We at USLawforNordics often meet with companies that are considering to establish a US entity, which may become the parent company of the group, or a subsidiary of their Nordic entity. It´s pretty common that the current managers, often based in the Nordics and employed by the Nordic company, will run both corporate entities, at least to begin with. It´s also very common that both entities will be selling the company´s products and services to customers on “their” respective market, whereas the ownership to the product or services still belongs to only the Nordic entity.
What Is Transfer Pricing?
If you do this, you need to consider the rules around Transfer Pricing. Transfer Pricing is a set of rules that were adopted to ensure that a group of companies don´t structure their business so that they get all their profit in a country where the taxes are low. Basically, the idea is that if you sell services or products between two companies that belong to the same group, and that are based in two different countries, you need to make sure these transactions are made on an arm´s lengths basis. For instance, you cannot sell services between two affiliates in different countries at a cheaper price than market price, in an active effort to make the buyer more profitable than the seller, since the seller pays higher taxes in its home country than the buyer. The countries of the world want to make sure they get their fair part of your profit.
Handling Transfer Pricing is more or less a mere formality and you should probably avoid spending too much money on it if you´re still a small startup with limited resources – especially so if you´re not even profitable, meaning you don´t pay taxes anyway. However, it is very important that you at least have this topic on the radar, since non-compliance may lead to an adjustment to income and, in some cases, penalty fees. Following the steps below will take you a long way. It might be beneficial you do these things for other reasons too, as described below.
The Basics
Although transfer pricing regulations may vary from country to country, here are the basics on how you may create your own transfer pricing policy, which lays out the level of payment a subsidiary or member of a group should pay for services provided by another member of the group.
- Your Transfer Pricing Policy shall consist of the following elements: (i) Overview of the business; (ii) Organization structure chart; (iii) Documentation required by regulation; (iv) Description of Transfer pricing methodology and reason for selection; (v) Discussion of alternative methods not selected; (vi) Description of controlled transactions; (vii) Description and analysis of comparables; and (viii) Economic analysis.
- Start by identifying the transactions that are taking place between different companies in your group of companies. Examples of intra-group transactions are: The US subsidiary selling Swedish-owned software to the US market; Your VP of Legal based in the US performing HR services for the Swedish entity; Your engineers based in Silicon Valley developing software that you for certain reasons have decided shall be owned solely by your Nordic parent company.
- Make sure these transactions are made at arm´s length basis, as if there were no connection between the group companies. This is the part where some companies feel they need to consult with a transfer pricing expert, who can help them do a proper benchmark study. The OECD (Organization for Economic Cooperation and Development) has set four major transfer pricing methods, which can be found here. You can use different methods for different intragroup transactions. For example, you may end up paying actual cost plus 10% for management services provided by your Head Quarter in Stockholm, a royalty fee for sale of software owned by your affiliate, and a market interest on any intragroup loan.
- Write down in a policy how the intragroup pricing was determined, and argue your case why it´s set at arm´s length standard. Make sure you enter into intra-group agreements between the group companies, where the pricing is documented. Common intragroup agreements are Management Service Agreement, Distribution Agreement, and Intra Group Loan agreements.
Extra Benefits From Doing You Transfer Pricing Homework
When you go through the steps above, chances are you will realize you didn´t quite understand the complexity of how services were provided and products were sold between the group companies. A startup often grows organically, where problems are solved on the go. Oftentimes, you don´t have a thought through strategy around what the country will do what. Let´s say you buy software apps from the Nordic entity, and then your US employees start using them – in this situation you need to make sure the US entity pays their fair share of the license cost. As you get more clarity in the intragroup transactions taking place, you will simultaneously have an excellent opportunity to think about whether things are set up in the most efficient way, or not. Maybe you will then realize you´ve come to a point where it makes more sense to purchase certain services, products or intangibles from a US third party vendor on the US market, rather than purchasing them from your Nordic parent company.
What we often see happen, is that a company realizes that they don´t know how they want their intellectual property to be owned – should it be owned by their Nordic company or the US company? Now, this is a much bigger question than creating a Transfer Pricing Policy, and if you haven´t thought your Intellectual Property (“IP”) strategy through before, now is definitely the time to do it. This is the kind of decision you want to make before your IP has become too valuable since any corrections you may end up doing might lead to tax consequences otherwise.
To Sum Up
To conclude, going through the exercise of creating a Transfer Pricing policy will not only keep you compliant with the Transfer Pricing rules, but it may bring some clarity to your organizational structure on other levels as well. As always, if you have any questions or concerns on how this should be done, you should consult with an expert. And of course, you should always feel free out to reach out to USLawforNordics, and we will be happy to make an introduction to an experienced transfer pricing expert in our network.
