Understanding Transfer Pricing: Strategy, Compliance, and Value Creation

Although it seems like a narrow topic, it’s a scrutinized and risky area of global finance and accounting. When done carefully, it presents rich opportunities for value creation.

What is Transfer Pricing?

Transfer pricing is important when a company expands across borders or engages in intercompany transactions across multiple entities because it complicates its corporate structure. It governs the terms and pricing for transactions between controlled parties, such as parent companies and subsidiaries, or entities under common ownership. These intra-group transactions can involve:

• Tangible goods, like inventory or raw materials
  
  
• Intangible assets, such as intellectual property, trademarks, or software
  
  
• Services, like management fees, R&D support, and back-office operations
  
  
• Financial arrangements such as intercompany loans and guarantees
  
  

In theory, pricing between related entities that operate in different countries should reflect the same terms that would apply if the entities were unrelated—what’s known as the arm’s length principle. This ensures profits are appropriately taxed in each jurisdiction, preventing companies from shifting income from low-tax jurisdictions through artificially manipulated intercompany pricing.

In practice, creating that distance is complex, involving comparability analysis, functional profiling, and jurisdictional requirements.

Why does Transfer Pricing Matter?

Transfer pricing affects how profits are allocated across jurisdictions. That, in turn, impacts how much tax is paid and where. Companies that don't properly manage transfer pricing expose themselves to:

• Double taxation if multiple countries claim the same income
  
  
• Significant penalties and interest for underpaid taxes or noncompliance, and
  
  
• Tax audits and legal disputes, which are increasingly aggressive and data-driven
  
  

But even beyond avoiding these risks, transfer pricing can also be a strategic lever for capital efficiency, tax optimization, and global alignment—especially for scaling businesses entering new markets or restructuring around core capabilities so that each entity is doing what it does best.

By carefully setting intercompany pricing, companies can allocate resources where they’re most productive, streamline profit repatriation based on TCJA regulations, and ensure each entity is fairly compensated based on the value it contributes.

What are the Key Components of Transfer Pricing?

1. Functional Analysis

An in-depth analysis of how value is created across an organization forms a basis for pricing that is both defensible and aligned with business operations. This identifies which entities perform key functions, bear risks, and own assets. For example, is research and development centralized in one location? Does one entity carry more inventory or warranty risk than others? This footprint guides how profits should be split.

2. Method Selection

The IRS and OECD recognize several accepted methods for testing transfer prices, including:

• Comparable Uncontrolled Price (CUP): Compares related-party pricing to third-party transactions to ensure they follow the arm’s length principle
  
  
• Cost Plus Method: Adds a markup that covers functions, risks, and assets to costs incurred by the supplier entity
  
  
• Resale Price Method: Starts with the resale price to an independent customer and subtracts a margin
  
  
• Transactional Net Margin Method (TNMM): Assesses net margins relative to benchmarks, usually by comparing them to similar companies
  
  
• Profit Split Method: Allocates combined profits based on the relative contributions of each party

Choosing the right method depends on transaction type, data availability, and the roles of the entities involved.

3. Benchmarking and Documentation

Benchmarking studies support the arm’s length standard. Robust documentation of transfer pricing reports should justify the pricing arrangements using comparable data and economic analysis, and many jurisdictions require this.

4. Ongoing Monitoring

Transfer pricing is not a one-time exercise. Changes in business models, supply chains, or tax law can mean pricing structures and documentation need to change, too. Regular reviews ensure alignment with current operations and lessen the risk of audits.

Who Governs Transfer Pricing?

Both local tax authorities and international guidelines govern transfer pricing. While OECD member countries broadly follow the principles of the OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, local requirements might vary in terms of:

• Documentation thresholds and deadlines
  
  
• Disclosure forms, such as form 5471 or BEPS Action 13 country-by-country reporting
  
  
• Audit approaches and penalties
  
  
• Advance Pricing Agreements (APAs)
  
  

The Base Erosion and Profit Shifting (BEPS) initiative has led to tighter examination worldwide, emphasizing transparency, consistency, and substance over form. Multinational companies are expected to align profits with where economic value is actually created—not simply where tax rates are lowest.

How Does Transfer Pricing Affect Growth-Stage Companies?

Mid-market companies with international operations face the same exposure as Fortune 500 companies—often without dedicated in-house tax teams. For example, it’s increasingly common for growth-stage companies to hire talent overseas through cost centers in order to drive down costs and accelerate growth. However, this creates transfer pricing obligations that will need to be addressed.

Common challenges include:

• Lack of internal expertise to establish compliant policies
  
  
• Poor documentation or inconsistent application of pricing models
  
  
• Cross-border IP arrangements, like developing software in one country and commercialization in another
  
  
• Cash flow mismatches due to transfer pricing adjustments or withholding tax obligations

These issues become even more complex when the company undergoes a capital raise, M&A transaction, or audit, where clean financial records and defensible policies are essential.

How Does a Company Implement Transfer Pricing?

CFOs, Controllers, and Financial Planning & Analysis teams looking to implement or improve their transfer pricing strategy should:

1. Involve Finance Early

Transfer pricing isn’t just a tax issue—it affects budgeting, intercompany settlements, and performance measurement. Finance leaders should collaborate with tax advisors and legal counsel to integrate transfer pricing into operational planning.

2. Centralize Policy Development

Keep pricing policies consistent and well-documented across entities. Create templates for intercompany agreements and invoicing to stay ready for audits.

3. Invest in Benchmarking Tools

Work with external advisors to run benchmarking studies and validate pricing, reducing the risk of audit disputes.

4. Use Technology to Track Intercompany Flows with Accuracy

Enterprise Resource Planning systems and consolidation software can flag non-arm’s length transactions or missing intercompany charges.

5. Prepare for Country-by-Country (CbC) Reporting

Be ready to submit CbC reports if your consolidated revenue exceeds local thresholds (e.g., €750 million under OECD guidelines). Even if below the threshold, aligning systems to support this reporting builds long-term readiness.

Final Thoughts

As tax authorities become more sophisticated and coordinated, transfer pricing enforcement will only intensify. Meanwhile, digital business models—particularly in software, platform, and IP-driven industries—raise new questions about where value is created and how it should be taxed.

The best-prepared companies will treat transfer pricing not as a compliance headache but as an opportunity to build more resilient structures, reduce global tax friction, and unlock strengths  across borders. Transfer pricing sits at the intersection of tax, operations, and strategy. While it can expose companies to substantial financial and reputational risk, it also offers a framework for sustainable and scalable international growth. 

For middle-market and growth-stage businesses expanding globally, the time to build a transfer pricing strategy is not when the audit comes—it’s now. With the right policy, documentation, and oversight in place, companies can confidently navigate complexity, demonstrate compliance, and create long-term value.

If you have questions about transfer pricing, please reach out.