You may be familiar with the term “transfer pricing data analytics” but what does it really mean? How is it regulated by the tax code, and how can businesses use it to control taxable income? And what are the implications for multinational corporations? Transfers between related parties to reduce income and/or avoid tax are prohibited under the Internal Revenue Code (IRC). These transactions are known as “transfer pricing” transactions. They are a major focus of the Internal Revenue Service’s (IRS) audits.
The term “transfer pricing” usually refers to two basic types of transactions: intra-group and inter-group transfers. Intra-group transfers occur within a multinational corporate structure, whereas inter-group transfers occur between such structures. For example, in a U.S.-based corporation’s Canadian subsidiary, the Canadian corporate tax rate (19%) is lower than the U.S. corporate tax rate (35%). Since several multinational corporations have subsidiaries in both countries, these transactions are often referred to as “ transfer pricing data analytics “.
To comply with the IRC’s anti-avoidance provisions, business operations are usually arranged so that all subsidiaries of a multinational corporation are viewed as being a single operation. This is done by creating a single consolidated set of books and records for the entire corporation. The result is that the U.S. income tax is paid on that consolidated income, even though it represents income for one of the subsidiaries of a single corporation.
The transactions outlined below are sometimes referred to as “transfer pricing”. They are examples of what is normally meant by this term, but they are not typical.
Intra-group transactions occur between related entities within one multinational corporate group with common ownership.
U.S. parent (or U.S.-owned) subsidiaries of a Canadian corporation may sell to their Canadian parent assets that are used in the Canadian business operations (e.g., machinery, equipment, real estate or raw materials) at prices that are lower than similar assets would be sold in the United States. The reason is that these assets can be sold for higher prices in the United States because of their greater value there, compared to the similar transfer pricing data analytics for these same assets.
Such intra-group transactions are commonly used to reduce taxable income and avoid U.S. withholding tax liabilities. A similar approach is used to lower the income of a U.S.-owned subsidiary of a multinational corporation by making payments for goods and services from another related group member (e.g., from another subsidiary or parent) at inflated prices so that the otherwise higher U.S. corporate tax rate is avoided or reduced in some jurisdictions (e.g., Canada, Singapore).
U.S. tax law was modified in a 2004 Technical and Miscellaneous Revenue Act (TAMRA). According to the Treasury Department, TAMRA amended the IRC’s rules for transfer pricing with an aim to “increase compliance” with the IRC’s “anti-avoidance provisions” by removing so-called “structuring opportunities”.
Inter-group transactions occur between separate multinational corporate groups that have common ownership but are not part of the same consolidated group of companies on the basis of ownership.
TRANSFER PRICING DATA ANALYSIS Is Effective
Transfer pricing data analytics can be a difficult analytical task, with a range of complexities that number in the hundreds. One of the biggest challenges for this field is gathering data from multiple sources and extracting meaning from it. Many transfer pricing analysts have explored multiple tools to help improve the quality of their data. One of these is the so-called transfer pricing z-score method; this approach is based on a method for determining what a “normal” score would be for a given set of data.
its author makes some very unrealistic statements about this technique being able to determine whether or not any particular transaction is in violation of anti-transfer pricing laws.
The transfer pricing z-score measure was developed as an aid to analyze a filing’s transfer pricing data. It is only one tool that might be used to analyze the data. The Z score considers the interaction of all tax jurisdictions in which income is earned, based on their level of development, the industries involved and bilateral tax treaties. The Z score offers an objective indicator of a filing’s compliance with transfer pricing laws for both domestic and foreign transfer pricing data analytics.
The Z score can help to determine verification risk and alert tax authorities to potential transfer pricing issues. It also provides a framework for further investigation by authorities that are concerned about transfer pricing compliance. The Z score is independent of the jurisdiction’s legal definition for a permanent establishment and does not consider internal transfer pricing policies or methods.
If a taxpayer is engaged in a regular pattern of transactions, the Z score will provide a consistent measurement of its transfer pricing practices. A sudden change in transfer pricing policy resulting in significantly lower (or higher) margins than previously disclosed may indicate an attempt to hide taxable income. Such a change should warrant further investigation.
The Z score is calculated by combining the following numerical factors:
The resulting “Z” score is constructed with values between 0 and 5. A Z score above 3 indicates that the transfer pricing data analytics are more likely than not to be technically accurate. A Z score below 2 indicates that the statements may not be reliable. A Z score of 1 indicates that the taxpayer’s statements are at least as likely as not to be technically accurate.
Z scores are computed by summing the digits of each column and dividing by the total number of digits in that column. The resulting number is then multiplied by 100 and rounded for convenience. The Z score is used by financial institutions to assist in anti-money laundering rule compliance.
The Z Score Methodology was used in the case of “Commission v. Microsoft Corporation”. It was used by the EU Commission to test the reliability of transfer-pricing information supplied by Microsoft. The Commission concluded that Microsoft’s transfer-pricing practice fell outside its TP Guidelines, but decided not to require a fine on the basis that Microsoft’s cooperation was partial, and in view of its compliance with other tax matters.