Question 1

IRS code Section 482 describes appropriate transfer prices as "the prices which would have been agreed upon between unrelated parties engaged in the same or similar transactions under the same or similar conditions in the open market." How does it refer to such prices?

Accepted Answer

The term "arm's-length prices" is commonly used to refer to prices that are determined according to the criteria outlined in Section 482 of the IRS code. These prices should be similar to the prices that would be agreed upon by unrelated parties in similar transactions under similar conditions.

Question 2

What is the time frame in which taxpayers must produce documentation to the IRS, in which it justifies the transfer pricing method that it has selected as being the most reliable measure of arm's-length price?

Accepted Answer

The answer of What is the time frame in which...

Question 3

In keeping with Internal Revenue Code, Clarence Company transfers goods to Marguerite Corporation, its foreign subsidiary, at the price Marguerite will sell the product to its customers, less the industry's average gross profit margin of 30%.What method of transfer pricing is Clarence using?

Accepted Answer

The method of transfer pricing used by Clarence Company is the Resale Price method. The price at which the goods are transferred to the subsidiary is based on the price at which Marguerite Corporation will sell the goods, less the average gross profit margin of the industry (30%). The resale price method is used when the subsidiary buys goods from the parent company and resells them to third parties. Under this method, the transfer price is based on the resale price charged by the subsidiary, less an appropriate gross profit markup.

Question 4

Profit indicators that might be considered in applying the comparable profits method include the ratio of:

Accepted Answer

The ratio of operating income to operating assets is a profitability indicator that can help to determine if a company is generating a reasonable return on its investments. This ratio is commonly used in financial analysis and can be helpful in determining the arm's length profitability of a controlled transaction. The other options (B, C, and D) are not directly related to profitability and would not be as useful in applying the comparable profits method.

Question 5

Which of the following is NOT within the power of the Internal Revenue Service (IRS) under Internal Revenue Code (Section 482)?

Accepted Answer

The IRS does not have the authority to stop intercompany transactions altogether, but it does have the authority to adjust or disallow certain transfer prices if they are deemed inappropriate.

Question 6

What is an ad valorem import duty?

Accepted Answer

An ad valorem import duty is a tariff charged by a government on the invoice price of goods coming into its country. It is calculated as a percentage of the declared customs value of the goods being imported.

Question 7

The Internal Revenue Service determined that Covington Ltd.should have been using a transfer price of $400 for the purchase of goods from its U.S.subsidiary but had set the price at $50.What is the rate of penalty that the IRS can impose on the taxpayer?

Accepted Answer

The penalty for underpaying taxes due to transfer pricing adjustments is 40% of the amount underpaid. This penalty is imposed to discourage taxpayers from intentionally setting transfer prices in order to evade taxes.

Question 8

What power is given to the Internal Revenue Service (IRS) under code section 482?

Accepted Answer

Code section 482 gives the IRS authority to audit and adjust international transfer prices, which are prices charged between related parties in different countries. It does not give the IRS the power to eliminate intercompany transactions or impose tariffs on foreign imports.

Question 9

Under what condition does the IRS consider the resale price method acceptable as a transfer price?

Accepted Answer

The resale price method is considered acceptable by the IRS when the related party involved acts primarily as a distributor of finished goods. This method is used to determine the transfer price based on the price at which a product is resold to an unrelated party, making it suitable for situations where the related party's main function is distribution.

Question 10

Which of the following is a limitation of cost-based transfer pricing?

Accepted Answer

Determining which measure of cost to use can be a challenging task as some costs may not be directly controllable by the selling division. Similarly, there is a lack of incentive for selling division to control cost as their profits are fixed, which can lead to inefficiencies in one unit being transferred to another unit. Therefore, all of the above options are the limitations of cost-based transfer pricing.

Question 11

Which of the following is true of profit split method?

Accepted Answer

This method assumes that the parties involved (buyer and seller) are part of a single economic entity, thus splitting profits in a manner that reflects the value contributed by each party to the overall transaction.

Question 12

According to (Internal Revenue Service) IRS code Section 482, what is the standard used by the IRS for international transfer pricing?

Accepted Answer

The IRS uses the arm's-length standard for international transfer pricing, which means that transactions between related parties should be conducted as if they were between unrelated parties, with pricing based on market rates. This ensures that profits are not shifted to lower-tax jurisdictions and that taxes are paid in the appropriate jurisdiction.

Question 13

A cost-plus transfer pricing scheme is allowed by the Internal Revenue Service when:

Accepted Answer

A cost-plus transfer pricing scheme is allowed when there are no comparable uncontrollable sales and the related buyer is more than just a distributor. This is because in such cases, it may be difficult to determine an appropriate price without considering the costs incurred by the seller in producing the goods or services being transferred. The IRS does not allow the use of cost-plus pricing when there are comparable uncontrollable sales or when the related party is primarily a sales subsidiary. The average industry markup is also not a factor in determining the appropriateness of a cost-plus transfer pricing scheme.

Question 14

The comparable uncontrolled transaction (CUT) method is one alternative for determining an arm's-length transfer price for what kind of intercompany transaction?

Accepted Answer

The Comparable Uncontrolled Transaction (CUT) method is primarily used for determining an arm's-length transfer price for licenses of intangible property. This method compares the terms and conditions (including the price) of a controlled transaction to those of a comparable uncontrolled transaction in similar circumstances.

Question 15

The "price" for using intangible property is called:

Accepted Answer

The "price" for using intangible property is called a royalty. Royalty is a payment made by one party (the licensee) to another party (the licensor) for the right to use intangible assets, such as patents, trademarks, copyrights, and trade secrets. Interest is the cost of borrowing money, rent is the payment for the use of tangible property, and a service charge is a fee for a specific service.

Question 16

What is the general rule for international transfer pricing advocated by the Organization for Economic Cooperation and Development (OECD)?

Accepted Answer

The general rule for international transfer pricing advocated by the OECD is to use arm's-length prices. Arm's-length prices refer to the prices that would be agreed upon between two independent parties in a similar transaction, without any special relationship or influence between them. This ensures that the transfer price is fair and reflects market conditions, rather than being subject to manipulation or distortion for tax purposes. Cost-based prices (A) may not reflect market conditions and negotiated prices (B) may be influenced by special relationships, while discretionary prices (D) may be subject to manipulation.

Question 17

According to the Internal Revenue Service, the most reliable measure of an arm's-length prices for sales of tangible property in intercompany transactions is:

Accepted Answer

The comparable uncontrolled price method is the most reliable measure of an arm's-length price for sales of tangible property in intercompany transactions according to the Internal Revenue Service. This method compares the price charged in the intercompany transaction to the price charged in a similar transaction between unrelated parties. This provides an objective measure of what the price should be, based on market forces rather than on the preferences or relationships of the parties involved.

Question 18

Which of the following statements is true about applying the arm's-length standard for transfer pricing?

Accepted Answer

The arm's-length standard allows for a range of acceptable transfer prices, enabling taxpayers to select a price within this range that may minimize their tax liabilities. This flexibility is a key aspect of the arm's-length principle.

Question 19

Withholding taxes on dividends paid by a foreign subsidiary to a parent can be reduced by:

Accepted Answer

The answer of Withholding taxes on dividends paid by a...

Question 20

Which of the following is a reason for a parent to use discretionary transfer prices?

Accepted Answer

Discretionary transfer prices can be used by a parent to achieve multiple objectives, such as improving the competitive position of its foreign operation, minimizing import duties, avoiding restrictions on the repatriation of profits, and maximizing overall profitability of the multinational enterprise.

Quiz 12: International Transfer Pricing