Join Scott Simpson, International Tax Director, for an in-depth interview of what you need to know about Transfer Pricing, such as what a transfer pricing study is, who needs a transfer pricing study, and the benefits of having a transfer pricing study done.
Get in contact with our Transfer Pricing professional today:
International Tax Director
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[00:00:00] Ashley: Hi, I’m Ashley and you are listening to the PKF Mueller podcast, “Business Owner’s Guide Tips, Trends, and Talks from a CPA”. Today, we welcome Scott Simpson from our Tax Department for discussion on Transfer Pricing.
Scott is an International Director in the Firm’s Tax department, and he brings over 30 years of tax experience with large multinational companies and public accounting for middle-market clients.
So, with that, let’s get right to it. Scott, can you please provide us with an overview of transfer pricing?
[00:00:44] Scott Simpson: Sure. Very simply transfer pricing is the act of fairly compensating, a related party on a cross border transaction. And that can be U.S. to somebody outside the U.S. or foreign to foreign.
[00:01:04] Ashley: Awesome, so now can you dive a little deeper and tell us what a transfer pricing study is?
[00:01:09] Scott Simpson: Yeah. A study is your documentation, that you can provide to the local tax authorities that shows that your transfer pricing is done on an arm’s length basis.
A real simple example. Let’s say you have a U.S. company, and they want to start doing business in Canada. So, the U.S. company has two options, they can either look to a third party to do whatever work is that needs to be done in Canada. That company let’s say they incur a hundred thousand dollars of costs. They’re going to charge the U.S. company, you know, $110 – $115. They want to make a profit. Option number two, you could go out and hire your own employee to pay him the $100,000. But under the transfer pricing rules, you look to what would the unrelated parties do and that charge would be $110 – $115.
You need to do something similar in Canada with your subsidiary. Seen this happen quite a bit in here in the middle of market. People in the U.S. think they can just open a subsidiary and run it at a net zero income basis and not paying any tax. The foreign tax authorities do not like that.
[00:02:36] Ashley: What does a transfer pricing study entail?
[00:02:38] Scott Simpson: Okay. So, the study itself has lots of moving parts. But it’s an analysis of several items, such as a summary of what the business transacts. You know, what’s their line of business? How do they make money? How is the corporate structure arranged? You know, who owns who, and what country are they in?
The transfer pricing study will identify the intercompany transactions themselves with a big company tip again, and that’s their overseas manufacturing and sales arms. You’re going to see an industry analysis because we, you know, that that helps companies identify what their arm’s length prices should be.
It identifies what we call an Interquartile range, which is the range of acceptable profits that a company makes compared to its peers in the industry. And then usually you see an industry outlook as well. That’ll tie those together. Next there is an analysis of the functions, risks, and assets of the company or companies.
There’s a discussion of what is the most correct transfer pricing method that is to be used. There’s also an economic analysis that identifies profit level indicators and a list of comparable transactions with non-related parties. These are known as the comps or comparable. And then finally, a transfer pricing study concludes, hopefully that the transfer pricing charges by the company in its cross-border transactions are all being done at an arm’s length and that they fit into this Interquartile range.
[00:04:31] Ashley: My next question is when do you need a transfer pricing study done?
[00:04:36] Scott Simpson: Right. So as far as timing goes, transfer pricing reports, need to be done soon after a year, yearend, and must be in a draft or mostly final draft, by the time that the tax return is filed, including extensions. The study itself will need to be updated every year. If the business doesn’t, you know, that the main function of the business doesn’t change, then you’re just changing the amounts charged based on the volume of transactions and variations in your line of business.
But if the business itself starts taking on new lines of business, new revenue streams, that revenue stream, if it is a cross-border transaction needs to be analyzed for transfer pricing purposes and included in the study.
The transfer pricing report itself, as I said, should be updated annually, but as a part of populating your transfer pricing report, there is a study of the comparable third-party businesses that are doing the same line of business as you and it’s you’re, you’re eligible to only update those comparables every three years, as opposed to the one-year renewal for the transfer pricing study.
[00:06:04] Ashley: As a follow-up to that who needs a transfer pricing study and why do they need a transfer pricing study?
[00:06:10] Scott Simpson: Well, like I said before, basically it’s anyone who is performing transactions across borders between two related parties.
It’s not uncommon for a taxpayer to believe that their foreign disregarded entity is exempt from transfer pricing. Nothing could be further from the truth. That’s a related party and you’re doing cross-border transactions with them. It is subject to transfer pricing rules.
Transfer pricing studies are needed because the taxing authorities around the world are really, they’re, they’re aware of, the act of businesses shifting profits into potentially lower tax jurisdictions. And those authorities are going to rely on transfer pricing rules to combat this base erosion or profit shifting. Um, they want to make sure that, you know, once again, that everything’s being done at an arm’s length basis.
[00:07:07] Ashley: So, what are the benefits of having a transfer pricing study done?
[00:07:11] Scott Simpson: The benefits are that you, you’ve proven that it’s at an arm’s length and by doing so you’re potentially mitigating or eliminating penalties from tax authorities, which can include failure to file penalties or insufficient data on your tax return, which could lead to additional penalties. A transfer pricing study is the number one piece of proof that what you’ve done is fair and correct.
[00:07:52] Ashley: Okay. So now that we have a better understanding of transfer pricing as a whole, let’s get into the more technical aspects. Can you provide us with some transfer pricing, tax, saving strategies?
[00:08:03] Scott Simpson: okay. So transfer pricing, tax savings strategies, uh, basically, you know, if you’re, if you’re doing your tax transfer pricing on an arms-length basis, you’re good to go, but we should really be doing is looking at it more frequently than just on an annual basis. Especially as a corporation starts doing, you know, much more significant volumes of cross border transactions.
You might want to be looking at, your, your pricing levels, quarterly or even more frequently than that. Usually what you have is a range of acceptable prices and profits and your company can either increase or decrease their prices to hit the higher end or the lower end of what we call the interquartile range of acceptable prices and profits to suit, to suit themselves.
[00:09:00] Ashley: Can you describe some red flags to look out for?
[00:09:03] Scott Simpson: Yeah. Red flags as they apply to transfer pricing. Typically, if a U.S. company has a foreign subsidiary, they have to file what’s known as form 5471. An inclusive of that form is schedule M as in Michael, which lists out all of your intercompany transactions.
With the U.S. parent and a foreign subsidiary or affiliate or branch, and those items, certain of those boxes and those numbers that are reported in that form are red flags to the IRS that there’s probably a transfer pricing issue. Um, conversely on an inbound or you let’s say a UK company that’s doing business in the United States. They file what’s called the form 54 72, which again, spells out the intercompany related party transactions. Another thing that an IRS agent, while he’s skimming through your tax return would say, oh, this company probably has a transfer pricing matter to look at.
Another red flag would be, if your company does get selected for an audit, usually IDR number one is provide us a copy of your tax return and potentially ID our number two, give us a copy of your transfer pricing study within the next 30 days. At that point that you know, the IRS is in fact, looking at your transfer pricing.
They may also notice the existence of some foreign tax credits on your U.S. tax return. And maybe they don’t see a form 54 71 or 54 72 and that could be a question as to how did you obtain these foreign tax credits? and in the process thereof where you are charging an arm’s length price under transfer pricing rules.
[00:11:02] Ashley: what is your take on COVID and its impact on globalization? Subsequently transfer pricing.
[00:11:09] Scott Simpson: In my opinion COVID is, somewhat responsible for the global supply chain issues that we’re, we’re all feeling and seeing in the world today. Transfer pricing is going to, those prices will be increasing due to the higher cost of the goods being produced overseas.
And as part of those costs, uh, you know, we have the transportation. Getting products from point A to point B. Train transportation costs will figure significantly into the amount of the cost of goods sold that are being, multiplied by your cost markup on your transfer prices.
So, yeah, I would say COVID is going to have a pretty severe impact on what the arm’s length prices for everybody. So, we may see costs simply go up because of that.
[00:12:10] Ashley: What are Biden’s tax plans in global tax developments? And how does this affect us?
[00:12:16] Scott Simpson: Uh, you know, some of the things that are in President Biden’s tax plan, some of them are seen as by other foreign entities that the U.S. has just given a handout.
There’s something in the tax law called the foreign derived intangible income, which allows a U.S. company to receive an extra deduction on their tax return for goods that they’ve manufactured and sold overseas. Like the previous ETI regime, the Fisk’s, the domestic international sales corporation, the discs, a lot of these things have come out of U.S. law and been challenged by other people around the world. So, one of the things Biden’s looking at doing is potentially getting rid of the FDII or what we call fitty.
Also included in there is the potential to raise corporate tax rates, including a minimum tax on the book earnings of a corporation, or so a corporation would pay the greater of that minimum tax or their regular income tax bill. Um, we are potentially looking at getting rid of the beat, which is the base erosion anti-avoidance tax and replacing it with the new moniker something called shield stop. Uh, Biden’s looking to modify the guilty regime in two manners. One would be to increase the minimum global tax that, the OUCD has presented, which would be 15%. And they’re actually looking to change up that calculation to be a country by country basis, such that U.S. companies would no longer be able to offset foreign earnings with foreign losses from other countries.
They’re also looking to potentially remove certain tax deductions. That come about to U.S. companies from moving jobs overseas, therefore pushing more of the cost of production into the United States where typically we have higher payroll.
[00:14:38] Ashley: My last question for you is how can you reduce transfer pricing risks?
[00:14:44] Scott Simpson: Simple document, document, document. Do the updates to your comps? Do the updates to your study. Keep in touch with your tax advisor. Always be cognizant that you need to inform the advisor of changes in the business. Significant changes to an existing line of business, such as COVID impacts.
So, whenever you are dealing with your own related subsidiaries and you are doing cross-border transactions, it is wise for you to contact your PKF advisor or a tax expert for a frank discussion on the transfer pricing issues and matters that may be in existence with your return.
[00:15:35] Ashley: great. Well, I think that was a really good overview and thank you for your time today to explain transfer pricing and PKF Mueller’s experience with this. If any of our listeners have any questions or would like to learn more, will you please share how they might be able to reach you?
[00:15:49] Scott Simpson: Yeah, sure Ashley, listeners can reach email@example.com or you can simply give me a call at area code (773) 756 5097.
[00:16:05] Ashley: Thank you to our listeners. Don’t forget to visit us at pkfmueller.com to learn more about our firm’s services and locations throughout the Chicago land area and Sarasota, you can also follow us on social media for updates, insights, and upcoming events.