A transfer pricing adjustment occurs when a tax authority challenges the prices and conditions of transactions between related parties and modifies them to reflect market norms based on comparative analysis.
Causes for Adjustment:
- Failure to adhere to the arm’s length principle standard requiring equivalence to independent operations
- Inadequate or missing contemporaneous documentation substantiating the transfer pricing methodology
- Errors or lack of economic substance found pertaining to the inter-party agreement terms
Example:
During an audit, significant adjustments were made to royalty payments a U.S. parent received from its Chinese subsidiary after analyzing comparable third-party licensing deals.
Takeaways:
While transfer pricing adjustments aim to prevent tax base erosion, uncertainty around outcomes encourage voluntary compliance efforts through upfront documentation and rulings. Penalties are avoidable through cooperative resolution on appropriate correlative adjustments.
