 Hello and welcome to this session. This is Professor Farhad and this session I'm going to be looking at the US transfer pricing roles and specifically the role that the IRS and the US Treasury plays in enforcement. This topic is covered in international accounting or taxation course. As always, I would like to remind me remind you to connect with me only then YouTube is what you would need to subscribe. I have 1500 plus accounting, auditing, finance and tax lecture. This is a list of all the courses that I cover, including CPA questions on my website. I do have additional resources such as PowerPoint slides, notes, true false multiple choice quasi CPA simulations and 2000 plus CPA questions. I strongly suggest you visit my website. Also, if you don't understand what transfer pricing is, check in the link in the description if you'd like to get a review of what is transfer pricing in the US, the Internal Revenue Service has the authority. This is the authority to audit international transfer prices and adjust the company's tax liability of the price deemed to be inappropriate. What does that mean? It means the IRS code section 482 gives the IRS agents the ability to question you to adjust your transfer prices. If they think you are setting up transfer prices for the sole purpose of reducing your tax liability, they can adjust it. They can assume a different price and based on that different price, they can recompute your tax liability and make you pay more taxes. So the IRS may adjust, may audit and adjust the transfer prices between companies controlled directly or indirectly by the same taxpayer. Obviously, the transfer prices is between related parties. In section 482 of the code applies to both upstream and downstream transfer between a parent and a foreign subsidiary, between a foreign parent and its US subsidiary, and between a US subsidiary and its foreign subsidiary of the same parent. So it applies to all type of interrelated transaction, whether it's upstream or downstream. And obviously the IRS concern is, are you paying enough taxes? That's the whole purpose of the IRS. Now the IRS follows a similar guidelines to OECD, which is what? Which is the arm length prices. What is the arm length prices? It's the prices which would have been agreed upon between unrelated parties engage in the same or similar transaction under the same or similar circumstances in the open market. You know, arm length means let's assume you are selling to somebody outside to your party. It's not your affiliate. It's not your parent company. It's not a subsidiary of yours. It's not a sister company. What price would you charge them? And that's the price that you should charge. Now, because some same or similar transaction with unrelated parties do not exist, determining an arm length price generally involve reference to comparable transaction under comparable circumstances. Now, oftentimes there is no market. In other words, your transaction is so unique that there is nothing to compare it to. Then you would look at comparable circumstances, comparable transactions, the closest to reality. Okay, now also the US Treasury have their own regulation that supplement that supplement section 482 of the IRS code and establishing more specific guidelines. They have more specific guidelines on determining what's an arm length transaction. US regulation says there's something called the best method rule require the taxpayer to use to transfer pricing method that under the fact that circumstances provide the most reliable measure at an arm length transaction. So basically the best method rule says use your best effort, best fact best circumstances in determining that price. Now, in determining which method provide, you know, the most reliable measure, you have to take into account to consideration. Comparability, the degree of comparability between the intercompany transaction and any comparable uncontrolled transaction. So you have to look at your transaction within the same entity and some comparable in control means with it with a third party transaction. And the quality of the data and assumptions used in the analysis. So when you determine your price, you know, what type of data are you looking at, what type of assumptions are you making in determining the price of the transaction. Now also determining the degree of comparability and the quality of the data and whether you have an intercompany transaction or an uncontrolled transaction, you can look at five factors in determining that price. So what are the five factors? I'm going to look at the five factors. Now, bear in mind these factors and, you know, require substantial judgment in each situation is different. I just want to give you a taste of them. So the first factor you would look at is the functions performed by the various parties in the two transaction. So what is your role here? But all depends whether you are research and development, whether you are doing the product design or engineering, maybe you're only the purchasing agent here or maybe you are doing transportation and warehousing. So what functions, you would look at what functions, that's one of the factors. The second factor is the contractual terms that could affect the result of two transactions. Well, what type of contract between the two parties are involved here? Not all contracts are the same. For example, is there any rights to update provisions and modification? If that's the case, you might have to charge a higher price. Maybe if there is sales or purchase volume, you may want to reduce the price. So depending on the contractual terms, in other words, there are many factors that goes into the pricing, not comparing apples to apples. You have to look at other things. Extension of credit and payment terms. What type of credit terms and payment terms are you offering in this transaction? So the contractual terms is another factor that you take into account. The third factor is the risk that affect the prices that would be charged or paid or the profit that would be earned in the transaction. So what type of risk is involved? Because different transactions, if they are located in different places, they are involved with different risks. For example, what is the market risk? What is the risk associated with success or failure of R&D activities if you're involved in R&D? What is the credit and collection risk if you're selling on credit? Well, if there is a risk, you're not going to collect your money. You may charge higher prices. Product liability risk. If you're selling a product and there's a product liability risk, again, you have to hedge. You have to factor a higher price because you're taking more risk. So simply put, the risk of the transaction plays a role in determining the price. For economic conditions that affect the price or profit earned in the two transactions, an economic condition could be in the same geographical area. Because if you're selling in a high inflationary area, it's different if you're selling something in South America, in Venezuela. It's a different risk as if you're selling it in Brazil because it's a different geographical market. The relative size of each market. Are you trying to obtain more market share or are you trying to penetrate the market? That matters. That matters how you determine your price. The location, specific cost of the factor production and distribution. Where's your factors of production and distribution? Are they located in that country? Do you have to bring them from the outside? That also matters. And the alternatives realistically available to the buyer and the seller. So if I don't sell this product or somebody does not buy it from me, what's my alternative? What's their alternative? If they have many alternatives, it means I should not be raising my price a lot. But if I have a quasi-monopoly and the buyer and the seller don't have many options, the price might be higher. So in other words, many factors goes into determining that price. And five is the property or service transfer in the transaction with the type of the property. Sometimes it's an intangible that is embedded in a tangible property or service being transferred. So there are many, many factors and those are the five big ones. Once again, in the real world, each transaction is unique. Each transaction is unique. There is no more unique word than unique. Therefore determining the price is tricky. And what companies have to do when they determine the transfer price, they have to document. I cannot emphasize this enough. This is the most important thing in transfer pricing. How did you come up? And this is a guideline as well. This is the guidelines of where you could look at to establish your documentation. So Treasury Department, the Treasury Regulation established guidelines for determining an online price for various kinds of inter-company transaction. Here we're talking about sales of tangible property, license of intangible property, inter-company loans, inter-company services. But the most common type of international transaction is the sale of tangible property when you sell tangible property. And that's getting to be less and less important because intangibles are getting more, you know, they're taking a larger role in the economic life of different companies. So in the next session, we would look at the sale of tangible property, specifically the rules that follow this. Once again, I would like to remind you that I have many other courses on my channel that cover various accounting, finance, and all the thing lectures. 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