Transfer Pricing (TP)

When a group's entities trade with each other, the price shifts profit from one to another. If the entities are in countries with different tax rates, the price affects total tax. Tax authorities therefore require prices to follow the arm's length principle, as if the parties were independent. Companies choose a method, such as comparing with similar third-party prices or comparing profit margins, support it with a benchmarking study and record it in transfer pricing documentation. Most countries require this file, often in a master file and local file format, before or soon after the return is filed. Intercompany agreements, invoices and actual conduct must match the documented approach. Adjustments by one country can cause double taxation unless the other country agrees to relief. Tax inspectors open a transfer pricing query by asking for the file, so a group without one starts the dispute already behind.

An appliance maker manufactures in one country and sells through a subsidiary in another. It sells to the subsidiary at a price that leaves the subsidiary with only a thin margin. The tax authority in the subsidiary's country questions this in an audit, so the group produces a benchmarking study showing that independent distributors earn similar margins.