Academic journal article Journal of Business and Accounting

An Analysis of Transfer Pricing Policy and Notable Transfer Pricing Court Rulings

Academic journal article Journal of Business and Accounting

An Analysis of Transfer Pricing Policy and Notable Transfer Pricing Court Rulings

Article excerpt


As a result of significant corporate tax disparity between the United States and other developed countries, businesses are exploring and utilizing many options to move income to lower tax nations. A US based company might use foreign marketing subsidiaries to market products overseas, or a US parent may engage in services to its subsidiaries in the form of management or administrative services for fees. A manufacturing plant in the US might sell components to an assembly plant in a foreign country for assembly and sale to other nations. When these transactions occur, a transfer price must be computed. In the case of financial reporting, a transfer price does not impact the overall income of a combined group of corporations, but from a tax standpoint there is a direct impact of how income is allocated between countries. For example, if a subsidiary in India provides management services for a parent company in the US, the Indian subsidiary will charge a transfer price to the US parent. This transaction will result in an expense (reduced taxable income) to the US parent, and revenue (increased taxable income) to the subsidiary in India. As such, income has been shifted from the US to India. Due to the subjectivity involved in making the determination of what constitutes an arm's length transaction and allowable transfer price, this is an area that has been highly litigated in the courts. This paper examines significant historical cases where the taxpayer has been successful and looks at the specific reasons when courts have favored the taxpayer over the IRS when dispute arises.


Transfer pricing transactions are governed under §482 of the Internal Revenue Code. The regulations under §482 are designed to assure that transactions are arm's length and do not allow an unreasonable shifting of income with the intent to avoid tax. Of the available methods, the entity is required to select the method that would be most representative of an arms-length transaction. From the perspective of the IRS, a major audit contention is to assure that transfer pricing transactions, known as controlled transactions are truly recognized as arms-length, and using the method that is the most accurate presentation as arms-length based on all available information. If it cannot be proven that a transaction is arm's length, §482 states that income needs to be allocated between the US entity and any foreign subsidiary. The ultimate objective of this paper is to look at a history significant of significant court rulings on these transactions and discuss patterns that have previously been used by courts in making determinations mostly in favor of the taxpayer.

When a transaction is examined, the pricing method deemed most appropriate to represent an arms' length transaction is the one that would be considered most reliable of the available methods. When a method is deemed to be reliable, the pricing is then compared to the overall comparability between the transaction that is controlled (the transfer price) and uncontrolled transaction to an outside, independent party. This comparability is deemed based on quality of data used, as well as the assumptions used by management to perform the analysis per §1.482(c)(2).

§1.482-1(d)(1) presents the main factors that are to be utilized to assess the overall controllability of transactions, and these factors include functions performed, risks assumed, contractual terms, economic conditions, and nature of the property or services transferred. The five methods permitted for estimating the arm's length transaction to satisfy the factors as defined under §1.482-3(a) are the comparable uncontrolled price method, the resale price method, the cost plus method, the comparable profits method and the profit split method for tangible transfers. These rules differ slightly when the transfer of intangibles is involved. Intangible transfer prices can be computed using the comparable uncontrolled transactions method, comparable profits method and profit split method. …

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