New Wave of Tariffs Sets Off Transfer Pricing Scramble

The White House announcement of broad 10% tariffs, and much higher levies on some countries, is leading multinationals to reexamine ways they can minimize costs.

The new tariffs may reverse longstanding incentives for transfer pricing and encourage companies to lower prices for goods coming into the US—with audit risks for companies that go overboard.

“Transfer pricing is something that companies can immediately take a look at and see if there’s an opportunity to mitigate the effect of tariffs,” Mayer Brown partner Sonal Majmudar said. “And one possible solution is sharing tariff impact between related parties.”

Transfer pricing refers to the way in which a corporation values international transactions between related companies.

While the importer is the one that pays the tariffs, companies can spread the ultimate cost throughout the supply chain by adjusting the price of transfers between related units, she said.

“But in order to do that, companies have to take a look at their transfer price and their transfer pricing analysis and evaluate what room they have to make that sort of adjustment,” Majmudar said.

Opposite Incentive

The changes could represent something of a reversal for companies that have historically directed taxable profits away from the US to lower-tax jurisdictions by strategic transfer pricing. Figuring out how to reverse course without risking major audits will be important.

Today, companies can shift taxable profits to more favorable jurisdictions by setting a high transfer price paid by units in the US, or high-tax jurisdictions, to related exporters in low-tax jurisdictions—for example, by housing valuable intellectual property in a low-tax country and charging the US entity a high price to use it.

President Donald Trump’s new tariffs provide an opposite incentive, because higher transfer prices typically increase the value of the imports subject to the tariff. So for a US company importing a $100 good that’s subject to a 25% tariff, for example, a transfer pricing adjustment bringing that price down to $90 would reduce the tariff owed by $2.50.

That reduction would mean higher profits, however, leading to an increase in US tax.

“Now you have to make a trade-off,” Bernstein senior analyst Courtney Breen said—eat the full tariff cost under your current arrangements, or reorganize in a way to increase tax exposure in order to bring down the tariff cost.

Companies mulling a change will have to weigh the difference in cost and effort—while making sure not to run afoul of laws and regulations.

Breen explored how companies can leverage transfer pricing to mitigate tariffs in a March 31 report on the impacts the levies could have on the pharmaceuticals industry. Pharmaceuticals got an exception from Trump’s tariffs, but the administration is looking to launch a Section 232 investigation into pharma and other sectors—which could lead to tariffs.

Big pharma has become a poster child for how companies can shift profits and leverage aggressive transfer pricing positions to reduce taxes in the eyes of some US officials. Sen. Ron Wyden (D-Ore.) has launched investigations, and Trump excoriated the Irish prime minister over Ireland’s use of its tax code to attract US pharma business, and profits.

Companies are supposed to value their inter-affiliate transactions at arm’s length—that is, as if they were being done between unrelated parties—but there is rarely a precise answer, and transfer prices typically have to fall within an accepted range.

“Previously, companies would’ve been at the top end of the range,” Breen said in an interview. “Likely they’ll be pushing to the bottom end of the range as an immediate action.”

But a sudden change in the transfer price without a corresponding change in actual operations could raise eyebrows at tax authorities, she said, and companies looking to make massive transfer pricing changes should probably accompany them with substantive operational changes if they can.

And the effort may not be worthwhile, Majmudar said, if the acceptable range of prices is too small to allow for a significant difference.

For taxpayers worried about audits, avenues to get some tax certainty from the IRS or to resolve disputes may be harder to come by this year than before.

Advance Agreements

One way for companies to solve the uncertainty problem would be to get an advance pricing agreement or access other dispute resolution mechanism with the IRS or other jurisdictions to ensure their tax positions are blessed before tax filing seasons.

APAs let companies get pre-approval for tax positions from one or more jurisdictions. Mutual Agreement Procedures also let companies hash out cases of double tax between treaty partners.

“If the word gets out that APA and MAP have figured out a way to deal with the tariffs, you’ll have a number of cases added in,” Steve Wrappe, Grant Thornton LLP transfer pricing technical leader, said at an International Fiscal Association conference in March.

But big budget and staff cuts at the IRS, including at the Advance Pricing and Mutual Agreement Program, already have practitioners worried about whether the agency can keep up with even its current workload.

A new wave of tariff-induced applications could strain that further.

Recent data showed that staffing at APMA had been on the rise in recent years, likely due in part to the boost in funding from the 2020 Inflation Reduction Act. The last two years have seen the time it takes to complete APAs dip—though the number of applications continues to outpace the number the agency is able to complete.

Still, Majmudar said APMA is likely up to the task.

“I actually think they’re very well resourced, even with potential cuts,” she said. “The teams and the personnel there tend to be very experienced, and I think they’ll find ways to manage the increased workload. And I think they’ll also develop tools to increase their efficiency in handling cases that involve a tariff impact.”