Transfer Pricing
What does "Transfer Pricing" mean in law?
Transfer pricing refers to the rules governing the prices charged in transactions between related entities, particularly in the international context where affiliated companies operating in different tax jurisdictions may set intercompany prices to shift income to low-tax jurisdictions. IRC Section 482 grants the IRS broad authority to distribute, apportion, or allocate gross income, deductions, credits, or allowances among commonly controlled entities to prevent tax evasion or clearly reflect income. The arm's length standard, which requires related-party transactions to be priced as if conducted between unrelated parties, is the foundational principle under both U.S. and OECD guidelines. Acceptable methods for establishing arm's length prices include the comparable uncontrolled price method, the resale price method, the cost-plus method, and the comparable profits method, with significant penalties under Section 6662(e) for substantial valuation misstatements.
Definition
Transfer pricing refers to the rules governing the prices charged in transactions between related entities, particularly in the international context where affiliated companies operating in different tax jurisdictions may set intercompany prices to shift income to low-tax jurisdictions. IRC Section 482 grants the IRS broad authority to distribute, apportion, or allocate gross income, deductions, credits, or allowances among commonly controlled entities to prevent tax evasion or clearly reflect income. The arm's length standard, which requires related-party transactions to be priced as if conducted between unrelated parties, is the foundational principle under both U.S. and OECD guidelines. Acceptable methods for establishing arm's length prices include the comparable uncontrolled price method, the resale price method, the cost-plus method, and the comparable profits method, with significant penalties under Section 6662(e) for substantial valuation misstatements.
Example
A U.S. pharmaceutical company that sells patented drugs to its Irish subsidiary at an artificially low price to shift profits offshore faces IRS scrutiny under Section 482, which can reallocate the income to reflect arm's length pricing.