Transfer pricing, once an arcane specialty, has been growing as more countries apply their own rules and regulations, some in accordance with the Organization of Economic Cooperation and Development’s initiative on curbing corporate tax avoidance.

The number of countries with transfer pricing regimes has now reached 150, according to the Chilean tax authority. The upshot of these transfer pricing regimes is that transnational organizations like the OECD are causing national governments to develop their own transfer pricing rules and regulations. These national governments then shift the onus of their transfer pricing rules to a wide variety of multinational taxpayers. Transfer pricing experts now must reflect these increasing transfer pricing responsibilities to meet the standards of professional care toward their business clients and themselves.

Both public sector transfer pricing administrations and their private sector counterparts might find it prudent to develop specialized industry-specific practices within the field of transfer pricing. We suggest that transfer pricing experts apply functional analysis groupings based on specialty areas or practice groups. Such groupings might include delineations of transfer pricing activities such as production, wholesaling, services and financing:

Production-based transfer pricing activities: The transfer pricing production-based analytical group should examine and articulate the manner in which the enterprise produces or manufactures its products. It is important for the transfer pricing analytical group to ascertain its production-level product streams, determining the amounts for significant products the business incurs at different phases of the production activities. This analytical process involves splitting off products for production activities and making byproduct versus joint product delineations for transfer pricing purposes.

Wholesale-based transfer pricing activities: The transfer pricing wholesale-based analytical group should examine and articulate the manner in which the enterprise wholesaler receives products from manufacturers. The analytical group should ascertain the manner in which a specific wholesaler distributes products to its retailers, taking into account resale or retail price rules when relevant.

Services-based transfer pricing activities: The transfer pricing services-based analytical group should examine and articulate the nature of services undertaken from one entity to another. The group should especially examine the uniqueness of the services, the transference of these services, service costs, and similar service issues, all from a transfer pricing context.

Financially based transfer pricing activities: The transfer pricing financially based analytical group should examine and articulate intercompany financially-based transfer pricing considerations. Such financially based transfer pricing issues might include such issues as debt/equity determinations, assessment of interest rates at the borrowers’ situs and the lenders’ situs, and the ability of each party to the transaction to withstand risk.

Applying industry-specific production-based transfer pricing

Production-based tax administrators and corporate-sector transfer pricing specialists are in a position to apply additional transfer pricing skill-sets to achieve their transfer pricing objectives. They should encompass the following four production-based activities: manufacturing, production, extraction and growth. Consider these examples:

1. Manufacturing

• An enterprise uses an iron foundry to produce steel products.

• An enterprise produces computer printers and printer cartridges.

• A pipe manufacturer products various pipe types and sizes.

• An auto manufacturer produces two brands: one brand locally, the other brand for international sales.

2. Production

• An enterprise produces tungsten carbide abrasives, cutting tools and armor-piercing rounds.

• An ethanol producer produces ethanol and feed stocks.

• A crude oil producer produces petroleum gas, asphalt and other petroleum products.

3. Agribusiness growth

• A rancher sells cattle and pigs, including offal products, tallow and meal.

• A cotton enterprise sells cotton and cottonseed oil.

4. Extraction

• The mining company removes sulfur from its mineral production and produces sulfuric acid.

• A petroleum company produces a wide variety of potential petrochemicals.

• A bauxite mine uses various levels of electricity to produce specific aluminum products.

Production-based transfer pricing factors

Enterprises undertaking production-based functional activities have a common thread. These facets set production activities apart from wholesale-based activities, services-based activities, and financially-based transfer pricing activities.

Barriers to entry: Production-based enterprises in general have higher “barriers to entry” to the relevant business activities than do other firms. These production-based activities require a higher level of business capitalization and necessitate more specific expertise than do non-production activities. These factors, in and of themselves, impact the relevant transfer pricing provisions together with the antitrust/competition law provisions.

Cost accounting considerations: Production-based enterprises need to develop specific cost accounting systems. The system should enable the enterprise to develop a cost and revenue analysis for each product or byproduct line. From a transfer pricing standpoint, the goal is to enable the enterprise to differentiate its products when different product streams apply.

Cost-plus method: The enterprise should evaluate the likelihood that the company’s best transfer pricing method from a transfer pricing standpoint might be the cost-plus method, including the relevant comparable profits methods.

Lack of comparable data: The lack of comparable data stymies transfer pricing analysis. Production-based enterprises often have unique, special activities and functions. All too often, there is a shortage of companies that provide true comparables. Reliance on SIC or NAICS codification alone frequently provides erroneous results for production-based enterprises.

Production differences: A company’s emphasis in the production-based activity context is often the company itself rather than the products. The enterprise might make products of various types in which some products terminate the processing functions at different points in time than do the company’s other products.

Existing international tax rules: U.S. tax law defines the nature of manufacturing, production, growth or extraction. For example, see Subpart F, IC-DISC and the domestic production deduction rules.

The rapid growth of transfer pricing regulations cries out for specialization with the transfer pricing field. Is transfer pricing training the order of the day?

Robert Feinschreiber

Robert Feinschreiber

Robert Feinschreiber is an experienced tax practitioner, attorney and counselor at Feinschreiber & Associates in Key Biscayne, Florida, who co-founded the Transfer Pricing Consortium.
Margaret Kent

Margaret Kent

Margaret Kent of Feinschreiber & Associates and the Transfer Pricing Consortium has been an attorney for over 20 years, focusing on law and international taxation.