Meaning
Formal agreement between a taxpayer and the tax authorities regarding the pricing of transactions between related parties. A transfer pricing settlement resolves disputes over whether intercompany charges for goods or services follow the arm’s length principle. The agreement prevents the double taxation of income.
Economic Justification
Selection of the most appropriate pricing method depends on the functions performed and the risks assumed by each entity in the transaction. Documentation must show that the prices charged to affiliates are comparable to those found in transactions between independent companies. The tax bureau analyzes financial data from similar industries to establish a benchmark range for acceptable profit margins.
This analysis includes the evaluation of operating assets and the cost of capital for each involved party.
Dispute Resolution
Negotiation of a settlement often involves a multi-year audit where the tax authority challenges the historical pricing of the company. Taxpayers may enter into an advance pricing arrangement to agree on future pricing methods and avoid future audits. This process requires the full disclosure of the global value chain and the allocation of intellectual property within the group.
Adjustment Period
Implementation of the settlement results in a recalculation of taxable income for the years under review. The taxpayer must pay the additional tax along with interest while adjusting the books to reflect the agreed transfer prices. A settlement typically covers a period of three to five years and provides a degree of certainty for the financial planning of the enterprise.
