Transfer Pricing Guidelines in the USA: A Comprehensive Overview

In a global economy where multinational enterprises (MNEs) play a prominent role, governments need to ensure that the taxable profits of MNEs are not artificially shifted out of their jurisdiction and that the tax base reported by MNEs in their country reflects the economic activity undertaken therein. For taxpayers, it is essential to limit the risks of economic double taxation.

Transfer pricing audits are increasing in number, complexity, and expense all around the world as tax authorities look for additional revenue from corporations. The Organization for Economic Cooperation and Development (OECD) also maintains its own transfer pricing guidelines. The OECD Transfer Pricing Guidelines provide guidance on the application of the “arm’s length principle”, which is the international consensus on the valuation of cross-border transactions between associated enterprises.

This January 2022 edition includes the revised guidance on the application of the transactional profit method and the guidance for tax administrations on the application of the approach to hard-to-value intangibles agreed in 2018, as well as the new transfer pricing guidance on financial transactions approved in 2020. Finally, consistency changes have been made to the rest of the OECD Transfer Pricing Guidelines.

In the USA, transfer pricing is regulated primarily under Section 482 of the Internal Revenue Code (the “Code”). Section 482 allows the Internal Revenue Service (IRS) to allocate income, deductions, credits and allowances among related business entities for all taxpayers. The statute itself is brief; detailed rules to govern transfer pricing are provided in the Treasury Regulations promulgated by the Treasury Department. These regulations set forth the arm’s length standard and provide guidance on how to determine arm’s length prices for intercompany transactions. Additionally, the IRS provides other guidance such as revenue rulings, revenue procedures, and agency directives.

The basic statutory underpinning of the current regime was instituted in the Revenue Act of 1928; the first sentence of Section 482 of the Code is largely unchanged from Section 45 of the 1928 legislation. Additional statutory language, dealing primarily with intangible property, was added in 1986 and 2017.

The IRS employs the arm’s length standard in administering transfer pricing. “A controlled transaction meets the arm’s length standard if the results of the transaction are consistent with the results that would have been realized if uncontrolled taxpayers had engaged in the same transaction under the same circumstances (arm’s length result).

Historical Development of Transfer Pricing Regulations in the USA

In the early 1960s, the IRS began to recognise the need for more structured transfer pricing rules. This led to the first significant developments in transfer pricing. In 1968, the Treasury Department promulgated detailed regulations that included methods (comparable uncontrolled price, resale price, and cost-plus) for evaluating transactions.

The Tax Reform Act of 1986 revised Section 482 of the Code by providing more formal requirements for transactions involving intangible property, instituting the “commensurate with income” standard. This was followed by a 1988 White Paper that initiated a review and overhaul of the transfer pricing regulations. The overhaul was completed with final regulations in 1994.

In 2017, Congress passed the Tax Cuts and Jobs Act (TCJA), which made additional changes to the Tax Reform Act of 1986 (addressing aggregation of intangible property with other property or services). The TCJA also introduced new tax rules that impact transfer pricing, such as the Global Intangible Low-Taxed Income and Foreign Derived Intangible Income provisions.

Scope and Application of Transfer Pricing Rules

Transfer pricing rules apply whenever there is a controlled transaction. Section 482 of the Code defines a controlled transaction as “any transaction or transfer between two or more members of the same group or controlled taxpayers”. These rules are primarily concerned with ensuring that intercompany transactions (ie, transactions between related parties) are at arm’s length - that is, on terms that would have been agreed to by unrelated parties under similar circumstances.

The transfer pricing rules do not require technical ownership for entities to be “controlled” but allow the IRS to apply a flexible test to determine the existence of a controlled transaction.

Transfer Pricing Methods in the USA

Several transfer pricing methods are specified in the US transfer pricing regulations. The options available are dependent on the type of service or property involved in the transaction, as follows.

Transfer of tangible property - the specified transfer pricing methods are:

• comparable uncontrolled price method;
• resale price method;
• cost plus method;
• comparable profit split method; and
• residual profit split method.

Transfer of intangible property, the specified transfer pricing methods are:

• comparable uncontrolled transaction (CUT) method;
• comparable profits method (CPM); and
• profit split method.

Controlled services transactions, the specified transfer pricing methods are:

• comparable uncontrolled services price method;
• gross services margin method;
• services cost method (SCM);
• CPM; and
• profit split method.

Mixed property transactions - the specified transfer pricing methods are:

• comparable profit split method; and
• residual profit split method.

Cost-sharing platform contributions transactions - the specified transfer pricing methods are:

• CUT method;
• income method;
• residual profit split method;
• acquisition price method; and
• market capitalisation method.

Taxpayers are allowed to use unspecified methods if they are justifiable and appropriate. There is no hierarchy of methods established in US transfer pricing regulations. Instead, the “best method” is to be used.

The USA does not have set ranges or statistical measures that are used in transfer pricing regulations. However, statistical measures are used in the arm’s length transactions. The IRS requires comparability adjustments to ensure transactions comply with the arm’s length standard under Section 482 of the Code. The Treasury Regulations require that these adjustments account for differences between related-party transactions and the comparables being used.

Transfer Pricing of Intangibles

The USA regulates transfer pricing of intangibles under Treasury Regulation Section 1.482-4. As mentioned above, the following methods are used for transfer pricing of intangibles:

• CUT method;
• CPM;
• profit split method; and
• unspecified methods.

Section 482 of the Code also provides that income from a transfer or licence must be commensurate with the income attributable to the intangible property. The USA applies the commensurate with income rules to all intangibles, including hard-to-value intangibles, because these items may be difficult to accurately value. In cases where an intangible is transferred at a price that is not consistent with the arm’s length standard, the IRS may make transfer pricing adjustments.

Cost sharing arrangements (CSAs) are governed by Treasury Regulation Section 1.482-7. This regulation provides detailed rules that define CSAs, set the conditions for their application, and specify how costs and benefits should be shared between parties. For a CSA to exist, each controlled participant must:

• engage in the cost sharing transaction;
• engage in platform contributions transactions; and
• receive a non-overlapping interest in the cost-shared intangibles (without an obligation to compensate another participant for the interest).

That is, in a CSA, the participants divide up the interests in the cost-shared intangible (typically by territory, but potentially by field of use or on another basis). This division is not subject to the arm’s length concept, with interests divided however the participants choose - so long as they are exhaustive and mutually exclusive ‒ and the division generally cannot be challenged by the IRS. However, the participants must share costs in proportion to their reasonably anticipated benefits (“RAB shares”). Further, the participants must make payments to each other for any platform contribution transactions (PCTs). A PCT is the contribution of any intangible that will be used to help develop the cost-shared intangible.

The sharing of development costs and payments for PCTs must generally adhere to the arm’s length principle (ie, the terms of the arrangement reflect those that independent parties would have agreed to under similar circumstances). The regulations, however, provide some specific rules on what is considered arm’s length, even where independent parties would not have reached the same agreement. Most notable among these is the requirement to share stock-based compensation costs.

The US tax rules allow for adjustments if it is found that the CSA does not reflect these modified arm’s length requirements.

Upward Transfer Pricing Adjustments

Taxpayers in the USA are allowed to make upward transfer pricing adjustments after filing their tax returns only under very limited conditions. As a general rule, taxpayers may not make transfer pricing adjustments after filing tax returns. There are exceptions when the IRS asserts adjustments, particularly that the taxpayer may assert a “set-off” adjustment relating to a different controlled transaction between the same controlled entities.

Information Sharing and Cooperation

There are several methods available to the USA to further co-operation in the sharing of taxpayer information across jurisdictions. The USA has signed bilateral tax treaties with numerous countries, creating a vast treaty network. These treaties allow for the exchange of taxpayer information (eg, information related to income, assets, and financial transactions) between the USA and agreeing countries.

Further, tax information exchange agreements (TIEAs) allow the USA to request information from and send information to other countries on individuals or entities suspected of evading taxes. Additionally, the USA can also operate through multilateral treaties such as the Convention on Mutual Administrative Assistance in Tax Matters and the Hague Evidence Convention.

In certain circumstances, the USA will co-operate with other tax authorities to conduct a joint audit. Although there is no widespread framework for joint audits in the USA, the IRS will participate in joint audits that involve transfer pricing, multinational enterprises (MNEs) and other cross-border tax issues under the established rules for those issues.

Advance Pricing Agreements (APAs)

The USA created the APA programme. The programme is well established for unilateral (a single taxpayer and the IRS), bilateral (the taxpayer, the taxpayer’s affiliate, the IRS, and a foreign tax authority), or multilateral (the taxpayer, the taxpayer’s affiliate(s), the IRS, and multiple foreign tax authorities) agreements. An APA identifies the entities and transactions that are covered and can be limited to select portions of a taxpayer’s operations.

The APA programme is administered by the Advance Pricing and Mutual Agreement Program (APMA) group. The APMA is overseen by the Director of Treaty and Transfer Pricing Operations, who reports to the Deputy Commissioner of the Large Business and International (LB&I) Division. The APA programme and mutual agreement procedures (MAPs) are both administered by the APMA and the same IRS personnel staff both programmes to resolve transfer pricing matters.

APAs are available to US taxpayers for “coverable issues”. Coverable issues include issues arising under Section 482 of the Code and other issues impacted by transfer pricing principles. Examples of other issues include:

• issues related to Section 637(d) of the Code (rules for certain repatriations of intangible property);
• competent authority issues arising under the business profits and associated enterprises articles of US tax treaties;
• the determination of the income effectively connected with the conduct of a trade or business within the USA; and
• ancillary issues such as interest and penalties to the extent the APMA has authority under the Code or a US tax treaty.

The APMA’s acceptance of a taxpayer’s request for an APA is discretionary. In April 2023, the IRS issued additional internal guidance instructing APMA personnel on how to evaluate whether to accept an APA or renewal request. The guidance provides for a new optional pre-submission review process designed to identify roadblocks to successfully concluding an APA and encourages taxpayers to obtain preliminary advice from the IRS as to whether an APA is an appropriate resolution to a taxpayer’s transfer pricing issues.

APAs are generally intended to apply primarily to prospective years but can also cover rollback years. The APMA normally expects an APA request to cover at least five prospective years and, for a unilateral APA, the APMA must receive a complete APA application by the date the US return is timely filed for the applicable prospective year.

To better co-ordinate the timing of discussions on bilateral and multilateral APAs, a taxpayer must file a bilateral or multilateral APA request no later than 60 days after a corresponding bilateral or multilateral request is filed with a foreign competent authority.

For APA requests received after 1 February 2025, the fees are as follows:

• original APAs ‒ USD121,600;
• renewal APAs ‒ USD65,900;
• small case APAs ‒ USD57,500 (applicable where the controlled group has sales revenue of less than USD500 million in each of its most recent three back years, the value of the proposed covered issue(s) is not expected to exceed USD50 million in any given covered year, the aggregate value of any transferred intangible rights is not excepted to exceed USD10 million in any given covered year, and the covered issue(s) do not involve intangible property arising from or related to an intangible development arrangement); and
• amendments to an APA ‒ USD24,600.

There is no upper limit on the number of years an APA can cover. The APMA generally requires that an APA application cover at least five prospective years. The APMA aims to have at least three prospective years remaining in the APA term upon the execution of the APA. As mentioned above, an APA can cover prospective years as well as prior (rollback) years.

Typically, a taxpayer requests that an APA cover rollback years, but the APMA may consider a rollback at its discretion even in the absence of a taxpayer’s request.

Penalties for Non-Compliance

The penalties in transfer pricing cases can be onerous and are either 20% or 40% of the amount of the tax underpayment, depending on the degree of non-compliance. In Section 482 cases, penalties most often result from valuation misstatements, but accuracy-related penalties for understatement of income tax, disregard of rules or regulations, or transactions lacking economic substance can also apply.

Penalties do not stack and, as such, the maximum accuracy-related penalty is 40% ‒ except for in instances of fraud, where the penalty can be 75%.

Penalties potentially applicable to transfer pricing cases are provided for in Section 6662 and include the following.

Net adjustment penalty ‒ a 20% penalty applies where there is a “substantial valuation misstatement”, which occurs when the net Section 482 adjustment exceeds the lesser of USD5 million or 10% of gross receipts. The penalty is increased to 40% if there is a “gross valuation misstatement”, which occurs when the net Section 482 adjustment exceeds the lesser of USD20 million or 20% of gross receipts.

Transactional penalty ‒ a 20% penalty applies where there is a substantial valuation misstatement in a transfer price of 200% or more or 50% or less of the arm’s length amount. The penalty is increased to 40% if the transfer price is 400% or more or 25% or less of the arm’s length amount.

Substantial understatement penalty ‒ a 20% penalty applies where the understatement of tax exceeds the lesser of 10% of the tax required to be shown on the return or USD10,000 (USD5,000 for corporations).

Transfer Pricing: Navigating the Complexities of Global Tax Regulations

Table: APA Fees (Effective After February 1, 2025)

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Recent Transfer Pricing Cases

The tax court ruled in 2020 that Coca-Cola Co. The tax court’s decision upheld the IRS’s method for reallocating profits between Coca-Cola and affiliates that made and sold ingredients for the company’s soft drinks.

Supreme Court announced that it wouldn’t review the Ninth Circuit’s 2019 decision in the semiconductor manufacturer Altera Corp. case. That decision required the cost of employee stock-based compensation (SBC) to be included in the pool of intangible development costs (IDC) under cost sharing arrangements (CSA).

While the IRS argued that the company owed nearly $1.4 billion in taxes, a tax court found in a 2016 opinion that it had underpaid by just about $14 million.

The tech giant is challenging a $1.73 million tax bill for 2010 that hinges on the value of intangible assets, such as trademarks and copyrights, that it transferred to an Irish subsidiary.

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