The recent “reciprocal tariff” environment has many multi-national enterprises (MNEs) scrambling to understand the impact on their supply chains and how to mitigate those effects. Executives are searching for short- and long-term solutions as tariffs are threatened across a wide range of goods, including those traded with large partners such as India and China, where tariffs can range from 25% to more than 100%.
While solutions such as moving manufacturing or near-sourcing may take years to implement, MNEs must also examine their current intercompany pricing models and agreements to identify strategies that can be implemented more quickly. Transfer pricing and tariffs, among other import taxes, are closely linked, and planning opportunities exist, though they must be carefully weighed due to the complexities involved and the multiple authorities that may review pricing changes.
The Comparable Profits Method and Its Implications
For many MNEs, the most common specified method for goods transfers among related parties is the Comparable Profits Method (CPM).
This method selects a tested party to the intercompany transaction and analyzes the profits of that tested party after paying the transfer price to the related party.
The goal is to select the simplest party in terms of functions, risks and assets, then test their profits relative to comparably situated enterprises. In tangible transfers, this is commonly the distributor, since the manufacturer is typically more complex, entrepreneurial and owns intangible property (IP).
Under the CPM, the level of profits earned by the distributor (the tested party) is fixed, while residual profits or losses accrue to the manufacturer (the related party). Most tax authorities, including the IRS, maintain that low-risk distributors should generally earn an operating profit and not experience extended periods of loss.
Example: Simple Supply Chain Structure
|
Foreign |
U.S. |
|
|
Revenues |
$150.00 | $200.00 |
|
COGS |
$100.00 | $150.00 |
|
Gross Profit |
$50.00 | $50.00 |
|
Op Ex |
$25.00 | $44.00 |
|
Operating Profit |
$25.00 | $6.00* |
|
*Target: 3% of revenues ($200.03) |
||
|
Customs value |
$150.00 |
In this example, the low-risk U.S. distributor is the tested party, while the foreign manufacturer is the related party. The transfer price is set so the distributor earns a 3% operating profit, achieved through regular invoicing and year-end adjustments based on annual external benchmarks. Historically, the customs value has equaled the transfer price, with little consideration given to optimizing it.
Allocating Tariff Costs Under the CPM
When disruptions occur, such as recessions, pandemics or tariffs, many MNEs ask: Can we share the losses associated with these events?
In most cases, the distributor is the importer of record and pays tariffs on imports from a related party. If tariff costs cannot be passed on to the consumer and transfer prices remain unchanged, the distributor bears the additional expense.
This raises an important question: Should year-end adjustments be made to keep the distributor profitable under the CPM, or should transfer prices be adjusted prospectively?
MNEs seeking to maintain the integrity of their transfer pricing policy often pursue both approaches. This shifts much of the tariff burden back to the manufacturer. Sharing these costs is possible under a CPM framework, at least in the short term, by moving the distributor’s profitability to the lower end of the comparable range or even allowing temporary losses.
Within a year, the effects of tariffs are likely to appear in third-party comparables, potentially reducing arm’s-length ranges and allowing the manufacturer to increase transfer prices slightly — though not necessarily to pre-tariff levels.
Using Component Benchmarking To Manage Dutiable Value
Another approach to addressing higher tariff costs is to examine the components of the transfer price itself.
When a manufacturer sells to its related distributor, the price includes compensation for materials, services and assets such as IP. Separately charging for these components can create planning opportunities since not all services attract customs duties or tariffs.
Example: Component-based Transfer Pricing
|
Transfer Pricing |
$150.00 |
|
| Production Cost (Cost + 25%) | $100.00 | |
| R&D Cost (Cost + 10%) | $20.00 | |
| Marketing Cost (Cost + 7%) | $10.00 | |
| Shared Services Cost (Cost + 5%) | $10.00 | |
| IP Charge (residual profit) | $10.00 | |
|
Total |
$150.00 |
|
|
Customs value |
$100 to | $110.00 |
By benchmarking and pricing each component separately, the manufacturer can isolate which elements contribute to the dutiable value. Services may not be subject to customs duties, meaning that only production and possibly IP charges factor into the dutiable amount. This structure can reduce the total customs value and lessen the impact of tariffs.
Exploring the “First Sale” Rule and Other Supply Chain Options
Some customs authorities permit MNEs to determine the dutiable value based on the “first sale.” For example, the sale from a third-party manufacturer in Asia to a foreign parent company before resale to a U.S. distributor. In these cases, the dutiable value may exclude services, assists and IP owned by the entrepreneurial manufacturer.
Beyond this, MNEs can explore moving certain income streams, functions or assets across their supply chain to optimize both tax and customs outcomes. These adjustments, however, are complex and may create additional tax consequences or gains that must be carefully managed.
Additionally, companies should evaluate potential tax incentives, trade zones and manufacturing locations to identify opportunities for cost savings and operational efficiency.
Looking Ahead as an MNE
Now is the time for proactive planning. The types of transfer pricing and customs valuation strategies described above are challenging to implement after the fact. Acting early allows MNEs to better manage costs, maintain compliance and identify opportunities that support long-term supply chain resilience.
Collaboration among tax, transfer pricing, trade and legal advisors is key, along with updated accounting and invoicing procedures between related parties. International tax reporting forms may also need review if inventory basis values differ between tax and customs purposes. Intercompany agreements should be updated to reflect any structural changes and include clauses that support the new approach.
Your Guide Forward
Cherry Bekaert’s International Tax team can help your organization evaluate how tariff-driven pressures may impact your current transfer pricing structure and identify strategies to support both near-term mitigation and long-term efficiency. Connect with our team to start a conversation about practical steps for your business.
