Transfer Pricing for International Businesses: Why Documentation Matters Before Revenue Hits $10M

Most founders operating internationally that we speak with at Antravia assume transfer pricing is something that matters later, if at all. We totally understand that this sounds like the domain of multinational corporations with dedicated tax departments, Big Four advisors, and cross-border structures so complex they require organizational charts just to understand who owns what! So for a business doing five million in revenue with operations in two countries, transfer pricing feels a bit irrelevant.

That assumption, unfortunately, is incorrect, and it becomes expensive when the assumption meets reality during a tax audit, due diligence process, or regulatory examination. Transfer pricing obligations don't begin at some arbitrary revenue threshold or level of corporate complexity. They begin the moment related parties in different tax jurisdictions transact with each other. If your U.S. entity pays your U.K. entity for services, that's a transfer pricing issue. If your holding company in Delaware licenses intellectual property to your operating subsidiary in Singapore, that's a transfer pricing issue. If your Australian company lends money to your U.S. subsidiary, that's a transfer pricing issue.

The question isn't whether transfer pricing applies to your business but whether you've addressed it before someone asks you to prove your related-party transactions were conducted at arm's length prices. Transfer pricing risk is not just about whether tax would ultimately be adjusted. Documentation failures create a separate risk layer. Many penalties apply regardless of whether the underlying pricing is ultimately sustained. Businesses often focus on whether their pricing “feels reasonable” and underestimate the independent exposure created by missing or inadequate documentation.

What Transfer Pricing Actually Means

Transfer pricing refers to the prices charged in transactions between related parties operating in different tax jurisdictions. When independent companies transact, market forces determine pricing. When related parties transact, there's no market forcing prices to any particular level, which creates the opportunity to shift profits from high-tax jurisdictions to low-tax jurisdictions through pricing manipulation.

Tax authorities worldwide have recognized this risk for decades, which is why transfer pricing rules exist in virtually every developed economy. The core principle, endorsed by the Organisation for Economic Co-operation and Development and incorporated into domestic law in most countries, is the arm's length standard. Related-party transactions should be priced as if the parties were unrelated entities negotiating at arm's length in a competitive market.

At Antravia we know that this sounds straightforward until you attempt to apply it. How do you determine the arm's length price for a management fee charged by a U.S. parent to its Irish subsidiary? What's the market rate for a cost-sharing arrangement between related entities developing software jointly? How do you price the use of a trademark when the trademark has no independent licensing history and exists only within a group of related companies?

Transfer pricing analysis attempts to answer these questions through various methodologies. The comparable uncontrolled price method looks at what unrelated parties charge for similar transactions. The cost-plus method examines costs incurred and adds an appropriate markup. The resale price method works backward from the price charged to end customers. More complex methods like the transactional net margin method or profit split method examine profitability and allocate it based on functions performed, assets used, and risks assumed.

The challenge for small and mid-size businesses isn't understanding these methodologies in theory. It's recognizing that tax authorities expect you to have applied one of them, documented your analysis, and maintained records that support your pricing decisions. Most businesses with cross-border related-party transactions have simply charged whatever seemed reasonable without any formal analysis, documentation, or contemporaneous support.

When Transfer Pricing Becomes Your Problem

The most common trigger is a tax audit in any jurisdiction where related-party transactions exist. Tax authorities conducting routine examinations look for cross-border related-party flows. When they find them, they ask for transfer pricing documentation. If that documentation doesn't exist or doesn't support the pricing actually used, the tax authority will make its own determination of what arm's length pricing should have been, adjust taxable income accordingly, and assess additional tax plus penalties and interest.

These adjustments can be substantial. A tax authority might determine that management fees your U.S. parent charged your foreign subsidiary were excessive, disallow the deduction in the foreign jurisdiction, and assess additional foreign tax. Or they might determine the fees were too low, increase your U.S. taxable income, and assess additional U.S. tax. You can face adjustment in either direction depending on which authority examines the transactions and how they view arm's length pricing.

Due diligence processes surface transfer pricing issues with increasing frequency. Private equity investors, strategic acquirers, and even sophisticated lenders conducting financial and tax due diligence will examine cross-border related-party transactions. They're looking for undisclosed tax liabilities, weak documentation that could lead to future adjustments, or structures that may not survive scrutiny. Transfer pricing exposure that might have gone undetected in normal operations becomes a deal issue when transactions require clean representations about tax compliance.

Regulatory filings can also trigger scrutiny. Many countries require contemporaneous transfer pricing documentation for certain transaction types or above specified thresholds. Penalties for failure to maintain required documentation can apply even if the pricing itself was appropriate. The U.S., for example, imposes penalties under Section 6662(e) for substantial valuation misstatements in transfer pricing, with penalty relief available only if contemporaneous documentation was maintained. Other jurisdictions have similar regimes that penalize documentation failures independent of whether adjustments are ultimately sustained.

Some businesses discover transfer pricing issues when expanding into new markets. A company that operated for years with informal arrangements between related entities suddenly needs clean documentation to support local entity formation, tax registrations, or regulatory approvals in a new jurisdiction. What worked when operating quietly in two countries doesn't work when growth requires engaging with tax authorities, banks, and regulators in a third or fourth country.

Common Related-Party Transactions That Create Exposure

Management fees represent one of the most frequent sources of transfer pricing issues for smaller international businesses. A U.S. parent provides management, administrative, or strategic support to foreign subsidiaries and charges a fee for these services. The fee might be calculated as a percentage of subsidiary revenue, an allocation of parent company overhead, or simply a round number that seemed reasonable. Without documentation supporting what unrelated parties charge for similar services, or a cost-plus analysis showing appropriate markup on costs incurred, these fees are vulnerable to challenge.

Intellectual property arrangements create particularly complex transfer pricing issues. A parent company in one jurisdiction develops IP and licenses it to operating subsidiaries in other jurisdictions. Or related parties enter cost-sharing agreements where they jointly fund IP development and share in resulting rights. These transactions involve significant value, limited comparable transactions, and subjective judgments about appropriate royalty rates or cost allocations. Tax authorities focus heavily on IP transactions because they represent prime opportunities for profit shifting. For intellectual property arrangements, pricing alone is not enough. Tax authorities increasingly focus on where IP is actually developed, enhanced, maintained, protected, and exploited. Legal ownership without operational substance is rarely persuasive. If your U.S. entity “owns” the IP but engineering, product decisions, and ongoing development sit elsewhere, the transfer pricing analysis must reflect that reality.

Intercompany loans are another common issue. A parent company or holding company provides financing to subsidiaries rather than having subsidiaries borrow from banks. The interest rate charged needs to reflect arm's length pricing, considering the creditworthiness of the borrower, the terms of the loan, subordination, guarantees, and market conditions. An interest rate that's too high shifts profits to the lender's jurisdiction. An interest rate that's too low or zero-interest related-party debt creates issues in the borrower's jurisdiction and potentially under thin capitalization rules.

Service arrangements often fly under the radar until examined closely. Related parties provide services to each other ranging from IT support to marketing to procurement to human resources. Sometimes these are charged at cost with no markup. Sometimes they're charged at cost-plus using an arbitrary markup percentage. Sometimes they're not charged at all under the assumption that it all nets out within a corporate group. Tax authorities don't accept "it all nets out" as transfer pricing documentation.

Goods transactions, while more straightforward to analyze than services or IP, still require attention. If a manufacturing subsidiary sells products to a distribution subsidiary, the transfer price needs to reflect arm's length pricing. If one entity is acting as a limited-risk distributor, it should earn a limited return. If it's bearing significant market risk and performing substantial functions, it should earn a higher return. The functional analysis matters, and it needs to be documented.

Why Documentation Matters More Than You Think

The biggest mistake small and mid-size businesses make is treating transfer pricing as something to address if and when questioned. Tax authorities in most jurisdictions expect contemporaneous documentation, meaning documentation prepared at the time transactions occur or tax returns are filed, not documentation created years later when an audit begins.

Contemporaneous documentation serves multiple purposes. It forces discipline in thinking through whether related-party pricing is actually defensible. It creates a record of the facts, comparables, and analysis that supported pricing decisions. And in many jurisdictions, it provides penalty protection even if tax authorities ultimately disagree with the pricing used.

The U.S. transfer pricing penalty regime under Section 6662 illustrates why documentation matters. Penalties can reach forty percent of additional tax owed if an adjustment meets certain thresholds (Net adjustment penalty (20%) can apply when the net IRC §482 adjustment exceeds the lesser of $5 million or 10% of gross receipts. The penalty can increase to 40% for “gross” cases, including where the net adjustments exceed the lesser of $20 million or 20% of gross receipts, and for certain extreme pricing variances under the transactional test.) However, penalties can be avoided entirely if the taxpayer maintained contemporaneous documentation and the pricing falls within a reasonable range even if not the exact price the IRS determines to be correct. Without contemporaneous documentation, there's no penalty protection regardless of how reasonable the pricing might have been.

Other jurisdictions have similar frameworks. The European Union has pushed member states toward consistent transfer pricing documentation requirements. The EU has an actual Code of Conduct on transfer pricing documentation (EU TPD) adopted by the Council in 2006. Many countries now require master file and local file documentation following OECD guidelines. While specific thresholds and filing requirements vary, the trend globally is toward more extensive documentation requirements, particularly for transactions above certain values.

The practical reality is that documentation created during an audit, after pricing decisions have been made and transactions have occurred, is inherently less credible than documentation prepared contemporaneously. An audit-year analysis trying to justify pricing from three years earlier will be viewed skeptically. The business appears to be reverse-engineering justification rather than having made informed decisions at the time.

Documentation also matters because transfer pricing is not a precise science. Reasonable people can disagree about appropriate comparables, adjustments, and methodologies. Well-prepared contemporaneous documentation that shows thoughtful analysis, even if not perfect, will fare better than no documentation or documentation that appears cursory or post-hoc.

What Actually Happens During an Audit

When a tax authority examines related-party transactions, the initial request is almost always for transfer pricing documentation. They want to understand what transactions occurred, what pricing was used, and what analysis supported that pricing. If comprehensive documentation exists, the examination often proceeds relatively smoothly even if there are disagreements about specific issues.

If documentation doesn't exist, the entire examination dynamic changes. The tax authority has wide discretion to make adjustments using whatever methodology and comparables they select. The burden shifts heavily to the taxpayer to prove the authority's position is wrong, which is difficult without having documented your own position contemporaneously.

Some jurisdictions use secret comparables, meaning the tax authority develops its own analysis using data the taxpayer doesn't have access to and may not be able to effectively challenge. Other jurisdictions require the taxpayer to prove not just that their pricing was reasonable, but that it falls within a specific range or meets other stringent standards. Without documentation, these standards become nearly impossible to meet.

The adjustments can be economically painful in ways that go beyond just the additional tax. If a tax authority in Country A adjusts your transfer pricing upward, increasing taxable income and tax owed in Country A, the transaction didn't actually change. The related party in Country B still has the corresponding deduction or lower income based on the original pricing. This creates double taxation unless mechanisms exist to obtain corresponding adjustments or competent authority relief under tax treaties.

Obtaining correlative relief is a separate process, often taking years, requiring extensive documentation, and involving uncertainty about ultimate resolution. Many small and mid-size businesses lack the resources or sophistication to pursue it effectively. They end up paying additional tax in one jurisdiction without relief in the other, resulting in effective double taxation on the same income.

The Revenue Threshold Misconception

There's a persistent belief that transfer pricing only matters once a business reaches a certain size. The reality is that transfer pricing rules apply to all related-party cross-border transactions regardless of company size or transaction value. A startup with two million in revenue can have transfer pricing exposure just as easily as a multinational with two billion in revenue.

What changes with size is the level of scrutiny and the resources available to address it properly. Larger companies are audited more frequently, face more sophisticated examination teams, and attract more attention from tax authorities. But smaller companies are not exempt from transfer pricing rules, and when examined, often face worse outcomes because they have no documentation and limited resources to defend their positions.

Some jurisdictions do have materiality thresholds below which certain documentation requirements don't apply or penalties won't be assessed. These thresholds vary widely. In the U.S., substantial valuation misstatement penalties generally apply when adjustments exceed five million dollars or ten percent of gross receipts. But that doesn't mean transactions below those thresholds are ignored. It means penalties might not apply or might be lower. The underlying obligation to price transactions at arm's length still exists.

The ten million dollar revenue range is particularly risky because it's substantial enough to support real cross-border operations, complex enough to have meaningful related-party transactions, but often not sophisticated enough to have addressed transfer pricing proactively. A company at this stage might have foreign subsidiaries, IP licensing arrangements, shared service arrangements, and intercompany financing, but still be operating with startup-era informality around documentation and compliance.

Fixing Transfer Pricing Issues Before They Become Problems

The first step is identifying what related-party cross-border transactions exist. Many businesses don't have a complete picture. Management fees, cost allocations, IP arrangements, and service charges accumulate over time as businesses grow and structures evolve. Creating a comprehensive inventory of intercompany transactions is essential before you can assess transfer pricing exposure.

Once transactions are identified, each needs analysis to determine whether current pricing is defensible. This doesn't necessarily require expensive economic studies for every transaction. Some transactions are straightforward and low-risk. Others are material or complex enough to warrant more thorough analysis. The goal is understanding where real exposure exists and where documentation gaps need to be addressed.

For transactions that lack support, there are generally two options. You can develop documentation that supports current pricing if that pricing is actually defensible. Or you can adjust pricing going forward to align with arm's length standards and document the new approach. Adjusting pricing often has accounting and business implications beyond just tax, so these decisions need to be made carefully with full understanding of consequences.

Contemporaneous documentation going forward becomes the standard practice. This doesn't mean hiring transfer pricing economists for every transaction. It means maintaining records of the analysis performed, comparables considered, and rationale for pricing decisions. For larger or more complex transactions, engaging specialists to prepare formal studies may be appropriate. For smaller routine transactions, internal documentation following consistent methodologies may be sufficient.

The other critical element is building transfer pricing considerations into business decisions prospectively. When considering a new IP licensing arrangement, intercompany service agreement, or cost-sharing structure, transfer pricing implications should be part of the decision process. Structures can often be designed to minimize controversy and simplify documentation requirements if transfer pricing is considered from the beginning rather than retrofitted after the fact.

When to Engage Specialists

Not every business needs transfer pricing economists on retainer, but knowing when to involve specialists is important. Complex IP transactions almost always warrant specialist involvement. The valuation issues, lack of comparables, and potential for significant value transfer make these high-risk transactions where quality documentation is essential.

Cost-sharing arrangements represent another area where specialist support is typically necessary. These arrangements require analyzing relative contributions, expected benefits, and ongoing cost allocations in ways that are technically complex and heavily scrutinized by tax authorities.

Preparation for audit or due diligence often requires specialist involvement even if day-to-day documentation has been handled internally. When facing examination by sophisticated tax authorities or due diligence by experienced investors, the quality of analysis and documentation needs to meet professional standards.

The key is distinguishing between ongoing documentation that can be maintained in-house with appropriate systems and guidance, versus specialized analysis that requires technical expertise. Many businesses can handle routine documentation for standard transactions once proper frameworks are established. Complex or high-value transactions require more sophisticated support.

The Interaction With Other International Tax Issues

Transfer pricing doesn't exist in isolation. It intersects with multiple other aspects of international tax planning and compliance. Base erosion and anti-abuse rules in many jurisdictions specifically target arrangements where deductible payments to related parties shift profits to low-tax jurisdictions. Transfer pricing documentation helps demonstrate that these payments reflect genuine value delivered at arm's length prices rather than profit shifting.

Controlled foreign corporation rules and other anti-deferral regimes often require analyzing income by category. Transfer pricing affects what income is earned in which entities, which can influence CFC income inclusions and related tax consequences. Poorly structured transfer pricing can inadvertently trigger inclusion regimes or lose tax benefits that could have been preserved with better planning.

Tax treaties contain mutual agreement procedures and corresponding adjustment provisions specifically to address double taxation arising from transfer pricing adjustments. But accessing these treaty benefits requires proper documentation and timely action. Transfer pricing documentation supports treaty claims and competent authority processes.

Customs valuation represents another intersection point. Transfer prices used for income tax purposes may affect customs valuations for goods crossing borders. Inconsistencies between transfer pricing documentation and customs declarations can create issues with both tax and customs authorities.

Why This Matters Now More Than Ever

International tax cooperation has increased dramatically in recent years. Automatic exchange of information, country-by-country reporting, and enhanced coordination between tax authorities mean that cross-border transactions receive far more scrutiny than they did even five years ago. Transfer pricing documentation that might have been adequate when each jurisdiction operated independently is insufficient when tax authorities are sharing data and coordinating examinations.

The OECD's Base Erosion and Profit Shifting project brought transfer pricing front and center globally. While much of the BEPS focus was on large multinationals, the compliance infrastructure it created affects companies of all sizes. Documentation standards have increased. Information reporting has expanded. And tax authorities have tools and political mandates to pursue transfer pricing enforcement more aggressively.

For small and mid-size businesses operating internationally, this environment creates both risk and opportunity. The risk is that informal arrangements and undocumented pricing that worked in the past increasingly won't survive scrutiny. The opportunity is that proactive attention to transfer pricing creates competitive advantage and cleaner structures that support growth, investment, and eventual exit. For larger or higher-risk groups, advance pricing agreements can provide certainty, but they are resource-intensive and generally impractical for early-stage or mid-market companies.

Transfer pricing is not optional for international businesses, regardless of size. It's not something that can be addressed during an audit or due diligence. It requires contemporaneous analysis, documentation, and ongoing attention as businesses grow and transaction patterns evolve. For companies serious about operating across borders, getting transfer pricing right is part of the foundation, not something to defer until later.

References

• OECD. OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations 2022. https://www.oecd.org/content/dam/oecd/en/publications/reports/2022/01/oecd-transfer-pricing-guidelines-for-multinational-enterprises-and-tax-administrations-2022_57104b3a/0e655865-en.pdf

• OECD. Transfer pricing (topic page). https://www.oecd.org/en/topics/sub-issues/transfer-pricing.html

• OECD. Guidance on the Implementation of Country-by-Country Reporting (BEPS Action 13). https://www.oecd.org/content/dam/oecd/en/topics/policy-sub-issues/cbcr/guidance-on-the-implementation-of-country-by-country-reporting-beps-action-13.pdf

• OECD. Country-by-country reporting for tax purposes (topic page). https://www.oecd.org/en/topics/sub-issues/country-by-country-reporting-for-tax-purposes.html

• IRS. Transfer pricing documentation best practices FAQs. https://www.irs.gov/businesses/international-businesses/transfer-pricing-documentation-best-practices-frequently-asked-questions-faqs

• Cornell Law School (Legal Information Institute). 26 CFR § 1.6662-6 – Transactions between persons described in section 482 and net section 482 transfer price adjustments. https://www.law.cornell.edu/cfr/text/26/1.6662-6

• IRS (Practice unit PDF). Tab I – Penalties 6662(e). https://www.irs.gov/pub/irs-apa/penalties6662_e.pdf

• EUR-Lex (Official Journal). Code of Conduct on transfer pricing documentation for associated enterprises in the European Union (2006/C 176/01). https://eur-lex.europa.eu/LexUriServ/LexUriServ.do?uri=OJ%3AC%3A2006%3A176%3A0001%3A0007%3AEN%3APDF

Disclaimer:
Content published by Antravia is provided for informational purposes only and reflects research, industry analysis, and our professional perspective. It does not constitute legal, tax, or accounting advice. Regulations vary by jurisdiction, and individual circumstances differ. Readers should seek advice from a qualified professional before making decisions that could affect their business.

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