Transfer Pricing Fraud

Abusive Offshore Tax Avoidance Schemes

Transfer Pricing Fraud

Many U.S. Companies will use transfer pricing schemes to legally underpay their U.S. tax liabilities.  However, may U.S. companies will become aggressive in their accounting and push to underpay their taxes more than they are legally entitled by using transfer pricing schemes.

Transfer pricing is a negotiation (in reality there is no negotiations) between related companies typically with common ownership. More often it involves the relationship between that of a U.S. parent and foreign subsidiary company. In this situation, the parent company needs to allegedly purchase goods, services, license, royalty, etc. from the subsidiary, but since the transfer of goods is internal, the negotiation of price is also internal.  The negotiations between these related companies is more often concerned with the overall reduction of taxes as opposed to the value of the goods and services being provided.  The point when it becomes illegal is when the transfer is used to manipulate the market price of the goods or services being provided. Often it is used so that a parent company may take advantage of a subsidiary company lower tax rates, using it to evade taxes.

Recently, companies in the United States have become increasingly liberal with their application of transfer pricing. U.S. companies have accumulated well in excess of $1 trillion in offshore profits, none of which was taxed in the United States.  Today, many politician are under the false belief that this profit sits offshore in the form of cash only to be brought back to the United States to boost the economy upon the U.S. giving a tax holiday or otherwise lowering the corporate tax rate in response to the corporation’s lobbyists.

Typically, the majority of foreign profit between related entities is earned from transfer pricing of the goods or services allegedly by provided and received between related companies.  Examples might include  

o Royalty payments
o Licensing fees
o Marketing costs
o Management fees
o Etc.

The convenience of abuse between subsidiary companies makes transfer pricing a top priority for the IRS.

Companies often find that transfer pricing can also be used to illegally reduce taxes by making the products transferred appear to be worth less than they are. Once the product price is deflated, the company appears to be making very little profit. Once a company makes very little profit, they only pay very little taxes. 

There have been numerous notable cases involving transfer pricing. 

In 2006 one of the biggest pharmaceutical companies in the world, GlaxoSmithKline (GSK), a UK based company, publicly announced that it would pay $3.4 billion to the IRS. The money was due the IRS as part of a settlement for a 17 year old transfer pricing scandal. The IRS claimed that GSK routinely shuffled money from its U.S. branch to its UK branch in order to dodge taxes. 

In a similar case in 2006, Merck was slapped with 4 tax disputes in both the U.S. and Canada. The potential penalties were up to $5.6 billion. One of the strategies Merck used was to use a subsidiary located in Bermuda. The company shifted the ownership of powerful patents to that subsidiary, then the main company “paid dues” to the Bermuda subsidiary for the right to use the patents.