Stop the Tax Leakage:
Why Mid-Market Companies Should Routinely Evaluate Their Transfer Pricing Policies
Mid-Market companies operate in an increasingly cash-constrained environment due to high interest rates, and elevated levels of cost of goods and operating expenses. Yet one of the largest, least visible drains on cash is unrelated to these factors. It is tax leakage caused by outdated and tax inefficient transfer pricing (TP) policies.
This risk of tax inefficient TP policies is especially prevalent among mid-market companies because the tax teams that would be the first line of defense to identify the issue are often stretched thin. As a result, many companies, after implementing a TP model many years ago (often via an intercompany agreement or agreement with a third party), tend to leave it untouched, even as entity revenues increase, cost structures evolve, entities change roles, or regulations shift. This causes a TP model, that was once an economically reasonable approach, to become misaligned over time. This results in avoidable and recurring cash outflows.
Impact of Selected TP Model
Two widely used TP models for routine, low-risk entities are Cost-Plus (e.g., cost + 8%) and Operating Margin (e.g., 3%). While both are permissible when they match an entity’s functions and risks, they produce different profit outcomes. Cost-plus ties profit to costs which is often a relatively stable and predictable base. Operating margin ties profit to revenue, which typically has a much larger and often more volatile base. As revenues grow faster than costs (common in mid-market operations), the operating-margin model produces significantly more profit than cost-plus for the same activity.
Below is a chart and accompanying explanatory grid showing the break-even level of profit highlighting the impact of the two models on an entity’s profit assuming costs are stable at $100,000:
Contact SingerLewak’s International Tax Team
The International Tax team at SingerLewak is equipped to assist you in achieving these tax savings through personalized guidance and planning. Contact our team today to discuss how we can effectively partner together.
- Robin Park | [email protected]
- Stephen Bolt | [email protected]
- Lipi Choudhury | [email protected]
- aniel Sheinfeld | [email protected]
