What is Transfer Pricing?

You might assume that moving money between two companies you own is as simple as a bank transfer. If you operate a single entity in one location, it usually is. But the moment you open a subsidiary in a different country or create a separate holding company, the rules change entirely.

Transfer pricing is the regulatory framework that dictates the prices charged for goods, services, and intangible assets between related legal entities. These are companies under common ownership or control.

It is not just about accounting entries. It is about tax law.

Governments want to ensure that taxable profits are reported in the jurisdiction where the value was actually created. They want to prevent you from shifting all your profits to a country with low taxes while incurring all your expenses in a country with high taxes. Transfer pricing rules prevent this profit shifting.

This is the scientific standard for transfer pricing. It states that the price charged between related parties must be the same as the price charged between independent parties under similar circumstances.

If your US headquarters hires your Canadian subsidiary to do software development, the US entity must pay the Canadian entity. The amount paid cannot be arbitrary.

It must be comparable to what a third party software shop would charge for the same work.

If you pay too little, the Canadian tax authorities will argue you are underreporting income there. If you pay too much, the US tax authorities will argue you are inflating expenses to reduce taxable income.

Founders often ignore this until a Series B round or an audit. That is a mistake. You need to consider transfer pricing in several common scenarios:

• International Expansion: You hire a sales team in the UK. The UK entity performs a service for the HQ. How does the HQ pay for that service?
• Intellectual Property: You transfer your IP to a holding company. That holding company licenses the IP back to your operating companies. What is the royalty rate?
• Intercompany Loans: One entity lends money to another. You must charge an interest rate that reflects market conditions.

It is important to distinguish between broad transfer pricing and specific management fees.

Management fees are a subset of transfer pricing. They specifically refer to charges for headquarters services like HR, legal, or executive management provided to subsidiaries.

Transfer pricing is the umbrella term. It covers those management fees, but also the sale of physical products, the licensing of software, and financial transactions between your entities.

Ignoring this does not make the liability go away. The biggest risk is double taxation.

If two countries disagree on your transfer pricing, both might tax the same income. You also face penalties and interest on unpaid taxes.

As you build, ask yourself these questions:

• Do we have legal agreements between our entities?
• Have we documented why we chose a specific price for these internal transactions?
• Are we reviewing these prices annually as the business changes?

Getting this right early builds a solid foundation for due diligence and future exits.