Meaning
Multinational corporations face potential adjustments and fines if the rates they charge their own subsidiaries do not match market prices. Management of transfer pricing risk is a primary concern for tax directors during the annual closing of accounts and the filing of corporate returns. It arises whenever a parent company provides management services and intellectual property to its branches.
Arm Length Standard
Regulators compare internal transactions against similar deals between independent parties to ensure that profits are not being shifted to low tax zones. A measurable transfer pricing risk exists if a firm cannot justify its internal pricing with an economic study. This standard is the global benchmark for fair taxation.
Tax authorities use database searches to find comparable transactions between third parties in the same industry.
Documentation Requirement
Companies must maintain detailed records of their pricing methodology and the market data they used. Failure to produce a transfer pricing report upon request often leads to a reversal of the burden of proof in tax court.
Profit Allocation
Tax authorities in different countries often compete for the same pool of corporate earnings. Mismanaged transfer pricing risk can result in double taxation if two nations claim the right to tax the same income.
