How Can a Company Reduce Transfer Pricing Audit Risk?

Companies may not completely eliminate the possibility of an IRS examination. However, they can reduce their risk by taking a proactive approach.

The following are some of the risk mitigation steps companies may take to reduce transfer pricing audit risk in the United States.

1.  Prepare documentation on time

Companies should not wait for an IRS audit to prepare transfer pricing documentation. They should prepare it beforehand. The documentation should support the position taken on the tax return and should be prepared in accordance with the applicable U.S. documentation rules.

2.  Perform regular financial testing

Companies should compare their actual results with their transfer pricing policy.

For example, if the U.S. subsidiary is expected to earn a routine operating margin, the company should monitor whether the actual results remain consistent with that expectation.

3.  Keep the transfer pricing analysis current

A transfer pricing study should not simply be prepared once and forgotten.

Changes in the business, products, functions, risks, supply chain, financing arrangements, or market conditions may require the analysis to be updated.

4. Make sure agreements match reality

The written intercompany agreement should be consistent with what the companies actually do.

For example, simply describing a company as a limited-risk distributor in an agreement may not be enough. If the company actually performs significant marketing activities, holds substantial inventory, and assumes related risks, the IRS may consider its actual activities and risks rather than relying only on the written agreement.

5. Reconcile transfer pricing data with the tax return

The amounts reported in the transfer pricing analysis should be consistent with the company’s books, financial statements, and tax return. Any differences should be identified and explained.

6. Review high-risk transactions

Companies should pay particular attention to high- risk transactions. Such transactions generally include the following:

• Royalties and intangible property
• Management and administrative services
• Intercompany financing
• Large purchases or sales of goods
• Business restructurings
• Cost-sharing arrangements
• Significant changes in the supply chain

7. Consider an Advance Pricing Agreement

An Advance Pricing Agreement (APA) is an agreement between a taxpayer and the IRS that sets out the transfer pricing method to be used for certain related-party transactions for future years.

For complex or high-risk transactions, an APA can give a company greater certainty about how its transfer pricing should be calculated.

Although obtaining an APA can take significant time and resources, it can reduce the risk of future transfer pricing disputes with the IRS.

8. Final Thoughts

Therefore, transfer pricing compliance in the United States is not simply about preparing a report once a year.

The IRS may look at whether the company’s actual transactions, contracts, functions, financial results, and transfer pricing analysis all tell the same story.

A strong transfer pricing program should therefore combine:

Appropriate pricing + reliable economic analysis + timely documentation + ongoing monitoring.

Taking these steps before an IRS examination can help a company defend its transfer pricing position, reduce penalty exposure, and minimize the risk of costly adjustments and double taxation.

Now that we understand transfer pricing audits and penalties in the United States, it is important to remember that even companies that make good-faith efforts to comply with the rules may still face a transfer pricing dispute with the IRS.

Next, let’s understand how to address and resolve transfer pricing disputes with the IRS.