Mistakes in Selecting and Applying Transfer Pricing Methods

U.S. regulations provide several methods for evaluating intercompany transactions. The taxpayer must select the best method based on which method provides the most reliable measure of an arm’s-length result.

The analysis generally considers:

1. How closely the controlled transaction can be compared with uncontrolled transactions; and
2. The reliability of the data and assumptions used in the analysis.

A common mistake is to select a method simply because it has been used in prior years or because it is convenient. The method should instead be supported by the facts of the current transaction.

Common mistakes include:

• Failing to properly explain why a particular method was selected.
• Failing to explain why other methods were rejected.
• Using unrelated companies as comparables when their functions, assets, or risks are materially different.
• Failing to make appropriate comparability adjustments.
• Using the same allocation approach for different products or services without considering their different economic characteristics.
• Charging no interest, or an inappropriate interest rate, on an intercompany loan.
• Charging no fee, or an inappropriate fee, for intercompany services.
• Charging an inappropriate rental amount for related-party use of property.
• Charging no royalty, or an inappropriate royalty, for the use of intangible property.
• Failing to properly account for all relevant costs in a cost-sharing arrangement.
• Applying a transfer pricing method without considering how the related transactions work together.

The IRS has specifically noted that transfer pricing documentation should provide a meaningful explanation of the best-method analysis rather than simply state that a particular method was chosen or rejected.