What Should Transfer Pricing Documentation in the United States Include?

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What Should Transfer Pricing Documentation in the United States Include?

Generally, U.S. regulations do not prescribe a standard report format for transfer pricing documentation. However, the IRS expects documentation to clearly explain how transfer prices were determined and why they satisfy the arm’s length standard.

According to the IRS, a comprehensive transfer pricing report generally includes the following:

Business Overview

The documentation should describe the multinational group’s business overview. This generally includes business, industry, organizational structure, and the role of each related entity involved in the controlled transactions. This provides the background necessary to understand how the business operates and how profits are generated.

Description of Controlled Transactions

The report should identify each material related-party transaction. Such transactions may include the following:

  • Sale or purchase of goods
  • Intercompany services
  • Royalty and licensing arrangements
  • Intercompany financing
  • Cost-sharing arrangements
  • Transfers of tangible or intangible property

The documentation should also identify the parties involved, the value of each transaction, and the commercial purpose of the arrangement.

Functional Analysis

A functional analysis evaluates the contribution of each party to the controlled transaction by examining:

  • Functions performed
  • Assets employed
  • Risks assumed

This analysis helps identify the tested party and forms the basis for selecting the most appropriate transfer pricing method.

Selection of the Transfer Pricing Method

The documentation should explain why the selected transfer pricing method provides the most reliable measure of an arm’s length result under the facts and circumstances.

Unlike the OECD Guidelines, which refer to the most appropriate method, U.S. regulations apply the Best Method Rule. Taxpayers should explain why the selected method was chosen and discuss any reasonable alternative methods that were considered but rejected.

Economic and Benchmarking Analysis

The economic analysis demonstrates whether the transfer prices are consistent with those that would have been agreed upon by independent parties.

This section typically includes:

  • Selection of comparable companies or transactions
  • Screening criteria
  • Comparability analysis
  • Any adjustments made to improve comparability
  • Arm’s length range
  • Financial calculations supporting the conclusion

Benchmarking studies should be reviewed periodically because comparable company data and market conditions change over time.

Financial Information

The documentation should include sufficient financial information to support the economic analysis.

Where applicable, taxpayers should provide:

  • Financial statements
  • Segmented financial data
  • Trial balances
  • Reconciliation between financial statements and the transfer pricing analysis
  • Supporting calculations and spreadsheets

The IRS encourages taxpayers to present financial data in a format that allows examiners to easily understand and verify the calculations.

Supporting Documentation

Transfer pricing documentation should also include documents supporting the analysis, such as:

  • Intercompany agreements
  • Invoices
  • Royalty agreements
  • Loan agreements
  • Cost-sharing agreements
  • Market research
  • Industry reports
  • Internal studies

The IRS expects these documents to be consistent with the company’s actual business practices.

IRS Documentation Best Practices

In addition to the principal documents described in the regulations, the IRS recommends including information that helps examiners understand the analysis more efficiently.

Useful supporting information includes:

  • A detailed explanation of the data used in the analysis
  • Functional and risk analyses
  • An explanation of how profits were allocated among the related parties
  • Discussion of significant business risks
  • Analysis of unusual business circumstances affecting profitability
  • Description of any limitations or challenges encountered during the analysis

Although these additional materials are not mandatory, they often streamline the audit process and may reduce the scope of IRS inquiries.