Transfer Pricing in the United States

United States Regulation

Transfer pricing regulations are governed by Section 482 of the Internal Revenue Code (IRC), which establishes guidelines for the allocation of income, deductions, credits, and allowances among related business entities. This legal framework aims to ensure that transactions between related parties reflect the prices or conditions that would have been agreed upon by independent parties under conditions of full competition.

Arm’s Length Principle

The fundamental principle governing transfer pricing regulations in the United States is the “arm’s length” or full competition principle. This principle requires that the outcomes of transactions between related parties be consistent with those that would have been obtained between independent parties under similar circumstances. 

The Arm’s Length Principle plays a key role in transfer pricing compliance and helps prevent the erosion of the tax base and the shifting of profits. The goal is to ensure that transactions with related parties are conducted fairly and transparently, reflecting market conditions and avoiding any undue tax advantages.

Scope of Application

Transfer pricing regulations apply to all taxpayers in the United States, including branches of foreign companies. Section 482 of the IRC authorizes the Internal Revenue Service (IRS) to make allocations of income, expenses, and other items among related entities to ensure a result of full competition.

Transfer Pricing Methodology

The United States legislation does not determine a hierarchy in the choice of analysis method. Instead, it indicates that the method that best reflects the economic reality of the compared operations should be applied. The importance of documentation supporting the choice of method used to determine transfer prices is recognized. The accepted methods are:

• Comparable Uncontrolled Price Method (CUP)
• Resale Price Method (RPM)
• Cost Plus Method (CPM)
• Transactional Net Margin Method (TNMM)
• Profit Split Method (PSM)

Supporting Documentation

Taxpayers must maintain two categories of documentation: principal documents and background documents. Principal documents include:

• General description of the taxpayer’s business
• Description of the taxpayer’s organizational structure
• Description and rationale for the selected method
• Description of transactions within the scope of transfer pricing
• Description of comparables and adjustments applied
• Description of any relevant data obtained after the end of the fiscal year and before filing a tax return
• General index of principal and background documents
• Description of the record-keeping system used to catalog and access those documents
• Any documentation specifically required by the 482 regulations

All principal documents must be presented to the IRS within thirty (30) days following a request.

Country-by-Country Reporting

As of June 30, 2016, the parent entities of U.S. multinational groups with revenues exceeding USD 850 million must submit Form 8975, which details information on income, taxes paid, and other economic indicators of the group. This form is filed with the parent entity’s income tax return and is automatically exchanged with the tax authorities of countries with bilateral agreements.

The IRS will automatically exchange information from Form 8975 with the tax authorities with which the United States has a bilateral competent authority agreement. However, information from a U.S. multinational group will only be exchanged with those countries in which the U.S. multinational group reports doing business.

Form 8975 can be filed in XML format. For parent entities that are not permitted to file electronically, the form must be submitted along with the income tax return paperwork.

Penalties

Non-compliance with transfer pricing regulations can result in significant penalties. Section 6662 of the IRC establishes penalties of 20% and 40% for adjustments attributable to Section 482, depending on the magnitude of the difference between the transfer price and the arm’s length price.