Tax Relief Blog
Transfer Pricing International Tax Controversy: An In-Depth FAQ
- Transfer pricing is the method by which multinational enterprises (MNEs) set prices for transactions between related entities across borders, directly impacting how profits are allocated and taxed in different countries.
- Controversies arise due to differing national rules, the risk of profit shifting, double taxation, and disputes over the “arm’s length” standard.
- Recent developments (including OBBB, effective July 4, 2025) and ongoing OECD initiatives are reshaping the landscape, with increased scrutiny, new compliance requirements, and evolving dispute resolution mechanisms.
Table of Contents
- What is Transfer Pricing?
- Why is Transfer Pricing Controversial?
- How Do Countries Regulate Transfer Pricing?
- What is the Arm’s Length Principle?
- What Are the Main Methods for Setting Transfer Prices?
- What Triggers a Transfer Pricing Audit or Dispute?
- How Are Transfer Pricing Disputes Resolved?
- What’s New in 2025? (OBBB and OECD Developments)
- Practical Next Steps for Tax Professionals
- Authority Trail
- Pre-OBBB vs. Post-OBBB Comparison Table
1. What is Transfer Pricing?
Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control, especially when those transactions cross international borders. These transactions can include the sale of goods, provision of services, transfer of intellectual property, or financing arrangements.
The goal is to ensure that profits are allocated fairly among countries where the multinational operates, reflecting the economic value created in each jurisdiction.
2. Why is Transfer Pricing Controversial?
Key Controversies
- Profit Shifting: MNEs may set transfer prices to shift profits to low-tax jurisdictions, eroding the tax base of higher-tax countries.
- Double Taxation: If two countries disagree on the appropriate transfer price, the same income may be taxed twice.
- Arm’s Length Disputes: Determining what unrelated parties would have charged is often subjective, especially for unique intangibles or services.
- Compliance Burden: Documentation and compliance requirements are complex and costly.
- Inconsistent Rules: Countries interpret and enforce transfer pricing rules differently, leading to uncertainty and disputes.
These issues are at the heart of many high-profile tax controversies and are a major focus for tax authorities worldwide.
3. How Do Countries Regulate Transfer Pricing?
United States
- Statutory Authority: IRC § 482 (as amended by OBBB) authorizes the IRS to adjust income, deductions, credits, or allowances between related parties to prevent tax evasion or clearly reflect income.
- Regulations: Treasury Regulations under § 482 provide detailed rules and methods.
- Enforcement: The IRS uses data analytics and risk assessment teams to identify potential transfer pricing issues and conducts specialized audits.
International
- OECD Guidelines: Most developed countries follow the OECD Transfer Pricing Guidelines, which set out the arm’s length principle and acceptable methods.
- Country-Specific Rules: Each country may have its own documentation requirements, penalties, and dispute resolution mechanisms.
- Recent Trends: Many countries are increasing enforcement, requiring more detailed documentation, and participating in international information exchanges.
4. What is the Arm’s Length Principle?
The arm’s length principle requires that transactions between related parties be priced as if they were between independent, unrelated parties under similar circumstances. This is the cornerstone of both U.S. and OECD transfer pricing rules.
- Application: The principle is applied by comparing the terms and pricing of controlled transactions to those of comparable uncontrolled transactions.
- Challenges: Finding truly comparable transactions can be difficult, especially for unique intangibles or services.
5. What Are the Main Methods for Setting Transfer Prices?
Common Transfer Pricing Methods
| Method Name | Description | Typical Use Case |
|---|---|---|
| Comparable Uncontrolled Price (CUP) | Compares price charged in a controlled transaction to price in a comparable uncontrolled transaction | Commodities, standard goods |
| Resale Price Method | Based on resale price to an independent party, minus a gross margin | Distribution of finished goods |
| Cost Plus Method | Adds an appropriate markup to costs incurred by the supplier | Manufacturing, services |
| Transactional Net Margin Method (TNMM) / Comparable Profits Method (CPM) | Compares net profit margin to that of comparable companies | Services, intangibles, when direct comparables are lacking |
| Profit Split Method | Allocates combined profits based on relative contributions | Integrated operations, unique intangibles |
In the U.S., the CPM/TNMM is the most commonly used method for tangible and intangible property transactions
6. What Triggers a Transfer Pricing Audit or Dispute?
Common Triggers
- Large or Unusual Transactions: Significant cross-border payments, especially for intangibles or services.
- Persistent Losses: Subsidiaries reporting losses while the group is profitable.
- Profit Shifting Indicators: High profits in low-tax jurisdictions, low profits in high-tax countries.
- Inadequate Documentation: Failure to maintain or provide required transfer pricing documentation.
- Whistleblower Tips or Data Analytics: Tax authorities increasingly use data analytics to identify risk areas.
7. How Are Transfer Pricing Disputes Resolved?
Dispute Resolution Mechanisms
- Administrative Adjustments: Tax authorities may adjust reported income and assess additional tax, penalties, and interest.
- Advance Pricing Agreements (APAs): Taxpayers can agree in advance with one or more tax authorities on the appropriate transfer pricing method for specific transactions, reducing future disputes.
- Mutual Agreement Procedures (MAP): Tax treaties provide for MAP to resolve double taxation arising from transfer pricing adjustments.
- Litigation: If administrative remedies fail, disputes may proceed to court.
The IRS and other tax authorities are increasingly encouraging APAs and MAPs to provide certainty and reduce litigation.
8. What’s New in 2025? (OBBB and OECD Developments)
OBBB (One Big Beautiful Bill Act) – Effective July 4, 2025
- Codifies and updates IRC § 482, reinforcing the arm’s length standard and clarifying documentation requirements.
- Mandates contemporaneous documentation for all large MNEs, with stricter penalties for non-compliance.
- Aligns U.S. rules more closely with OECD Guidelines, but retains unique U.S. features (e.g., specific methods, penalty structures).
- Transition Rules: Existing APAs and MAPs remain valid, but new agreements must comply with OBBB standards.
OECD Developments
- Pillar One and Pillar Two: Ongoing implementation of global minimum tax and new profit allocation rules for large digital and consumer-facing businesses.
- Amount B: Simplified and standardized approach for baseline marketing and distribution activities, aiming to reduce disputes over routine returns.
9. Practical Next Steps for Tax Professionals
- Review and Update Documentation: Ensure all transfer pricing documentation meets OBBB and local requirements for 2025.
- Assess Risk Areas: Use data analytics to identify transactions or entities at higher risk of audit or adjustment.
- Consider APAs: For complex or high-value transactions, consider negotiating APAs to gain certainty.
- Monitor OECD and Local Developments: Stay current on evolving international standards and country-specific rules.
- Prepare for Increased Scrutiny: Expect more detailed information requests and potential audits, especially for digital and intangible transactions.
10. Authority Trail
- OBBB (H.R. 1, 119th Congress, Public Law 119-21, July 4, 2025) – controlling for all U.S. transfer pricing rules post-2025.
- IRC § 482 (as amended by OBBB)
- Treas. Reg. § 1.482-1 et seq. (to the extent not superseded by OBBB)
- OECD Transfer Pricing Guidelines (2022, as updated 2024)
- IRS IRB Guidance:
- IRB 2025-15 (transfer pricing methods and profit level indicators)
- IRB 2025-03 (arm’s length standard and restructuring)
- IRB 2022-1, IRB 2023-01, IRB 2024-01 (transfer pricing definitions and rulings)
- IRS Publications: Non-binding, for educational context only
11. Pre-OBBB vs. Post-OBBB Comparison Table
| Feature / Rule | Pre-OBBB (2024 and prior) | Post-OBBB (2025 and after) | Effective Date |
|---|---|---|---|
| Statutory Authority | IRC § 482 (pre-OBBB) | IRC § 482 (as amended by OBBB) | July 4, 2025 |
| Documentation Requirements | Contemporaneous, but less strict | Mandatory, detailed, stricter penalties | July 4, 2025 |
| Penalties for Non-Compliance | Up to 40% for gross misstatement | Increased, with lower thresholds | July 4, 2025 |
| APA/MAP Standards | IRS discretion, OECD-influenced | Must comply with OBBB and OECD | July 4, 2025 |
| OECD Alignment | Partial, with U.S. differences | Closer alignment, but U.S. retains unique features | July 4, 2025 |
| Digital/Intangible Focus | Growing, but not uniform | Explicit focus, with new rules | July 4, 2025 |
Practical Next Steps
- Immediate: Review all intercompany agreements and documentation for compliance with OBBB and OECD standards.
- Short-Term: Identify high-risk transactions and consider APAs or MAPs for certainty.
- Ongoing: Monitor IRS and OECD guidance for further updates, and train staff on new requirements.
Conclusion
Transfer pricing remains one of the most complex and controversial areas of international tax. With the enactment of OBBB and ongoing OECD reforms, the landscape is shifting rapidly. Tax professionals must stay vigilant, update their practices, and leverage dispute resolution mechanisms to manage risk and ensure compliance in 2025 and beyond.
Authority Trail:
- OBBB (H.R. 1, 119th Congress, Public Law 119-21, July 4, 2025)
- IRC § 482 (as amended)
- Treas. Reg. § 1.482-1 et seq.
- IRB 2025-15, IRB 2025-03, IRB 2022-1, IRB 2023-01, IRB 2024-01
- OECD Transfer Pricing Guidelines (2022, 2024 updates)
- IRS Publications: Non-binding, for context only
Other International tax controversy issue
A US corporation that owns a foreign branch, is the income comprised of sales to foreign parties for foreign use from the foreign branch FDII qualifying income?
- Under OBBB (effective for tax years beginning after December 31, 2025), income from a U.S. corporation’s foreign branch that consists of sales to foreign parties for foreign use generally does not qualify as FDII (now FDEI) for section 250 purposes.
- FDII/FDEI is limited to income derived from property sold or services provided by the U.S. corporation (not its foreign branch) for foreign use. Income earned by a foreign branch is not eligible, as it is not considered derived by the U.S. corporation directly for FDII/FDEI purposes.
Analysis
1. OBBB Changes and FDII/FDEI Eligibility
- OBBB (H.R. 1, 119th Congress, Public Law 119-21) rebrands FDII as FDEI (foreign-derived deduction-eligible income) and clarifies the scope of qualifying income.
- The law and pre-OBBB regulations both require that, to qualify as FDII/FDEI, the income must be derived by the U.S. corporation from:
- The sale of property to a foreign person for foreign use, or
- The provision of services to a person or with respect to property located outside the U.S.
- However, income earned by a foreign branch is not considered “derived by the U.S. corporation” for FDII/FDEI purposes. Instead, it is treated as foreign branch income, which is specifically excluded from the FDII/FDEI calculation.
2. Statutory and Regulatory Authority
- IRC § 250 (as amended by OBBB) and Treas. Reg. § 1.250(b)-3 and -4 (pre-OBBB, but not superseded on this point) require that the income be derived by the U.S. corporation, not its foreign branch.
- The IRS instructions for Form 8993 and related guidance confirm that foreign branch income is not eligible for the FDII deduction, even if the sales are to foreign parties for foreign use.
3. Practical Example
- If a U.S. corporation operates a foreign branch, and that branch sells inventory to foreign customers for use outside the U.S., the income is foreign branch income, not FDII/FDEI.
- Only sales made directly by the U.S. corporation (not through its foreign branch) to foreign persons for foreign use can qualify as FDII/FDEI.
Authority Trail
- OBBB (H.R. 1, 119th Congress, Public Law 119-21, effective for tax years beginning after Dec. 31, 2025)
- IRC § 250, as amended by OBBB
- Treas. Reg. § 1.250(b)-3, -4 (pre-OBBB, still applicable for branch exclusion)
- IRS Instructions for Form 8993 (non-binding, but consistent with above)
- OBBB summary and technical explanation (“OBBB Chapter 3 – Business and Internat.md”)
Pre-OBBB vs. Post-OBBB Comparison
| Rule Aspect | Pre-OBBB (2018–2025) | Post-OBBB (2026+) |
|---|---|---|
| FDII Name | Foreign-Derived Intangible Income (FDII) | Foreign-Derived Deduction-Eligible Income (FDEI) |
| Foreign Branch Income | Excluded from FDII calculation | Still excluded from FDEI calculation |
| Qualifying Sales | U.S. corp sales to foreign persons for foreign use | Same; must be by U.S. corp, not foreign branch |
| Effective Date | Tax years after 2017 | Tax years after Dec. 31, 2025 |
Practical Next Steps
- Exclude foreign branch income from the FDII/FDEI calculation on Form 8993.
- Only include sales and services income derived directly by the U.S. corporation to foreign persons for foreign use.
- Review OBBB and any future regulations for updates, but as of 2025, the exclusion of foreign branch income remains controlling.
Summary: Income from a U.S. corporation’s foreign branch, even if comprised of sales to foreign parties for foreign use, is not FDII/FDEI qualifying income under section 250 as amended by OBBB. Only income derived directly by the U.S. corporation from such sales or services qualifies. (“OBBB Chapter 3 – Business and Internat.md”)
