When a U.S. company expands into another country, transfer pricing becomes an important part of their international expansion plan.
The U.S. company may set up a foreign subsidiary, branch, manufacturing facility, distribution company, or service center. Once the U.S. and foreign businesses are part of the same group, transactions between them may be subject to the transfer pricing rules of both countries.
The U.S. company therefore needs to consider transfer pricing before expanding outside the United States.
Next, let’s understand some key steps involved in transfer pricing planning for a U.S. business operating outside the United States. First, let’s understand how a U.S. business should set up the right pricing structure to minimize the transfer pricing risks.
A U.S. company and its foreign subsidiary may have many transactions with each other, including the following:
The pricing for each transaction should reflect what each company actually does, what it owns, and what risks it takes.
For example, a U.S. company may manufacture products and sell them to its foreign subsidiary, which then distributes the products in another country.
The transfer price should generally give each company an arm’s-length return that reflects its functions, assets, and risks.
The company should also consider the foreign country’s transfer pricing rules. The foreign tax authority may have different requirements for transfer pricing methods, documentation, and filing deadlines.
Transfer pricing should be considered before a U.S. business enters a new foreign market.
The company should first determine how the foreign operation will operate, and which company will perform key activities and assume key risks.
For example, a U.S. company may initially set up its foreign subsidiary as a limited-risk distributor. At that stage, the subsidiary may mainly sell products and provide basic customer support.
As the business grows, however, the foreign subsidiary may take on additional responsibilities, such as:
When the foreign subsidiary’s role changes, its transfer pricing may also need to change.
This is why a U.S. business should review its transfer pricing when it:
Transfer pricing should therefore be part of the international expansion strategy from the outset, rather than addressed only after the foreign business is already operating.
International transfer pricing can create tax issues in both the United States and the foreign country.
For example, the IRS may determine that a U.S. company earned too little income from a transaction with its foreign subsidiary, thereby increasing its U.S. taxable income.
At the same time, the foreign tax authority may take a different position and argue that more income should be reported in the foreign country.
The result could be the same income being taxed in both countries.
Companies can reduce this risk by:
For large or complex transactions, a company may also consider an Advance Pricing Agreement (APA). An APA can provide greater certainty by agreeing in advance with the tax authorities on the transfer pricing method to be used for certain transactions.
Before entering a new foreign market, a U.S. company should ask the following questions:
The goal is to make sure that the business structure, actual operations, intercompany agreements, and transfer pricing policy all work together. This can help a U.S. business expand internationally while reducing the risk of unexpected tax adjustments and disputes.