Transfer Pricing (TP)

One of the most common methods of reducing the overall tax burden of multinational entities (MNEs) is by entering into international transactions between the companies comprising the group. Through such transactions, the MNE shifts the group’s profits from countries with high tax rates to jurisdictions where tax rates are lower. Google, for once, is diverting most of its profits to Ireland. To overcome the problem of profit shifting, many countries enacted a series of laws and regulations that require maintaining transfer pricing documentation and applying market conditions on such transactions.

What is Transfer Pricing?

Transfer Pricing (TP) is the term used to describe all aspects of transactions between related parties (a definition which differs from one jurisdiction to another). Most commonly, those inter-company transactions include:

  • the sale (transfer) of tangible property – for example for distribution purposes;
  • the utilization/transfer of intangible assets – such as for manufacturing or assembling purposes (but clients lists, for instance, are also an intangible asset for this purpose, as well as IP used for further R&D purposes by a different entity in the group);
  • the provision of services (management, marketing, R&D, tech. support, assembly/manufacturing etc.);
  • financial transactions (loans, capital notes, ESOP, guarantees, credits, etc.).


All inter-company transactions must be regulated in accordance with local TP rules, which mostly require: (1) a TP study, which demonstrates the arm’s length results (market price) of the tested inter-company transaction (and upon which, each relevant entity must pay its taxes); (2) an inter-company agreement based upon the outcome of the study; (3) actual implementation of the results of the study; and (4) if applicable – a TP policy (required mostly for groups of no less than 3-4 subsidiaries).


What is the “Right” TP Model a Company Should Implement?

The answer is complex and depends on the circumstances of each company and the different characteristics of each transaction. For each type of transaction, the local TP regulations determine a different TP method. It should be specifically noted, that the too common use of the “cost plus” model is more often than not incorrect, either in terms of the applicable TP method (which should have been different due to the characteristics of the transaction) or in terms of the “cost” and “plus” determined by the parties. For example, should options granted by the Company to employees of its subsidiaries be calculated as part of the “cost”? The answer depends on the TP model adopted and on the relationship between the parties.

Another example would be in intercompany financing matters, where not only the “arm’s length” interest rate and the loan terms need to be taken under consideration, but also the company’s capital structure. Each company has a different supply chain, IP ownership structure, functions and risks allocation among its group companies, etc. and thus the “right model” has to be carefully considered in order to abide by applicable rules.

What Are the Critical Issues When Implementing the TP Model?

The bottom line is that in order to really implement the TP model, the daily business routine between the relevant companies has to reflect every aspect of it. The financial statements have to be separated in a way that enables to trace each intercompany transaction. All inter-company transactions have to be backed-up with proper agreements and documentation, which will demonstrate to the tax authorities that the inter-company pricing is similar to (or in the range of) non-related third party transactions; or explain why it’s not.

Our experience shows that many MNEs see themselves as an unseparated unit, which can create difficulties in implementation and significant exposures.


What are the consequences for not implementing TP?

The main exposures are to double taxation, fines, interest, linkage, and adjustments to the group’s financials (roll back period). It should be noted that TP legislation overcomes any treaties and even allows tax authorities to re-open previously closed tax assessments. Aggressive audits and heavy fines are some of the measures tax authorities worldwide are using nowadays, and it seems they have no intention of stopping there. Additionally, wrong TP models (or the lack thereof) also bear implications on VAT and customs exposures.

Additionally, in certain countries the company’s CFO has to sign a unique form (or tick the box), stating the company is acting in accordance with the TP regulations (i.e. holding a study and acting thereby). In Israel, the obligatory form 1385 requires the description and detailed pricing of each inter-company transaction performed with related parties.

Bar Zvi & Ben Dov is a boutique law firm specializing inter alia in transfer pricing. The firm has been active since 2006, and has filed over 500 studies worldwide, with 100% success rate in tax audits worldwide. The firm is recommended by the Legal 500 international guide in the fields of Tax and High-Tech, has offices in Tel-Aviv and NYC, and is a partner of Transfer Pricing Associates, the world’s largest independent group of international experts in transfer pricing, providing local sign-offs in more than 60 counties.