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Transfer Pricing 101

There’s no denying transfer pricing is its own complex niche in the world of international tax, and if you’re not totally clear on what it is, you’re not alone.

A transfer price is the price charged for goods or services by one entity of a company to another. In cross-border transfer pricing, those two entities belong to a multinational enterprise (MNE) and are in different countries. Pricing between those related parties must be at arm’s length—or in other words, what an independent company would charge another independent company for the same goods or services. Read: fair market value.

While the premise seems straightforward enough, transfer pricing is complicated. Arm’s-length pricing is a moving target—one that multinational companies and tax authorities often have trouble agreeing on, which can be bad news for the MNE group. Cross-border pricing affects profits, and in which jurisdiction those profits land dictates just how much tax revenue those tax authorities can collect.

Transfer Pricing Compliance

Now that you understand what transfer pricing is and about the arm’s-length principle, there’s more. Given that the arm’s-length principle is subjective, MNEs have to defend their pricing and how they came to determine that it is in fact arm’s length—and that’s what transfer-pricing compliance is all about.

Transfer-pricing documentation requirements vary between jurisdictions, which makes transfer-pricing compliance a head-spinning exercise. Back in 2015, the Organization for Economic Cooperation and Development (OECD) tried to help by introducing Base Erosion and Profit Shifting Action 13 (BEPS Action 13)—a three-tier transfer-pricing documentation recommendation that includes a master file (an overview of the MNE group), a local file (a description of the local entity’s involvement in the transfer pricing transaction), and the country-by-country report (a report that breaks down a group’s financials jurisdiction by jurisdiction). The problem? Not every country adopted BEPS Action 13—some adopted parts of it, others made additions to it—so, one generic report just won’t do. In fact, a single transfer-pricing transaction means a mountain of paperwork.

Keeping track of global jurisdictions’ documentation requirements is one of the fundamental challenges of transfer pricing, and many MNEs rely on technology as a solution. Though, no matter where you have operations, the goal of that documentation is the same: To defend your arm’s-length pricing. Take those documentation requirements seriously, because if tax authorities question your transfer prices, they can adjust them, causing your taxable income to grow—and then there’s the bill for millions of dollars in underpaid taxes. Add to that steep penalties—and maybe double-taxation—you can see why it pays to get it right the first time around.

Want to learn more about transfer pricing compliance? Sign up for CrossBorder Solutions’ free Transfer Pricing University.