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Transfer Pricing Considerations for Pre-revenue or Loss-making Companies (Part I)

“Well the company doesn’t make any money yet, so we’re not concerned with transfer pricing.” These can be famous last words.

Should pre-revenue companies or companies with significant losses be considering transfer pricing? If you’re a multinational company or you’ve got multiple US entities, some of which are located in states that do not allow combined reporting, then the short answer is yes, you should be considering transfer pricing.

Taxpayer: “We’ve heard of profit splits, but we don’t have any profits.”

Transfer pricing does not just refer to how companies split profits among related parties; it also deals with how companies split losses.

As soon as a company establishes a related party, their transfer pricing story begins. This story starts being written whether a taxpayer addresses transfer pricing or not. The only difference is who is going to control the narrative of the story if the taxpayer is selected for a tax audit. In the case of a taxpayer that has not evaluated its transfer pricing, the tax authority gets to write the story. Let’s look at an example.

A US company decides to establish a subsidiary abroad to help develop a product that has not been commercialized yet. At this point, the US parent has little or no revenue, and is recording a significant loss due to its research and development costs. The new foreign sub will have some product development people as well, and will be funded via loans from its US parent. Like its parent company, the new foreign sub will also take on losses, as it will have no revenue, but will bear the costs of its employees and any other expenses related to its product development activities.

The company described in the case above wants all of the intangibles related to the product it’s developing reside in the US. Based on the situation described above, however, tax authorities would likely impute some of that intangible ownership to the foreign sub.

Intangible ownership can be a significant factor in tax planning, and the lack of appropriate transfer pricing consideration can cause companies to lose control over where their intangibles are owned for tax purposes. Where intangibles are registered or owned legally is no longer the primary determinant of where an intangible resides for tax purposes. Appropriate transfer pricing planning allows companies to maintain that critical control over its intangibles.

Companies can and should address transfer pricing at each stage of their operations. Transfer pricing specialists can set up policies that maintain flexibility and that can change as the business changes. In fact, transfer pricing policies are supposed to change as businesses change. Transfer pricing policies are based on functions performed, risks assumed, and assets employed. These items change as companies move from pre-revenue to revenue generating. An appropriate transfer pricing policy allows companies to maintain control of their tax planning options.

This topic will be continued in a subsequent article.