Transfer Pricing Study Counters IRS Challenge and Penalties
A medium sized multinational, foreign owned engineering, procurement, and construction company focused on projects within the upstream and downstream energy industry.
- Multi-year transfer pricing studies
- Solution & Benefits
The company engaged us to perform multi-year transfer pricing studies, based on each related party entity’s current risk and functions, within each respective year under analysis. PKF Texas documented intercompany transactions between the U.S.- and Russian-related parties by first selecting the tested party or entity that best represents the transfer pricing method and accordingly comparing them. This usually results in the entity with the least risks and functions.
In order to grasp intercompany pricing policies, PKF Texas gathered support from the company’s CFO and controller to better understand the entity’s risks and functions profile. Furthermore, the client was advised that while profitability margins appeared low in comparisons to similar independent companies, there was a strong case to maintain a basis for current pricing practices.
Based on the fact that consistent pricing methods are difficult to implement, PKF Texas supplied interpretations within the study that intercompany pricing between the U.S. and Russian entities was reasonable. Each project is unique, and many times, contains varying level of engineering services. Bifurcating costs between equipment and services would provide an inadequate pricing method since the two are so integrated. Moreover, the U.S. entity is highly dependent on the Russian entity for administrative support. Therefore, the cost of this support is indirectly passed on to the U.S. entity through a lower sales price for equipment sold, from the U.S. entity to the Russian entity.
The transfer pricing study was completed by the IRS deadline. In addition, the documentation was sufficient in supporting that the intercompany transactions met the arm’s length principle and was compliant with local regulations. Similar to many instances in client service work, adequate due diligence of the tested parties will aid in making reasonable assertions. In this instance, when intercompany profit margins deviated from the expected range, PKF Texas, through thorough research of the organization and advanced understanding of current transfer pricing principles, determined that the price was, in fact, right.
Under audit, the company was appealed by the IRS to provide transfer pricing documentation within 30 days that must highlight intercompany pricing policies within the organization. The existing intercompany pricing structure yielded a significantly lower than expected product pricing range on equipment sold from the U.S. entity to the Russian entity. The expected price range was based on a comparison of how profitable similar transactions are among unrelated parties.
Profitability margins below normal thresholds are at risk of adjustment by revenue authorities that could have resulted in several hundred thousand dollars before penalties.