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Expanding Outside the U.S.? Take Care with Transfer Pricing

U.S. companies expanding to other countries must consider how their new foreign operation will interact with its related party in the U.S. When intercompany transactions exist, as they almost always do when a subsidiary is established, transfer pricing rules apply. For new operations, it is not uncommon for the activities of the new subsidiary to change as the operation grows and matures. As those changes occur, the way the subsidiary interacts with its parent company may change as well, which means that the transfer pricing policies governing those interactions may also need to change.

All companies are different, but it is instructive to provide an example of how new foreign operations can evolve and what transfer pricing implications arise during the process. Let’s take the example of a manufacturer based in the U.S. (“USCo”) that produces and sells proprietary products. If USCo sees an opportunity to reach customers located outside the U.S., or if USCo already has customers located outside the U.S., it may decide to establish a foreign presence (“ForeignCo”) to better serve such customers. ForeignCo may be established to serve a particular country or region. At first, ForeignCo may only have a small number of employees providing sales support to foreign customers who purchase directly from USCo. At that point, an intercompany service transaction may exist, and the transfer pricing regulations governing service transactions would apply. Over time, ForeignCo may begin physically distributing USCo’s products to foreign customers. If ForeignCo begins taking title to the products, the intercompany transaction may change from a service transaction to a tangible product transaction, at which point the transfer pricing regulations governing tangible product transactions would apply. Finally, ForeignCo may stop purchasing products from USCo and begin manufacturing the products on its own. If those products are proprietary to USCo, ForeignCo will likely need a license from USCo that allows ForeignCo to manufacture and sell the products outside the U.S. The intercompany transaction may then change from a tangible product transaction to an intangible property transaction, in which case the transfer pricing rules governing intangible property transactions will apply.

At each stage in the example, the transfer pricing policy governing the intercompany dealings between the U.S. entity and its foreign related party would change to correspond to the type of transaction that is occurring. A policy that is appropriate for one type of transaction is unlikely to be appropriate for a different type of transaction. Taxpayers should evaluate their transfer pricing as their company operations change and expand to ensure that their policies are compliant with the transfer pricing rules of each applicable jurisdiction.