The “Catch 22” of Multinational Transfer Pricing


Recently, internationalization of corporations has become an attractive strategy due to the numerous advantages of conducting business overseas, including: access to bigger markets, increased profits, networking, and gaining a competitive advantage.[1] However, this strategy is daunting because of the complexity of international laws and foreign regulations.[2] One of the core issues for these multinational corporations is transfer pricing.[3] How a corporation formulates its transfer pricing strategy ultimately affects its net profits and taxable income abroad.[4] Transfer pricing is a crucial part of international trade because approximately 60% of international trade occurs within multinational corporations.[5] Thus, it is essential to understand transfer pricing strategy, especially on an international scale where tax authorities and international organizations increasingly scrutinize and penalize corporations for misusing transfer pricing.[6]

What Is Transfer Pricing?

A transfer price is the price at which divisions of a company trade goods and services with each other.[7] Transfer pricing applies to both tangible and intangible goods like loans, components of a product, and labor.[8] This term applies when: (1) parent and subsidiary companies operating in different jurisdictions trade goods and services, and (2) two subsidiaries of a parent company operating in different jurisdictions trade goods and services.[9] On an international scale, a subsidiary and its parent company often operate in different countries and thus set transfer prices to export and import supplies for intercompany transactions.[10] This concept exists because the transfer price for intercompany transactions is usually less costly than the transaction costs between separate, unrelated companies.[11]

Advantages of Transfer Pricing

Transfer pricing offers several advantages for multinational corporations.[12] It allows corporations to simplify their accounting methods, improve efficiency, and improve business strategy.[13] Most prominently, transfer pricing allows multinational corporations – to a certain extent – to shift their taxable income to jurisdictions with lower tax rates.[14]

There is an incentive to utilize transfer pricing when a parent company operates in a jurisdiction with a high corporate tax rate and its subsidiary operates in a jurisdiction with a low corporate tax rate.[15] If the subsidiary company exports goods and services to the parent company for a high price, then the parent company can deduct the price it paid for those transactions when it files income tax statements. Decreasing the amount of pre-tax profits the parent company has in the jurisdiction with a high corporate tax rate thus reduces the amount that it must pay in overall corporate taxes.[16] The remainder of the parent company’s pre-tax profits is then transferred to its subsidiary and taxed in a jurisdiction with a lower corporate tax rate. This process allows the corporation to retain a greater amount of overall net profits by shifting its taxable income to the jurisdiction with a lower tax rate, as opposed to retaining most of the taxable income in the jurisdiction with the higher tax rate.[17]

Applicable Law Governing Transfer Pricing

There has been a persistent increase in international regulation of transfer pricing.[18] Some regulating sources include: (1) the World Trade Organization, (2) bilateral and multilateral treaties, (3) local regulations, and (4) the Internal Revenue Code.[19] Governments are increasing the frequency of corporate audits to detect aggressive transfer pricing.[20] § 482 of the Internal Revenue Code governs the determination of the appropriate transfer price for international transactions between two related companies.[21] Legal issues arise when a corporation inflates its transfer price so that the transaction costs paid to its subsidiary for goods and services in a jurisdiction with a lower tax rate is unreflective of comparable transactions under similar circumstances.[22]

To prevent this type of aggressive transfer pricing, § 482 requires that a company’s transfer price must be consistent with the income that would have been generated if unrelated taxpayers had engaged in comparable transactions under comparable circumstances.[23] The transfer price set according to this “arms-length” principle generally ensures that the price reflects regular market prices for transactions between independent companies.[24] However, setting transfer prices for intangible goods like intellectual property tends to complicate matters because the intangible value of a patent or trademark is difficult to quantify.[25] Specifically, corporations like Apple and Amazon have been inspected for abusing transfer pricing strategies with intellectual property.[26]

Legal Requirements to Comply with International Transfer Pricing Regulations

Because there is increased pressure on government officials to generate revenue, authorities are increasing their scrutiny of international transfer pricing.[27] What constitutes effective compliance with transfer pricing regulations is still uncertain.[28] There are three transfer pricing methods prescribed in § 482 which facilitate compliance with the arms-length principle: the (1) comparable uncontrolled transaction method, (2) cost plus method, and (3) profit split method.[29] Often, authorities will ask that you use more than one method to assure that your numbers are correct.[30] It is also important to keep all financial records[31] and obtain accountants’ reports for transparency.[32] Negotiation advance pricing arrangements (APA) between taxpayers, corporations, and tax authorities may also be useful to clarify acceptable transfer pricing arrangements in a given country.[33] Finally, if transfer pricing issues require immediate resolution, dispute settlement forums like arbitral tribunals are always a viable alternative to litigation, because these tribunals are generally less expensive and time-consuming than litigation, and any judgment remains private.[34]

[1] Kevin Johnston, Advantages of Having an International Business, Chron: Small Business, (last visited Oct. 5, 2017).

[2]See id.

[3] Transfer Pricing, Tax Justice Network, (last visited Oct. 5, 2017).

[4] Mary Riley, Transfer Pricing and Int’l Taxation: A Continuing Problem for Tax Authorities, in 2014 Tax Emerging Issues 7267 (Matthew Bender & Co., 2014).

[5] See Tax Justice Network, supra note 3.

[6] Cf. Eaton Corp. & Subsidiaries v. Comm’r, No. 5576-12, 2017 Tax Ct. Memo LEXIS 147, at *147 (U.S. T.C. July 26, 2017);, Inc. v. Comm’r, No. 31197-12, 2017 U.S. Tax Ct. LEXIS 9, at *9 (T.C. Mar. 23, 2017).

[7] Thomas Pearson, Proposed International Legal Reform for Reducing Transfer Pricing Manipulation of Intellectual Property, 40 N.Y.U. J. Int’l L. & Pol. 541, 542 (2008).

[8]   Id.

[9] Molly Dean, Frederick J. Feucht, & L. Murphy Smith, International Transfer Pricing Issues and Strategies for the Global Firm, Internal Auditing, 2008 WL 1748153 (Warren Gorham & Lamont).

[10] Id.

[11] Id.

[12] See Pearson, supra note 7 at 544.

[13] See Pearson, supra note 7 at 545.

[14] See Dean, supra note 9.

[15] Dean, supra note 9.

[16] Dean, supra note 9.

[17] Dean, supra note 9.

[18] See Pearson, supra note 7 at 546.

[19] See Pearson, supra note 7.

[20] See generally, John Mckinely & John Owsley, Transfer Pricing and its Effect on Financial Reporting, J. of Accountancy (Oct. 1 2013), (noting that in a 2010 survey, “52% respondents reported undergoing a transfer-pricing audit”).

[21] 26 I.R.C § 482.

[22] See Dean, supra note 9.

[23] 26 I.R.C § 482.

[24] See Dean, supra note 9.

[25] See, e.g., In re Nortel Networks, Inc., 532 B.R. 494 (Bankr. D. Del. 2015).

[26] See, Inc. v. Comm’r, No. 31197-12, 2017 U.S. Tax Ct. LEXIS 9, at *70 (T.C. Mar. 23, 2017); Press Release, European Commission, State Aid: Ireland Gave Illegal Tax Benefits to Apple Worth Up to €13 Billion, (Aug. 30, 2016)

[27] See, e.g.,, Inc. No. 31197-12, at *76 (“This court invalidated § 1.482-7(d)(2), Income Tax Regs., the provision that requires stock-based compensation costs to be included in the Intangible Development Costs (IDC) pool. Our decision in that case was appealed to the U.S. Court of Appeals for the Ninth Circuit on February 19, 2016. The case remains pending on appeal.”).

[28] Id.

[29] See Dean, supra note 9.

[30] See Dean, supra note 9.

[31] See Dean, supra note 9; Transfer Pricing Guidelines, OECD Centre for Tax Policy and Administration, (last visited Oct. 5, 2017).

[32] See id.

[33] See id.

[34] Transfer Pricing, KPMG, (last visited Oct. 5, 2017).


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Fordham Journal of Corporate & Financial Law