If your accountant suggests that your firm should consider a transfer pricing study, you should heed this advice. One of the current waves of IRS audits involves transfer pricing, which is covered in Internal Revenue Code 482. What is this and why do I have to be concerned?

Companies with offshore subsidiaries or intangible assets in these subs need to establish the pricing of goods and services which flow between/among these entities. Often, intellectual property (IP) will be transferred to a foreign country and leased back to the US entity. The transfer price or licensing fee should be at market value, since the IRS is looking for transfers that move taxable revenue outside the US.

The key ingredient of an arm's length price is the comparability of non-controlled taxpayer transactions. Usually the best method to provide needed support to the IRS is the Comparable Profit Method. This technique determines best pricing by analyzing the present value of projected future income or profits.

With the above in mind, here are the primary ingredients for preparing for an audit:

  1. Ensure that the documentation is clear and complete, as much as possible.
  2. Assess the sensitivity of the search parameters and the strength of the benchmarking.
  3. Determine that the profits are shared fairly between the entities.
  4. Reflect on the profit's comparability in light of the current economic environment.
  5. Use examples of inter-company transactions, if possible.
  6. Tell the compelling story of how and why you set the pricing terms.
  7. Show how the burden of risk factored into your analysis, and how you countered it.

Go forth and face the audit!