Transfer pricing when you have two companies and eleven employees

The structure is extremely common and rarely described as what it is. A US LLC takes the revenue because that is where Stripe works and where the customers want to contract. A company in India, Poland, Brazil or the Philippines employs the people who do the work. Money moves between them when it needs to.

That flow is a transfer price, and two tax authorities have an opinion about it. Neither cares that you own both sides. Both apply the same principle: price the transaction as if the two companies were strangers.

Why both countries care, in opposite directions

Every dollar you move from the revenue entity to the delivery entity is a deduction in one country and income in the other. So the incentives are perfectly opposed:

• The country of the delivery entity wants the price to be higher. More profit taxed locally, and its rules will say your local company is bearing real cost and risk and is under-rewarded.
• The country of the revenue entity wants it lower. It will say you have shifted profit out.

You cannot satisfy both by picking a number you like. You satisfy both by picking a number you can justify by reference to what unrelated parties charge, and by writing down why before anybody asks.

The mistake that precedes all the others

Fix that before optimising anything. One intercompany services agreement, describing what the delivery entity does, what it is paid, on what basis, and when. Monthly invoices that match it. Payments that match the invoices.

How to price it

For the ordinary case — one entity performs routine services for the other — the method is cost plus a markup. You establish the cost base, add a margin reflecting what an independent provider would earn for that kind of work, and charge it monthly.

The important discipline is that the characterisation comes first and the number follows from it. Founders reason backwards — choosing a margin that produces a nice group tax rate and then describing the entity to fit. That reasoning is visible in the documentation, and it is the reason documentation prepared after the fact reads badly.

The cost base is where the errors live

1. 1Include everything. Salaries, employer contributions, benefits, rent, equipment, software, recruitment and a share of local overhead. A markup on salaries alone understates the cost base and understates the local profit.
2. 2Decide on pass-through costs deliberately. Costs incurred purely as an agent, with no value added, may be recharged without markup — but that treatment has to be consistent and documented rather than applied to whatever is convenient.
3. 3Do not mark up a markup. If a third supplier is in the chain, the group should earn one margin on the activity, not one per hop.
4. 4Reconcile annually. Budgeted cost plus actual cost never match. Either true up at year end or charge on actuals — but pick one and apply it every year.

What documentation is proportionate

The formal master file and local file requirements sit behind revenue thresholds far above founder scale, and country-by-country reporting is for very large groups. You are almost certainly below all of it. That does not mean nothing is required: most countries expect a taxpayer to be able to explain a related-party price on request, and penalty protection in the US and elsewhere depends on having contemporaneous support.

The proportionate version is short and takes an afternoon a year:

• The intercompany agreement, signed, with the pricing basis stated in it.
• A one-page functional analysis — who does what, who bears which risks, who owns what.
• The basis for the margin, with whatever benchmark you relied on and its date. A published study, an adviser's range, or a comparable third-party quote.
• The annual computation, showing the cost base and the charge, reconciled to both sets of accounts.

The three adjacent risks it drags in

1. 1Permanent establishment. If the local entity's people are negotiating and concluding contracts for the revenue entity, the revenue entity may have a taxable presence locally regardless of the transfer price.
2. 2Withholding. Service fees are usually outside withholding, but reclassify them as royalties or technical service fees — which several countries do by domestic definition — and withholding appears. Check the specific country rather than assuming.
3. 3Employment status. If the 'local entity' is really one person invoicing you, the exposure is misclassification before it is transfer pricing, and it is faster and more expensive.

The honest simplification

If you have two entities and the second exists only to employ people, the answer is nearly always the same: cost plus a modest markup, charged monthly under a signed agreement, reviewed once a year. That arrangement is boring, defensible in both countries, and cheap to maintain.

If you are contemplating something more elaborate — routing revenue through a third country, charging a large intragroup royalty, or moving the residual profit somewhere with no people in it — the elaborate version needs substance, documentation and advice that costs more than it saves below a fairly high threshold. That threshold is the real question, and it is the same one that governs holding companies.