Introduction to
Transfer Pricing
Principles
Distributors/Resellers
One World US
Sale of Finished
Goods
Payment
Amount?
One World Ireland
Sales
3P
Excessive Profit Shifting?
Revenues
COGS
Gross Profit
Salaries
OpEx
Total Expenses
Op Profit
Op Margin
21%
12.5%
US US
One World
$
90,000,000
60,000,000
30,000,000
Ireland
$
150,000,000
90,000,000
60,000,000
$
14,000,000
6,020,000
20,020,000
$
8,000,000
3,000,500
11,000,500
$
9,980,000
$
48,999,500
11.1%
32.7%
Evaluating Ireland’s Profitability
Comparable Companies
Wolseley Industrial Group Ltd
WESCO International
Fastenal Ltd
HD Supply GmbH
W.W. Grainger S.p.A.
25th Interquartile
Median
75th Interquartile
One World Ireland Ltd
FY17
FY18
FY19 3 Yr Avg
2.1%
1.2%
3.6%
2.3%
1.2%
1.1%
1.4%
1.2%
4.2%
4.1%
4.0%
4.1%
5.9%
6.1%
8.1%
6.7%
0.9%
1.1%
0.6%
0.9%
1.2%
2.1%
4.2%
1.1%
1.2%
4.1%
1.4%
3.6%
4.0%
1.2%
2.3%
4.1%
33.1%
31.8%
32.7%
32.5%
IRC Section 482

In any case of two or more organizations,
trades, or businesses (whether or not
incorporated, whether or not organized in the
United States . . . ) owned or controlled by the
same interests, the Secretary may distribute,
apportion, or allocate gross income,
deductions, . . . between or among such
organizations, trades, or businesses, if he
determines that such distribution,
apportionment, or allocation is necessary . . .
IRC Section 482
in order to prevent evasion of taxes or clearly
reflect the income of any of such organizations,
trades, or businesses. . .

Under IRC section 482, related parties (e.g.,
U.S. parent and foreign sub) should price
transactions in the same way that
uncontrolled entities would under similar
circumstances - this is the “arm’s length”
standard
IC Transactions

The following transactions are representative of the
types of intercompany (IC) transactions subject to
IRC section 482
Sale of tangible property
 Intercompany loans
 License of intangible property (patents, trademarks,
processes, know-how, etc.)
 Provision of IC services

Research & Development, technical services
 Management, strategic support
 Back office (accounting, HR, IT, tax, legal, etc.)


Lease or rental of tangible or real property
Intercompany Services
One World US
IC Services
Payment
Amount?
One World UK
Payment
Amount?
One World Swiss
IC Services
License of Intangible Property
One World US
License of IP
Royalty
Amount?
One World Ireland
Sales
3P
Transfer Pricing Concept

Absent IRC section 482, potential exists to
inappropriately erode the U.S. tax base by undercompensating U.S. parties and correspondingly overcompensating foreign related parties

Higher risk when U.S. corporate income tax rate was 35%
Importance of Transfer Pricing



Application of the U.S. and foreign transfer
pricing laws may be subjective
There is potential for significant/material
adjustments to income by tax authorities
Tax authorities dispute their share of the same
profit pool
Importance of Transfer Pricing



Financial statement effect and disclosure
Important cases in litigation (Coca-Cola, Amazon,
Microsoft)
Organisation for Economic Co-operation and
Development (OECD) initiatives are playing a key
role in changing the international tax landscape

E.g., global minimum tax rate of 15%
Arm’s Length Standard


Identical transactions can rarely be located
Test whether transaction produces an arm’s
length result by reference to the results of
comparable transactions under comparable
circumstances
How would third parties act and price a
comparable transaction?
Arm’s Length Standard


The arm’s length range includes the results of all
comparable transactions
Arm’s length range is determined on an
interquartile range


Treas. Reg. 1.482-1(b)(1)
No adjustment to taxable income is made if the
taxpayer reports results within the arm’s length
range
Comparability


Standard of comparability: need not be identical,
but sufficiently similar
Factors to consider in the comparability analysis
include
Functions
 Contractual terms
 Risks
 Economic conditions
 Property or services


Treas. Reg. 1.482-1(d)
Comparability

A thorough functional analysis is performed to
determine the degree of comparability between
controlled and uncontrolled . . .
Transactions
 Parties involved in the transaction


The degree of comparability is central to
determining the reliability of any transfer pricing
analysis
Transfer Pricing Methods
Comparable Profits Method
(CPM)


Identical transactions are difficult to identify to set
an arm’s length price
CPM benchmarks an arm’s length result by
reference to the profitability of a set of companies
determined to be comparable to one of the parties
to the IC transaction (the “tested party”)
Comparable Profits Method
(CPM)

The determination of an arm’s length result is
based on the amount of profit that the tested party
has earned on related party transactions compared
to a set of comparable companies. Treas. Reg.
1.482-5

Profit level indicator
Operating margin (OM)
 Return on assets (ROA)

Comparable Profits Method
(CPM)

The tested party will be the party in the
controlled transaction
Whose operating profit can be verified using the
most reliable data
 For which reliable data regarding uncontrolled
comparables can be located
 That is considered the least complex of
the controlled taxpayers and will not own
valuable intangible property or unique assets that
distinguish it from potential independent comparable
companies

Evaluating Ireland’s Profitability
Comparable Companies
Wolseley Industrial Group Ltd
WESCO International
Fastenal Ltd
HD Supply GmbH
W.W. Grainger S.p.A.
25th Interquartile
Median
75th Interquartile
One World Ireland Ltd
FY17
FY18
FY19 3 Yr Avg
2.1%
1.2%
3.6%
2.3%
1.2%
1.1%
1.4%
1.2%
4.2%
4.1%
4.0%
4.1%
5.9%
6.1%
8.1%
6.7%
0.9%
1.1%
0.6%
0.9%
1.2%
2.1%
4.2%
1.1%
1.2%
4.1%
1.4%
3.6%
4.0%
1.2%
2.3%
4.1%
33.1%
31.8%
32.7%
32.5%
IRS Proposes IRC 482 Adjustment
21%
12.5%
IRS Sec 482 Adjustment to 3% OM
US
Revenues
COGS
Gross Profit
Salaries
OpEx
Total Expenses
Op Profit
Op Margin
$
Ireland
World US $
90,000,000 $One
150,000,000
60,000,000
90,000,000
30,000,000
60,000,000
$
14,000,000
6,020,000
20,020,000 $
8,000,000
3,000,500
11,000,500
$
9,980,000 $
48,999,500
11.1%
32.7%
US
Ireland
135,000,000 $ 150,000,000
60,000,000
135,000,000
75,000,000
15,000,000
$
14,000,000
6,020,000
20,020,000 $
8,000,000
3,000,500
11,000,500
$
54,980,000 $
3,999,500
40.7%
2.7%
IRS determines comparable independent
distributors earn a 3% operating margin
No IRS Adjustment Warranted
Comparable Companies
Wolseley Industrial Group Ltd
WESCO International
Fastenal Ltd
HD Supply GmbH
W.W. Grainger S.p.A.
FY17
FY18
FY19 3 Yr Avg
2.1%
1.2%
3.6%
2.3%
1.2%
1.1%
1.4%
1.2%
4.2%
4.1%
4.0%
4.1%
5.9%
6.1%
8.1%
6.7%
0.9%
1.1%
0.6%
0.9%
25th Interquartile
Median
75th Interquartile
1.2%
2.1%
4.2%
1.1%
1.2%
4.1%
1.4%
3.6%
4.0%
1.2%
2.3%
4.1%
One World Ireland Ltd
1.4%
2.2%
1.8%
1.8%
Profit Split Method

Evaluates whether the allocation of the
combined operating profit attributable to an IC
transaction is arm's length by reference to the
relative value of each related party’s contribution
to that combined operating profit

Treas. Reg. 1.482-6
Profit Split Method


The relative value of each related party’s
contribution to the success of the relevant
business activity must be determined in a manner
that reflects the functions performed, risks
assumed, and resources employed by
each participant
Such an allocation is intended to correspond to
the division of profit or loss that would
result from an arrangement between third parties
Profit Split Method

The relative value of each party’s valuable
contributions should be measured in a manner
that most reliably reflects each party’s
contribution and role to the combined business

E.g., value each party’s contributions based on
relative costs
Profit Split Method



Profit split methods are typically used when both
parties contribute valuable services and/or
intangibles to the combined transaction
Each party’s contributions can be difficult to value
The use of profit split methods is on the rise by
foreign tax authorities
Transfer Pricing Documentation



Transfer pricing studies may be produced to
support transfer pricing methodologies
Documentation describes a taxpayer’s IC
transactions and how these transactions were
priced at arm’s length
Transfer pricing studies are provided to the IRS
to support the transfer pricing tax return position
Transfer Pricing Documentation

Transfer pricing documentation typically
contains the following sections
Company overview
 Detail of the IC transaction
 Industry analysis
 Functional analysis
 Economic analysis

Selection of the best method analysis
 Tested party discussion
 Conparable companies and interquartile range analysis

Transfer Pricing Penalties

Producing transfer pricing documentation is not
mandatory


Provides penalty protection
Under IRC section 6662(e), penalties can be
applied to a transfer pricing adjustment proposed
by the IRS if

The transfer pricing documentation was not prepared
contemporaneous to the filing of the tax return
References







IRC section 482
IRC section 6662(e)
Treas. Reg. 1.482-1(b)
Treas. Reg. 1.482-1(d)
Treas. Reg. 1.482-4(c)
Treas. Reg. 1.482-5
Treas. Reg. 1.482-6