Transfer pricing is one of the most important issues in international tax–particularly as the globalization trend continues. Transfer pricing is the establishing of a price for the exchange of goods and services between two related legal entities within an enterprise.
The determination of the prices for goods, services and intangible assets exchanged between related parties is highly controversial. Given the contentious nature of these transactions, the determination of prices between related parties are often challenged by the IRS and other tax authorities around the world.
A pending case involving Coca-Cola is illustrative of the IRS’s intense scrutiny of such transfers.
Details of the Coca Cola Case
After auditing Coca-Cola, the IRS issued a $3.3 billion “Notice of Deficiency” based on transfer pricing adjustments of approximately $9.4 billion. The adjustments related to the licensing fees charged to seven foreign affiliates, located in several countries, for the use of trade name, manufacturing formulas, and other intangible assets. The IRS claims that Coca-Cola undercharged its foreign affiliates for intellectual property used in the foreign production and sale of Coca-Cola concentrates. In December 2015, Coca-Cola filed a petition with the U.S. Tax Court challenging the IRS’s Notice of Deficiency. The case is currently pending trial.
Transfer pricing rules require that transaction prices charged between controlled entities should be at “arm’s-length.” This means that a related third party should be charged the same amount for the exchange of services, assets or licenses as the prices charged between unrelated entities. The U.S government has become more aggressive in pursuing transfer pricing dispute cases such as those brought by Microsoft, Medtronic, Caterpillar and Amazon. The Coca-Cola case is being watched closely because the IRS wants to set an example of their firm stance against Multinationals that may consider abusing the use of intangible assets as a way of shifting the profits to lower tax jurisdictions.
An Action Plan for the Valuation of Intangible Property
The Organization for Economic Co-operation and Development (OECS) has recently formalized a plan named “The Action Plan on Base Erosion Shifting” (BEPS) that has implications for valuations of intangible property. This action plan indicates that the profits should be taxed where they are being generated. As part of the action plan, OECD issued a three-tiered reporting requirement to enhance the sharing of information among tax administrations. Meanwhile, the IRS is tightening its controls on how multinational companies including OECD member countries, are assigning value to their intangible property between related entities. This increase in scrutiny by the tax administrations indicates that intangible property related transfer pricing tax cases will continue in the future.
What Should You Be Doing Now?
In order to adjust to the increased scrutiny of transfer pricing guidelines by tax authorities, companies should analyze their business operations and determine whether the location of their intangible property is supported by their functions, risks and economic ownership of these intangibles. This proactive approach will help ensure the proper allocation of the profits generated by using intangible property. It is highly advised that companies begin to adopt the proper transfer pricing methodologies and documentation in order to avoid unforeseen issues and possible fines in the event of IRS audit.
Transactions involving transfer pricing, particularly those involving “intangible property,” should not be entered into lightly. If you would like to benefit from our expertise in this area, or if you have further questions on this Advisory, do not hesitate to contact our International Tax specialists, or call us at 1-800-239-1474.