Transfer pricing is one of the most important issues in international tax, and one closely watched by taxing authorities for evidence of wrongdoing or actions with nefarious aims.
Transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a parent company, the cost of those goods paid by the parent to the subsidiary is the transfer price.
In vertically integrated multinational companies, transfer pricing is used for two purposes: compliance with countries’ tax rules and internal management and control.
According to the Organization for Economic Co-operation and Development (OECD), 70 percent of international trade happens within, rather than between, multinationals: that is, across national boundaries but within the same corporate group.
Last fall the OECD issued a series of recommendations aimed at stopping large companies in many industries from using complex but legal structures to avoid paying hundreds of billions of dollars in corporate income taxes every year. Most recently, Google paid $185 million to settle a tax dispute with Britain, and Apple reach an agreement with Italy’s tax authorities to pay $343 million to settle a tax dispute.
Google’s tax deal in the U.K. is the latest sign that big corporations are moving to change their tax practices amid of a shake-up in global tax rules, according to a recent Wall Street Journal report.
How should companies account for dual-rate transfer pricing?
Here in the U.S. in September 2015, I testified as a management accounting expert for a global power management company in a case brought by the Commissioner of Internal Revenue (IRS).
The U.S. Tax Court case centers on allegations that the firm violated advanced pricing agreements with the IRS covering transactions between the firm’s offshore manufacturing operations and U.S. customers, including its U.S. assembly plants. The judge is expected to rule in the case this spring.
— Professor Shannon Anderson
Bloomberg BNA, Tax Management Transfer Pricing Report, January 21, 2016
While the complex case covered many aspects of transfer pricing for tangible and intangible assets, a portion of my testimony covered the appropriate use of dual rate transfer pricing to solve conflicts between taxation agreements and management accounting practices. Distinct from financial accounting that serves external audiences such as investors or creditors, and tax accounting used for determining tax obligations, management accounting focuses on providing accounting information to assist managers in running the operations of the firm.
For companies that use dual-rate transfer pricing, the sale of the product is recorded at one price for the up-stream business unit, but the purchase of the product is recorded at a different price for the downstream business unit.
My experience with this IRS case allowed me to bring highly relevant perspectives on this topic into my Master of Professional Accountancy course this year.
In addition, as a result of my expert testimony in the case, I co-authored an article with colleagues from The Brattle Group for Bloomberg BNA’s “Tax Management Transfer Pricing Report” (January 21, 2016). The article demonstrates dual rate transfer pricing and explains why differences between tax and management accounting transfer prices are important to firm performance—and emphasizes the need to explain the differences to tax authorities who may question a company’s motive
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