustments, including correlative allocations and conforming adjustments. Correlative allocations are made only after there has been a final determination concerning a transfer pricing allocation. Conforming adjustments may involve the treatment of an allocated amount as a dividend or a capital contribution, or, in appropriate cases, repayment of the allocated amount without further income tax consequences.
Exemptions
The US has no exemptions other than a de minimis exception for underpayments of less than $10,000.