What is Transfer Pricing and How Does it Relate to Intercompany Accounting?
Transfer pricing is an accounting practice that allows for the establishment of prices for the goods and services exchanged between legal entities of the same consolidated group. Some companies have used transfer pricing to reduce the overall tax burden of the parent company, but tax authorities are increasingly contesting these claims. The IRS states that the transfer pricing between intercompany transactions should be the same as it would have been if the transaction had been done outside the company.
Slack transfer pricing practices can haunt multinational finance, accounting, and tax teams with:
- Poor visibility/examinability/documentation
- Rolling intercompany balances/unreconciled balances
- Financial reporting risk and delays
- Uncertain tax positions in ambiguous, subjective, and continuously changing environments
- The possibility of restatement
Corporate finance, accounting, tax, and shared services leaders must buttress their transfer pricing policy with definitional clarity, granularity, and transparency of costs.
Determining supportable pricing rates has historically followed two paths – negotiations between related parties doing business together or, more commonly for large multinationals, through pricing set by the parent company for its subsidiaries.
Intercompany financial management (IFM) experts recommend that transfer pricing be set by the parent company removing the temptation for a business unit to overestimate its own profitability. Individual business entities can sometimes struggle to accurately understand per-product profitability. Conversely, the corporate accounting and tax teams have visibility into the financials of all related entities making them better able to define contributions when facing a complex value chain.
What is its relationship to intercompany accounting?
Intercompany accounting is a discipline for managing transactions within a corporation and between its legal entities. While it goes far beyond transfer pricing, the discipline is designed to efficiently maximize accounting accuracy while optimizing tax exposure and ensuring regulatory compliance.
Without a foundation of disciplined transfer pricing policies and practices, companies are at risk for more numerous tax enforcement actions and higher imposed settlements. The external forces demanding improved intercompany accounting efforts combine with internal realities to add additional urgency to improved practices.
Increased globalization means adhering to more local laws and reporting requirements; reconciling across additional legal entities and jurisdictions; and juggling multiple disparate finance, invoicing, and receivables systems. Taking control of transfer pricing processes with sound intercompany financial management practices is a corporate imperative, especially given the scarcity of qualified transfer pricing talent and the high cost of outsourced options.
Accurate price-setting lies at the heart of transfer pricing best practices. Section 482 of the IRS code protects government tax revenue by requiring transfer pricing determination is “at arm’s-length,” meaning transaction pricing between two related parties should be the same as it would be between two unrelated parties on the open market. IRC 482 applies to all nature of economic transfers for both COGS and direct costs including: material movement, long-term assets, intangible assets, intercompany loans, and services.
FourQ can help
FourQ helps companies centralize the management of intercompany processes, technology, and master data to create improved tax and resource efficiency while reducing operating costs. FourQ’s OneBiller solution automates intercompany accounting by translating relevant data into compliant invoices and documentation to support intercompany transactions, real-time audits, and improved transaction transparency while reducing operational costs.
The art of establishing company-wide process uniformity requires experienced intercompany pros. FourQ has guided consistency across customer organizations improving compliance and reducing risk. Uniformity and consistency are important defense lines in any transfer pricing audit as they communicate a sense of control and defend against disorder.