Transfer Pricing in the United States

The United States of America was one of the first countries along with Great Britain to incorporate transfer pricing rules for more than eight decades, so its rules have evolved over time.

Currently, transfer pricing legislation in the United States has been framed by Section 482 of the U.S. Tax Code, as well as Section 6662.

They are also regulated by Treasury Regulations 1.482, 1.6662, 1.6038A and 1.6038C and Revenue Procedures No. 99-32, 2015-40, 2015-41, 2007-13 and 2005-46.

In 2017, new tax reforms were approved, which included some regarding transfer pricing, this tax reform was given through the “Law of Tax and Employment Reduction”, which established provisions related to Base Erosion and Anti-Abuse Tax; Foreign Derived Intangible Income; Global Intangible Low Taxed Income and Section 250 and 951A of the Internal Revenue Code.

Definition of Transfer Pricing

Transfer prices are defined as those prices or values for transactions carried out between related parties, also called intercompany transactions.

Principle of Arm’s Length

The principle of arm’s length or also called, by non-English speaking countries, as the principle of free or full competition, is the pillar that governs transfer pricing.

It is based on the fact that the prices agreed between related parties are in accordance with market value.

The transfer pricing legislation of the United States of America has adopted this principle in its Treasury Regulation §§1.482-1 through 1.482-9.

This regulation states that in order to determine the actual taxable income of a controlled taxpayer, it must follow the principle or standard of full competition, which will be verified if the results of the transaction are consistent with those agreed by non-controlled or independent parties.

Definition of Related Parties in the United States

According to Treasury Regulation §1.482-1(i)(5), a related party or controlled taxpayer is one of two or more taxpayers who are directly or indirectly owned or controlled by the same interests.

A related party is a taxpayer who exercises ownership or control over the other taxpayers.

Also, the term control includes any type of control, whether direct or indirect, legally enforceable or not, and in any manner that may be exercised, which includes the control resulting from the conjunction of actions of two or more taxpayers acting with a single objective or common purpose.

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

Transfer pricing methods in the United States are regulated in the Treasury Reg. §§1.482-3(a), -4(a), -7g) (1), and -9(a).

The types of methods will depend on the type of operation to be analyzed in order to observe whether it complies with the arm’s length principle.

Thus, in case of transfer of tangible property, one of the following methods may be used:

  • Comparable Price Uncontrolled Method (CUP).
  • Resale Price Method (RPM).
  • Additional Cost Method (CPM).
  • Comparable Benefits Method (CPM).
  • Benefit Sharing Method (comparable and residual).

Likewise, in case of a transfer of an intangible asset, the U.S. transfer pricing legislation provides for the following methods:

  • Comparable Uncontrolled Price (CUP) Method.
  • Comparable Benefits Method (CPM).
  • Benefit Sharing Method (comparable and residual).
  • Other unspecified methods.

With respect to services performed between related parties, the U.S. transfer pricing standard provides for the following methods:

  • Cost of Service Method.
  • Comparable Price Method of Uncontrolled Service.
  • Gross Service Margin Method.
  • Added Cost of Services Method.
  • Comparable Benefits Method.
  • Benefit Sharing Method.

The taxpayer will choose the best method for the analysis of its related party transaction.

Transfer Pricing Documentation in the United States

The taxpayer that carries out transactions with related parties must have documentation that proves that the agreed values are in accordance with the Arm’s Length principle, in order to be delivered to the Internal Revenue Service (IRS) when required.

Said documentation must 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 operation as indicated in the 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 submitted to the IRS within 30 days of being required.

Likewise, it should be noted that such documentation must be available for any transaction between related parties, since the transfer pricing legislation in the United States of America has not established exception thresholds.

Country by Country Report Declaration 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, proposed by Action 13 of the OECD’s BEPS Plan.

Thus, the Treasury Reg. § 1.6038-4, states that every parent company of a multinational group in the United States must declare the Country by Country Report or CbC Report.

However, they will be exempt from such declaration if the annual income of the Multinational Group is less than USD 850,000,000.00, according to the Treasury Reg. § 1.6038-4 (h).

This report shall be filed on Form 8975, which shall contain the information of each of the entities of the group, such as their identification in each of their jurisdictions and financial and tax information such as income generated, taxes paid or accumulated losses.

IRS Action on Transfer Pricing

The IRS has been implementing guidelines in order to have better practices regarding transfer pricing.

Thus, in 2018 this Tax Administration issued the “Transfer Pricing Examination Process“, which provides a framework and guidance for the examination of these.

Penalties for Noncompliance with Transfer Pricing in the United States of America

Transfer pricing penalties are regulated under Section 6662(e)(3) of the U.S. Tax Code.

Thus, if the IRS observes that the prices agreed upon between related parties are not in accordance with the arm’s length principle, it may impose a penalty of up to 20%, if the price is 200% or less than 50% higher than the price that should have been agreed upon based on the aforementioned principle.

This fine will increase to 40% in case the transfer price is 400% higher or 25% lower than the full competition price.

The penalty may only be imposed when the prices comply with the above-mentioned thresholds, however, it may be waived to the extent that the taxpayer demonstrates a reasonable cause for the establishment of such declared price, which shall be achieved based on the documentation indicated above.

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