How Tariffs Can Affect Your Transfer Pricing Strategy

Changes in tariffs can significantly impact a company’s transfer pricing position. Adjusting transfer prices in response to shifts in tariffs requires careful and deliberate consideration to keep the company compliant with the arm’s-length standard.

Any transfer pricing adjustment must be supported by a well-constructed narrative that demonstrates the revised prices continue to adhere to the arm’s-length principle – and reflect how unrelated parties would operate under similar circumstances.

Organizations can consider a few approaches when evaluating the transfer pricing implications arising from tariff-related policies:

• Perform quarterly reviews and make incremental pricing adjustments to align with the appropriate arm’s-length range by year-end. Taking these actions provides flexibility while still targeting an annual result within the acceptable range.
• Treat recently imposed tariffs as extraordinary expenses for transfer pricing purposes, as they were unforeseeable events when budgets and initial transfer prices were established. This shift can help support a profit-based analysis that is commonly adopted in transfer pricing documentation.
• Review intercompany agreements and contractual terms to identify any provisions that enable pricing modifications due to unforeseen circumstances like tariff changes.

Ultimately, companies must properly substantiate any transfer pricing adjustments stemming from tariffs.

Reviewing intercompany agreements

In the face of changing tariffs, companies must closely examine their intercompany agreements and associated contractual terms, which often contain provisions that allow for pricing adjustments in response to unforeseen circumstances, such as newly imposed tariffs or other similar trade barriers.

It is crucial to revisit these agreements, as doing so can afford an opportunity to modify transfer pricing policies and realign them with new economic realities. Well-drafted contracts frequently include clauses that permit renegotiation or price revisions when external factors significantly impact the original agreed-upon terms.

This proactive approach empowers companies to properly adapt their pricing strategies and maintain an arm’s-length standard, even in dynamic trade environments.

Benchmarking challenges

In the current environment of uncertainty and ongoing change, performing a benchmarking analysis to support transfer pricing positions can present unique challenges. Comparable companies used for benchmarking might not face the same tariff exposures as the tested party, leading to potential distortions in the benchmark results.

For example, if the tested party is a U.S. distributor heavily affected by tariffs on goods imported from China, but the comparables primarily are domestic distributors without Chinese imports, their profitability levels likely will look very different.

Adjustments to account for differential tariff impacts might be necessary to have an apples-to-apples comparison when relying on external benchmarking data. However, publicly available information does not always provide enough transparency into a company’s supply chain and trade flows to calculate precise adjustments for these differences.

Significant professional judgment might be required to quantify the effects of tariffs on the comparables and align their results to the tested party’s specific situation. Close coordination between the transfer pricing, trade, and operational teams is critical to better understand the underlying facts and make reasonable adjustments to the benchmarking analysis.

The second issue is the lag in availability of financial data. When transfer pricing documentation for FY 2025 is prepared, there could be cases where the most recent financial data would be for the 2024 period. Thus, further analysis and adjustments might be needed.

Evaluating supply chain solutions

In the face of tariff changes, companies must critically evaluate their alternatives and options for modifying their supply chain and weigh the effects of implementing potential solutions. The first key step is conducting a comprehensive review of existing supply chains to identify areas of exposure and opportunities for potential diversification.

Companies also must also examine their intercompany agreements to determine if any supply chain shifts align with existing contractual terms. Renegotiating or restructuring agreements could be necessary to facilitate compliant changes.

Ultimately, supply chain decisions in a tariff-impacted environment require a holistic, cross-functional approach. Transfer pricing teams – along with operations, tax, and legal – must collaborate to model scenarios, calculate impacts, and identify optimal solutions that balance business and financial needs with compliance obligations.

Inventory management considerations

As companies grapple with the impact of tariffs, some have resorted to building inventory buffers by pulling forward purchases to mitigate the effects of potential cost increases. This strategy involves accelerating purchases from jurisdictions before anticipated tariff hikes take effect, allowing companies to stockpile inventory at pretariff prices.

However, this approach is not without risk. By accumulating excess inventory, companies might inadvertently alter their risk profiles and expose themselves to various challenges, from tying up working capital to shifts in consumer demand.

If the U.S. taxpayer is a limited-risk distributor in the adopted transfer pricing model, for example, then holding excess inventory could invalidate that functional classification. In some cases, companies have contemplated changing the international commercial terms, which also could impact functional classifications. Furthermore, the timing and pricing of these transactions could be scrutinized by tax authorities.

Companies must carefully evaluate transfer pricing implications of inventory management decisions – and support any adjustments to inventory levels and purchasing patterns with robust economic rationales and appropriate documentation. Ultimately, while inventory buffers could provide a temporary reprieve from tariff impacts, companies must weigh the potential benefits against the associated risks and costs.

A holistic assessment of supply chain dynamics, market conditions, and financial implications is crucial before implementing such strategies. Engaging cross-functional teams, including supply chain experts, finance professionals, and transfer pricing specialists, can help organizations navigate these complex tradeoffs effectively.