The United States of America has been one of the first countries in applying Transfer Pricing. This article provides a brief overview of the legislation in this area, starting with a definition of Transfer Pricing, the cases of linkage, valuation methods, accurate documentation, and sanctions for non-compliance.
The United States of America was one of the first countries along Great Britain to incorporate the Transfer Pricing rules more than eight decades ago, and these rules have evolved as time goes by.
Currently, Transfer Pricing legislation in the United States is framed by Section 482 of the U.S. Tax Code and Section 6662.
They are also regulated by Treasury Regulations 1.482, 1.6662, 1.6038A, and 1.6038C and Revenue Procedures Nos. 99-32, 2015-40, 2015-41, 2007-13 and 2005-46.
In 2017, new tax reforms were approved, including some transfer pricing regulations. The “Tax Reduction and Jobs Act” gave rise to this tax reform, establishing provisions related to Base Erosion and Anti-Abuse Tax, Foreign Derived Intangible Income, Global Intangible Low Taxed Income, Section 250, and 951A of the Internal Revenue Code.
Definition of Transfer Pricing
Transfer pricing is an accounting practice that consists of the purchase and sale price of goods and/or services provided between companies and allows the pricing of goods and services exchanged between subsidiaries, affiliates, or commonly controlled companies that are part of the same larger enterprise.
Based on the Arm’s Length Principle, it makes the Related Parties pay income tax in the country where the profit is generated, avoids the transfer of profits to countries of lower or zero taxation regimes by avoiding price manipulation, and analyzes the comparability through a working methodology that checks whether transactions between Related Parties are at market value as if they had been sold or purchased from an unrelated company to avoid paying an additional income tax rate.
Arm’s Length Principle
The Arm’s Length principle regulates transfer pricing, based on prices agreed between related parties are at market value.
The transfer pricing legislation of the United States of America has adopted it in its Treasury Regulation §§1.482-1 to 1.482-9.
Thus, to determine the actual taxable income of a controlled taxpayer, this must follow the Arm’s Length principle to verify whether the results of the transaction are consistent with those that would have been agreed upon by uncontrolled or independent parties.
Definition of Related Parties in the United States of America
Under Treasury Regulation §1.482-1(i)(5), a related party or controlled taxpayer to any of two or more taxpayers who are directly or indirectly owned or controlled by the same interests.
The taxpayer who exercises ownership or control over the other taxpayers is included within the linkage.
In addition, the term control includes any type of control, whether direct or indirect, legally enforceable or not, and in any manner that can be exercised, including control that comes from the joint actions of two or more taxpayers acting with a single common objective or purpose.
Taxpayers who exert property or control over the others, the former are included in the linkage.
Thus, under Treasury Regulation §1.482-1(i)(4), a presumption of control arises if income or deductions have been arbitrarily shifted.
Transfer Pricing Methods in the United States of America
Transfer Pricing methods in the American Legislation are governed by Treasury Reg. §§1.482-3(a), -4(a), -7(g) (1), and -9(a).
The methods depend on the type of transaction to be analyzed to ascertain whether the Arm’s Length principle is met.
Thus, in the case of transfer of tangible property, one of the following methods may be used:
- Comparable Uncontrolled Price Method (CUP)
- Resale Price Method (RPM)
- Cost Plus Method (CPM)
- Comparable Profit Method (CPM)
- Profit-Sharing Method (comparable and residual)
Also, in the case of a transfer of an intangible asset, the American legislation provides the following methods:
- Comparable Uncontrolled Price Method (CUP)
- Comparable Profit Method (CPM)
- Profit-Sharing Method (comparable and residual)
- Other methods not specified
Regarding services performed among related parties, the U.S. transfer pricing standard identifies the following methods:
- Service Cost Method
- Comparable Price of Uncontrolled Service Method.
- Gross Service Margin Method.
- Service Added Cost Method.
- Comparable Profit Method.
- Profit-Sharing Method
The taxpayer shall choose the best method for the analysis of the related party transaction.
Transfer Pricing Documentation in the United States of America
The taxpayer who performs transactions with related parties must have documentation that proves the agreed values being according to the Arm’s Length principle, in order to be filed to the Internal Revenue Service (IRS) when required.
Such documentation shall contain the following information:
- A general description of the taxpayer’s business or activity.
- An organizational description of the taxpayer’s structure.
- Specific information depending on the type of transaction as required by U.S. Transfer Pricing rules.
- A description and explanation of the selection of the method used in a reasonable manner.
- Description and amounts of related party transactions.
- Analysis of related party transactions.
- A description of the comparable transactions used.
- A summary of any relevant data obtained after the end of the tax year and before filing the tax.
Such information must be filed to the IRS within 30 days of being requested.
It should also be noted that the aforementioned documentation must be available for any transaction among related parties because the U.S. Transfer Pricing legislation has not established exception thresholds.
Country by Country Report Statement in the United States of America
The Transfer Pricing regime in the United States of America has incorporated the third level of documentation for this matter, set by Action 13 of the OECD BEPS Plan.
Thus, Treasury Reg. § 1.6038-4 states that every parent of a U.S. multinational group must file a Country-by-Country Report (CbC Report).
Nonetheless, they will be exempt from the affidavit if the annual income of the Multinational Group is less than $850,000,000.00 under Treasury Reg. § 1.6038-4 (h).
This report must be filed on Form 8975, which must contain information on each of the entities of the group, such as their identification on each of their jurisdictions, and financial and tax information such as income generated, taxes paid, or accumulated losses.
IRS Transfer Pricing Procedures
The IRS has been implementing guidelines to have better practices regarding Transfer Pricing.
Thus, in 2018 this Tax Administration issued the “Transfer Pricing Examination Process“ providing a framework and guidance for the examination of these.
Sanctions for Transfer Pricing Non-Compliance in the United States of America
Transfer Pricing sanctions are governed by Section 6662(e)(3) of the United States Tax Code.
Thus, if the IRS observes that the prices agreed among related parties are not under the Arm’s Length Principle, the former may impose a fine of up to 20% if the price is 200% higher or less than 50% of the price that should have been agreed based thereon.
This fine will increase to 40% if the Transfer Price is 400% higher or 25% lower than the Arm’s Length Principle.
The sanction may only be imposed when the prices comply with the thresholds quoted above. Nonetheless, the taxpayer may be exempted if he demonstrates a reasonable cause by fixing such a declared price through the documentation mentioned above.
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