Dynamic Adjustments in Transfer Pricing Agreements
By David Broomhall
David Broomhall is an economist in the IRS Chief Counsel’s Advance Pricing Agreements Program. In previous positions, he worked as an economic consultant at Global Insight (formerly Standard and Poor’s DRI) in Washington, DC, performing economic forecasting, and for the Purdue University Extension Service in West Lafayette, Indiana. He received B.S. degrees in Economics and Geography from the University of California, Riverside, an M.A. from Washington State University, and a Ph.D. from Virginia Tech.
This paper examines the issue of using past economic performance to benchmark transfer prices in advance pricing agreements (APAs) and explores methods that allow transfer prices to reflect current economic performance. The paper applies these methods to the electronics industry and finds that capacity utilization provides a much better proxy for current economic performance than does the typical interquartile range of profits of comparable companies generated over some historic interval prior to the APA. While taxpayers who benchmark results on capacity utilization lose the certainty of a fixed range, they gain by allowing transfer prices to reflect changing economic conditions.
