For multinational enterprises, transfer pricing—the pricing of transactions between related entities (such as a parent company and its foreign subsidiary)—is one of the most heavily scrutinized areas of international taxation. Tax authorities globally watch transfer pricing to ensure profits aren't shifted to low-tax jurisdictions.
The Arm's Length Principle
IRS Section 482 requires transactions between related parties to be priced as if they occurred between unrelated parties under similar conditions. This is known as the arm's length principle. Companies must conduct economic benchmarking studies to justify their pricing methods.
Documentation Requirements and Audits
Failure to maintain transfer pricing documentation exposes companies to severe tax adjustments and double taxation. Because global tax authorities actively audit international transfers, proactively establishing a robust transfer pricing policy is essential.