What is “Transfer pricing”?
Lots of people have the idea of setting up an offshore company in a low or zero tax jurisdiction and then charging the original company (that’s in high tax jurisdiction) with management or marketing fees (or similar fees).
Well, there are rules against doing this. These rules are called “transfer pricing rules”.
If you are billing from one company to another that’s abroad and these companies are related (owned by you, your family member, etc) you have to bill the fair price as you would bill an unrelated third party.
So, what you are paying your own company, for example, for marketing services needs to be similar to what you would pay some random marketing company that’s completely unrelated to your businesses if it was doing the same thing for you.
So before billing your own company for some service, many countries require you need to do transfer pricing study. This will tell you what is the fair market value for that service.
Depending on the country there are different rules about how you need to conduct these studies, the pricing methods involved and then what reporting is involved.
If you don’t do this, or you do it and misprice those transactions (what’s called “transfer mispricing”) you can be subject to fines in some cases ranging up to 400% of the difference.
All this takes lots of work initially, especially for a small business. So, when we do international structuring we are looking to avoid transfer pricing since it lowers your costs and risks at the beginning.
However, transfer pricing is widely used by all the big companies (it’s rare to find a Fortune 500 company that doesn’t use it in one form or another) because sometimes it’s the only viable option to save on tax and it pays for itself many times over.
Transfer pricing will prevent you from excessively abusing your ability to shift profits from a high tax jurisdiction to a low tax jurisdiction and shouldn’t ever be the first choice for international tax planning but it is very useful to have in your belt.
So, even though setting up proper transfer pricing structure is lots of work initially this is something that can massively pay off later on.
We help clients legally reduce their tax through international tax planning, as well as help with company formations, bank account openings, residency, citizenship, and payment processing. Have a question you want answered? Book a consultation now!