When a foreign company plans to establish a business in the United States, it should consider transfer pricing from the outset. It should be part of the company’s decisions about its U.S. entity, business activities, and tax structure.
Before starting operations, the foreign company should answer three basic questions:
These questions are important because transactions between the U.S. company and its foreign parent or affiliates should generally follow the arm’s-length principle. In simple terms, the price should be similar to what two independent companies would agree to under similar circumstances.
Properly planning transfer pricing from the start can help the company allocate profits appropriately between U.S. and foreign businesses and reduce the risk of an IRS transfer pricing adjustment later.
Next, let’s understand some key steps involved in transfer pricing planning for a foreign business operating in the United States. First, let’s understand how a foreign business should set up a U.S. operation to minimize the transfer pricing risks.
A foreign company should consider transfer pricing when planning how its U.S. business will operate.
For example, consider a foreign manufacturer that wants to sell its products in the United States. It may create a U.S. subsidiary to handle sales and distribution.
The U.S. subsidiary may perform activities that are as follows:
The foreign parent may continue to manufacture the products and own important intellectual property, such as patents, trademarks, or proprietary technology.
The transfer pricing arrangement should reflect what each company actually does, what it owns, and what risks it takes.
If the U.S. subsidiary performs only routine distribution activities, it should generally earn an arm’s-length return for those activities. The foreign parent should earn an appropriate return for the manufacturing, intellectual property, and other valuable contributions it provides.
This means transfer pricing should be planned together with the legal structure of the U.S. business, its tax classification, its actual operations, and its intercompany agreements.
Next, let’s understand how foreign businesses should price goods and services to accurately reflect the arm’s length standard and to account for customs duties.
Foreign businesses operating in the United States often purchase goods or services from related foreign companies.
For example, the U.S. subsidiary may purchase finished products from its foreign parent and resell them to U.S. customers. The price paid for those products is an intercompany transaction and should generally be set at arm’s length.
The same applies to services. The U.S. company may receive management, administrative, technical, or marketing services from a foreign affiliate. The charges for these services should also generally reflect what independent companies would have agreed to pay.
Since these prices affect how much profit is reported in the United States and how much is reported overseas, the foreign company should use an appropriate transfer pricing method. Also, they should maintain documentation explaining how the prices were determined.
For foreign companies that import goods into the United States, another important issue is customs.
The price paid to the foreign parent for imported goods can affect both the company’s U.S. income tax position and the customs value of the goods.
Therefore, a transfer price that works for income tax purposes may not necessarily work well for customs purposes. Foreign businesses that import goods should consider income tax and customs consequences together when setting their intercompany prices.
Transfer pricing is not something a foreign company should consider only when it first enters the U.S. market. It should be reviewed regularly as the business changes.
For example, a U.S. subsidiary may make large payments to a foreign affiliate for the following reasons:
These payments can reduce the U.S. company’s taxable income. As a result, the IRS may examine whether the payments are consistent with the company’s actual business activities and the arm’s-length principle.
A transfer pricing policy that was appropriate when the U.S. business started may no longer be appropriate if the company’s functions, risks, assets, or business model change. Therefore, a foreign company operating in the U.S. should continuously update its transfer pricing policy in the U.S.
A foreign company entering the U.S. should consider the following transfer-pricing-related questions:
For a foreign business entering the U.S., transfer pricing should be part of the business planning process. It should not be an issue addressed after the business is already operating.
The company should make sure that its U.S. structure, actual business activities, intercompany agreements, and transfer pricing policy all tell the same story. This can help support the company’s tax position and reduce the risk of costly disputes with the IRS.