Finding someone you can work with is equally important.  You want someone who shares your goals (e.g., practical vs. theoretical; simple vs. complex).  That can only be evaluated with a face-to-face discussion.  We think that the typical proposal process, with its formal presentations, is not a very good forum for evaluating this.  Companies are better served to narrow the field to two or three potential advisors and then spend a day (or half a day) with each of them to discuss your particular situation.  During that time, competence, approach, and personality can be evaluated.

Then, when you’ve decided which advisor fits your needs best, hire them!  And, good luck.  It should be an interesting experience for both sides. – Deloris R. Wright

In addition, you need an advisor who works well with you and takes your interests as his marching orders.  Too many times, advisors try to sell a “canned study” that is a one-size-fits-all approach, e.g., database dump CPM.  Or, there are some advisors who are economists who want to turn your engagement into a sophisticated economic analysis that only they can understand.  Sometimes you want something dense and impenetrable by normal people, but most companies don’t benefit from it.  Most companies want advice they can understand, use, and implement.  That’s what this blog is all about.

Second, our experience is that companies need advice as much or more than they need the typical economic study.  You want somebody who understands your situation (the size of the transaction relative to your company’s size, etc.) and can help devise a strategy that meets your needs.

Third, ask yourself whether you’re looking for an advisor who takes a theoretical approach, e.g., “the regs say you have to do this, so this is what you have to do.”  The alternative is the practical approach that tries to fit advice to your situation.  Sometimes, it is wise to sacrifice theoretical purity for an approach that the company can manage and maintain over time.  The longer we do this work, the more convinced we are that simpler is preferred to complex.  Missing some of the theoretical detail is preferred to putting together a policy that can’t be managed.  We quickly point out, however, that transfer pricing is, by its very nature, complicated.  You can’t avoid all complications.  It is important to know, however, how and when you can cut corners to make a policy workable within the company.

Theory is fine if you’re a Fortune 10 company that is in the middle of a litigation battle where you want to use academics to make your case.  The rest of us need a practical, common-sense approach that will ensure that you keep the cost reasonable.  You also need an approach that won’t blow up because the people who need to manage the day-to-day affairs don’t understand its complexity.  You want this policy to work for years – or until the facts change.

More on advisor selection in the next blog. – Deloris R. Wright

Middle market companies have a tough decision to make.  We’ll finish this series of blogs by suggesting that taking the time to discuss transfer pricing planning with a capable advisor is time, and money, well spent.  A relatively short discussion can flesh out the probable exposures that you may have and may suggest more tax efficient structures as well.  It is a small price to pay for peace of mind.  Then, when we see what IRS is going to do, you will know what, if anything, should be done next. – Deloris R. Wright

The question is, what are the significant transactions?  There are two options, in general.  First, the big transactions usually relate to sales of tangible property, e.g., raw materials, work in process, or finished goods inventory.  On the other hand, the transactions that IRS is currently focusing on are transfer of intangibles (e.g., patents, know-how, trademarks, etc).  These transactions are pretty universally unrecognized by middle market companies (and many of the big boys), and can involve enormous amounts of money.  Our advice is to begin with either or both of these types of transactions.

Then, pursue one of the previous three approaches.  We should point out that in our experience, middle market companies ordinarily put tax-inefficient structures in place.  For that reason, spending a bit of time thinking through the structure is wise (e.g., is this just a service fee issue, or can we reorganize the transactions to better reflect business reality and, at the same time, defensibly lower the global taxes that the company pays). – Deloris R. Wright

The benefit of this approach is clear – it is cheap.  What are the issues with it?  (1)  We need to be honest and recognize that some international tax lawyers like this approach.  As one of them told us recently, “I like these database dump CPM analyses because they are so clearly indefensible that I know if there is a serious audit I can simply say, ‘that study is junk’ and then I can do whatever I want to do to defend what the company did.”  For people who take this view, they also believe that the hurdle to obtain penalty protection is very low.  That may or may not be the case, but it is certainly perceived to be so by a number of good international tax lawyers.

(2)  The primary issue, from a technical standpoint, relates to whether or not an adversary could pick apart this approach to the detriment of the company.  And, the answer is definitely yes.  The so-called comparable companies will be all over the ball park.  Some will be distributors, some will be manufacturers, some will be in the client’s industry and some will not, etc.  It doesn’t take a rocket scientist to pick apart such a study and come up with a range that is detrimental to the company.

(3)  Another issue is whether IRS will agree, in the new world that they are creating, that this type of documentation is adequate for penalty protection.  We have been waiting for years to see whether IRS will raise its standards.  So far, they haven’t.  It is going to be interesting to see whether things will change in the future. – Deloris R. Wright

Now, you can take some simple, and relatively inexpensive, steps to put basic documentation in place.  For example, you might put intercompany agreements in place, or you might make sure that invoices are actually cut and payment between related parties happens under the payment terms that you adopt.  You might also want to write down the policy that you’ve chosen to use so that you can show that you’ve developed the policy and it has logic behind it.  Of course, you only want to do that if you intend to follow the policy.  Having a policy (or intercompany agreements) that you ignore is never a good thing.

Then, when the intercompany business grows to be a material amount, you will need to provide more detailed documentation, including a transfer pricing study to show that the prices you’re using are arm’s length.  If you used a competent advisor and developed the facts properly, you should have a transfer pricing policy that will be defensible so that this transfer pricing study will be relatively simple to put in place.  The problems (and significant expense) arise when the existing transfer pricing policy is not arm’s length and you have to undo the past in order to put the new structure in place. – Deloris R. Wright

In our view, a company should begin by asking what you’re looking for in an advisor.  For example, you may be interested in evaluating your exposures, or in starting a planning project as part of a global reorganization of your business, you may just want someone you can bounce ideas off to get input into an otherwise entirely in-house activity, you may need help with an audit or appeals/competent authority matter, you may be looking for a global advisor, i.e., someone who knows what is happening globally, or, finally, you may be looking for someone who can quickly and cheaply provide a database dump CPM.

If you’re interested only in a cheap, simple CPM analysis designed to provide you with “something” that can be provided to IRS or other nations’ tax authorities on audit, then the best approach is probably what these types of companies are already doing, i.e., put the job out for bid and select the low bidder.  It really doesn’t matter who does this study as it will not stand up to an intense challenge in any event.  So keep it cheap, and keep it simple.

What if this is not your goal?  That’s the subject of the next blog. – Deloris R. Wright

Even if you decide that you need to “get it right,” you don’t necessarily have to spend tens of thousands of dollars to accomplish your goal.  For example, you may decide to develop the facts internally, rather than use an advisor.  This may be dangerous if you’ve never done transfer pricing before, but there are companies that do it internally.  If the amount at stake is relatively small, any errors or omissions in the facts may be missed by the IRS audit or not really matter very much anyway.  In that case, keep it simple and do it yourself.

The real challenge in “doing it right” is in developing support for the transfer prices that you use.  Many of the middle-market companies are convinced (maybe I should say CONVINCED) that they have iron-clad proof for the correctness of their transfer prices.  Our experience is that the proof rarely meets the requirements of the transfer pricing rules.  There are various reasons for this that we won’t go into here.  Suffice it to say that supporting transfer prices requires knowledge of the transfer pricing rules, and experience in dealing with these issues.  Support can take many forms, ranging from a  detailed data analysis, to a  very general “database dump,” which will be described in a later blog.  In addition, you may choose to support only the large transactions, which is also discussed later. – Deloris R. Wright

Having said that, once the facts are developed, you have the four approaches listed in the previous blog.  The first approach is to simply “get it right.”  Getting it right is rarely a good alternative for most middle market companies because it is usually too expensive relative to the size of the transactions at issue.  Of course, if you have an audit starting or you just got burned by an audit anywhere in the world, it is a good idea to suck it up and spend the money.  But, in the absence of such a situation, this option is generally a non-starter.  We’ll talk about various alternative ways of “doing it right” in the next blog. – Deloris R. Wright