How IFRS will Impact Transfer Pricing Part I: Cost Base and Comparability
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While the FASB and the IASB have still not achieved convergence between U.S. GAAP and IFRS, recent statements by both Boards have embraced an aggressive timetable to achieve convergence by 2011. Thus, the question does not seem to be if the U.S. will adopt IFRS, but rather when. Adoption of IFRS by the U.S. has far-reaching implications for all facets of financial reporting as well as tax planning and compliance by American companies. This blog is the first in a series examining the potential ramifications of IFRS adoption for transfer pricing by U.S. multinationals.

The so-called Holy Grail of transfer pricing has long been the comparable uncontrolled price (or transaction). The elusive publicly reported transaction between third parties which nearly perfectly matches the facts and circumstances of the related group transaction seldom exists. As such, taxpayers around the world most often rely on a range of results derived from uncontrolled parties – known as comparables – as the basis for determining whether or not the results of the transaction under review satisfy the arm’s length standard. The reference companies selected for comparability need not only meet certain functional and operational criteria in order to be comparable (e.g., functions performed, assets employed, risks borne), but financial standards as well. Differences between revenue, expense, asset, liability and equity treatment between IFRS and U.S. GAAP are significant. In the short-term there may be difficulty establishing comparability between the financial data of companies reporting under IFRS versus those reporting under U.S. GAAP. While the IRS requires U.S. GAAP to be used by all U.S. taxpayers if the comparable companies under consideration are non-U.S. companies traded on foreign stock exchanges the same rules do not apply. As can be seen from the example below, a small difference in the manner in which cost is reported (e.g., above or below the operating income line) can have a major impact on the ultimate result.

For example:

Comparable Company

Revenue

Total Cost

Operating Income

Mark-up on Total Cost

IFRS

$100

$95

$5

5%

U.S. GAAP

$100

$90

$10

11%

For U.S. taxpayers examining the results of potentially comparable companies from around the world this development means a tremendous amount of extra effort – either the taxpayers must reconcile the financial statements of all potential comparables back to U.S. GAAP in order to perform the analysis or the taxpayer must find and use only those companies who report their results under U.S. GAAP. Ultimately both choices are poor and will lead to less accurate and complete analyses. It remains to be seen to what extent IFRS and U.S. GAAP will impact comparability for transfer pricing purposes and how the lack of convergence will affect U.S.-based multinationals. If recent trends associated with companies adopting IFRS hold, it is likely that net income under IFRS will likely exceed the amount reported under other comprehensive bases of accounting. Given all of these factors, it is likely that – for the foreseeable future – transfer pricing will need to start with local country GAAP reporting rather than IFRS.

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One Response to “How IFRS will Impact Transfer Pricing Part I: Cost Base and Comparability”

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