Reform In Sight for U.S. Transfer Pricing?


News Finance

Recent litigation is poised to challenge the status quo in U.S. transfer pricing (TP), where the arm’s-length standard continues to be the norm. According to a PwC report, the problem with current practice, however, is that finding a basis for comparison between an inter-company exchange and a similar independent entity exchange is that sometimes the transactions between related parties are very niche. In short, for many of these transactions, there is no basis for comparison1.

Much of the murky water associated with TP also stems from issues involving foreign legal restrictions, International Tax Review reports. Blocked income, or the payment or receipt of funds between related entities, has been a topic of debate since the 1950s but has largely found outcomes in favor of taxpayers. However, recent litigation at the Supreme Court level in two cases, Coca-Cola v. Commissioner and 3M Co. v. Commissioner, appears to be on the verge of a new development in TP and the blocked income issue2.

Both cases involve Brazilian restrictions that limit the royalties that can be paid by Brazilian entities. Those limitations, according to International Tax Review, “limit a taxpayer’s ability to make deductible payments without prohibiting the payment of non-deductible dividends, and thus do not qualify under the regulations.” Both cases, therefore, seek to challenge the validity of blocked income rules established under the Administrative Procedure Act, and prior related cases. Multinational entities currently impacted by foreign legal restrictions could soon see clarification regarding TP and blocked income as the Tax Court has ruled to base its decision on Coca-Cola v. Commissioner and the ruling in 3M v. Commissioner2.

So, what can those in financial advisory roles do to prepare their clients for potential movement on the blocked income debacle? According to a member of KPMG’s Detroit Tax Practice Bob Alltop, the best course is to stay the course. “While waiting for further guidance from the courts, corporate tax professionals and CFOs may want to maintain the course that they have been following. Where companies are paying dividends from Brazil to the U.S. parent in lieu of blocked royalty income, for example, they will likely wish to continue doing so.”

Nevertheless, he adds that there are other transfer pricing considerations a company may want to consider:

  • What changes to the business supply chain can be made to reduce the level of blocked income?
  • Are there functions, assets and risks currently undertaken or borne in a jurisdiction with blocked income that can be changed, moved, or reduced? For example:
  • A company can consider whether there are elements of product IP that it would be beneficial to develop and own in the country with blocked income. This could minimize the level of royalties owed back to the U.S. and would be most applicable if the IP is specific to the local market and therefore does not need to be deployed in other jurisdictions. 
  • If a manufacturing entity with blocked income owes a royalty to its U.S. parent on sales made not only in its own country but to affiliates in neighboring jurisdictions (e.g., a Brazilian plant supplying South American affiliates), the entity could be converted to a contract manufacturer for sales outside of its own country, thereby reducing the sales based on which the blocked royalty would be calculated.  

Finally, as companies await further guidance, it is prudent to consider what an elimination, change, or continuation of the current regulations may mean for their cash management, supply chain, and tax planning. Members can login to MICPA Connect to continue the conversation on transfer pricing, blocked income and other emerging issues.

  1. Mercader, Amparo & Paige Hill. “Doing Business in the United States: Transfer Pricing.PwC. 2021. Accessed on 22 Jul 2021.
  2. Bettge, Thomase & Mark Martin. “US: Approach to TP and Blocked Income.International Tax Review. 28 Jun 2021. Accessed on 22 Jul 2021.

Source: MICPA

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