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Current Trend of IRS Transfer Pricing Practices

November 8, 2013

Index 1. What is Transfer Pricing?

2. Basics of Transfer Pricing – Why is it important?

3. U.S. Transfer pricing rules

4. Common Intercompany Transactions

5. Transfer Pricing Disclosures & Penalties

6. Transfer Pricing Methods

7. Transfer Pricing Report

8. Recent Developments

9. Transfer Pricing Rules - Mexico

10. Transfer Pricing Rules - IMMEX Companies

11. Transfer Pricing Rules - Canada

12. Questions

13. CDH Transfer Pricing Team - Contact Information

What is Transfer Pricing?

• A “transfer price” is the price at which one company buys and sells goods or services or shares resources with a related affiliate in its supply chain.• “Transfer Pricing” is the system of laws and practices used by countries• Aggressive transfer prices may inflate profits in low-tax jurisdictions and depress profits in high-tax countries.

Basics of Transfer Pricing – Why is it important?

• Compliance• Tax planning - minimizing tax liabilities for the entire

global group• Benchmark for business planning and profitability• Related party transactions• Arm’s length standard• Section 482 - preventing tax avoidance

U.S. Transfer Pricing RulesIRS Code Section 482• Purpose is to ensure that taxpayers report and pay tax on their actual share of income arising from related party transactions.• Requirement that intercompany transactions be priced at arm’s length.• A taxpayer should incur the same profitability from a related party transaction as a third party would have realized from a similar transaction under similar circumstances.• The taxpayer must use the “Best Method” that provides the most reliable estimate of arm’s length price.

Common Intercompany Transactions

• Purchases of tangible property (i.e. inventory)• Sales of tangible property (sales to Parent or affiliates)• Royalties• Commissions• Management and administrative fees• Service income• Interest

Transfer Pricing Disclosures & PenaltiesDisclosures to be submitted to the IRS with the tax return • Form 5471 or • Form 5472, and• Schedule UTP (For 2012 – Equal to or over $50 million in Assets).

Penalties• A penalty of $10,000 is imposed for each Form 5471 or Form 5472 that is filed after

the due date, including extensions, of the income tax return; e.g. 3 related companies – 3 forms, if not filed the penalty will be $30,000.

• When the tax authority requests a taxpayer’s transfer pricing documentation, the taxpayer has 30 days to submit documentation.

• Potential penalties of 20%-40% if result is underpayment of tax.• There is no penalty for failure to provide documentation, but documentation may help

to avoid a penalty. • IRS has three years from the tax return filing date to make adjustments.

Transfer Pricing Methods

There is no hierarchy of “best methods” prescribed by the IRS.

• For Tangible property transactions, the most common methods used are:– Comparable Profits Method (CPM, equivalent to OECD’s Transactional Net Margin Method ‘TNMM’) and– Cost Plus Method

• For Intangible property transactions, the most common method is:– Comparable Uncontrolled Transaction Method (CUT)

• For Services transactions, most common methods used are:– Cost of Services Plus Method and– CPM

Transfer Pricing Report

• Functional Analysis• Related Party Transactions• Industry Analysis• Economic Analysis• Appendices

Recent Developments• The APA (Advance Pricing Agreement) program shifted to an office

under a new Transfer Pricing Director.• New Advance Pricing and Mutual Agreement (APMA) Program

created in March 2012.• IRS is doubling the total number of Transfer Pricing staff in 2012.• Intangibles and Value Creation.• High Risk Transactions – Management Fees and Head Office

Expenses• Movement towards Master File Approach

Transfer Pricing Rules - Mexico• Governed by the Servicio de Administracion Tributaria (SAT)• Annual filings required• Documentation of related party transactions must be prepared by income

tax return filing due date.• Documentation must be in Spanish• Foreign comparables (US Companies) are acceptable to SAT• Statute of limitations on assessment for transfer pricing adjustments is five

years from the date of filing the income tax return.• Penalties of 40% of tax deficiency apply if paid before notice of deficiency

issued, 55-75% in other cases. • Advance Pricing Agreements are available• Similar transfer pricing methods like the U.S., however CUP is preferred.

Transfer Pricing Rules of IMMEX Companies

IMMEX Companies may comply with transfer pricing rules mainly under two alternatives:

1. Prepare a transfer pricing study based on a cost plus method, and adding an amount equal to 1% of all the M&E provided by the foreign related parties and used by the IMMEX Company, or

2. The Safe Harbor Method, pursuant to which the IMMEX Company must generate a tax profit equal to the greater of 6.9% of the value of assets used in their activity or 6.5% of the amount of ordinary costs and expenses of their operation.

Transfer Pricing Rules - Canada• Governed by the Canada Revenue Agency (CRA)• Canada generally follows the OECD Transfer Pricing Guidelines for

Multinational Enterprises & Tax Administrations (July 2010)• Form T106 must be filed if total reportable transactions for all nonresidents

combined exceeds Canadian $1,000,000.• Documentation contemporaneous with transactions is required to avoid a

potential transfer pricing penalty and must be prepared by income tax return filing due date.

• Penalty of 10 percent of the total transfer pricing adjustment may be imposed if adjustment exceeds a threshold.

• Foreign comparables are acceptable to the CRA• Advance Pricing Agreements are available

Any questions?

CDH Contact InformationFor more information, please contact:

• Koh Fujimoto, Principal

voice 630.285.0215 ext. 8229

kfujimoto@cdhcpa.com• Daniel Duncan, Principal

voice 630.285.0215 ext. 8227dduncan@cdhcpa.com• Yoko Yamamoto, Manager

voice 630.285.0215 ext. 8262

yyamamoto@cdhcpa.com• Seeta Khanna, Transfer Pricing Consultant

voice 630.285.0215 ext. 8234skhanna@cdhcpa.com