Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control. It allocates profits (or losses) amongst business entities and/or countries, and therefore tax authorities may contest them.

Section 482 of the Internal Revenue Code (“IRC”) of 1986 (“Section 482 Regulations”) outlines the regulatory guidance for intercompany transactions among members of common ownership or control. Section 482 allows the United States (“U.S.”) Treasury to prevent the evasion of taxes or to reflect the appropriate income of U.S. members. The basis to ensure that the intercompany transfer price for goods, services and intangible property clearly reflect income for U.S. Federal Tax purposes in the Section 482 Regulations is the arm’s-length standard.

Transfer pricing documentation must be maintained in any case of two or more organizations, trades, or businesses owned or controlled directly or indirectly by the same interest, with controlled transactions between these related entities. Controlled transactions may include tangible property, intangible property, loans, and/or services to or from foreign affiliates in exchange for payment. These transactions must be at a price that is consistent with an arm’s length price. CFR § 1.6662-6(d) outlines the ten transfer pricing documentation requirements and the penalty regime that may be imposed for large transfer pricing adjustments.

The arm’s length result of a controlled transaction must be determined under the method that, under the facts and circumstances, provides the most reliable measure of an arm’s length result. There is no strict priority of methods, and no method will invariably be considered to be more reliable than others.

Data based on the results of transactions between unrelated parties provides the most objective basis for determining whether results of a controlled transaction are arm’s length. First, a company conducts a functional analysis to determine what kind of comparables to use. After conducting a functional analysis, the company compares its financial results(such as margin or financial ratios) with others without controlled transactions. The relative reliability of a method based on the results of transactions between unrelated parties depends on the degree of comparability between the controlled transaction or taxpayers and the uncontrolled comparables, taking into account the factors described in CFR § 1.482-1(d)(3).

IRS LB&I Division announced the approval of transfer pricing compliance campaign. Hence, if a large business and international entity is audited by IRS, IRS agent will inquire regarding transfer pricing compliance. Transfer pricing documentation should be updated annually to account for normal business and market developments. Retention of transfer pricing documents is three to six years from the filing date of the associated tax return.