How Trump's Tariffs are Reshaping Transfer Pricing Policies for Global Companies

The imposition of higher tariffs during the Trump administration has significantly altered the global tax and trade landscape, compelling multinational corporations (“MNCs”) to revisit and adapt their transfer pricing (“TP”) policies. Functioning as an added cost layer, tariffs can erode profitability - especially for companies unable to pass those costs on to end customers.

This shift has prompted companies to reassess how profits are allocated among related entities across jurisdictions, as traditional TP models may no longer reflect commercial realities.
 

A Simplified Example

Consider a straightforward transaction between two related companies: a Singapore-based principal and its U.S.-based affiliated distributor. As part of the same corporate group, transactions between them must comply with the arm’s length principle - a standard that requires related-party transactions to be priced as if the parties were independent and dealing at arm’s length. 

In this scenario, the U.S. company acts as a Limited Risk Distributor (LRD) and, based on a TP study, is entitled to a routine return of 6%.

Scenario 1: Before Tariff Increase

The Impact of Increased Tariffs on Transfer Pricing

When tariffs are introduced or increased - say, to 10%, the effective cost of imported goods increases. If the end-customer price remains fixed due to market constraints, the U.S. distributor’s profit margin may be significantly reduced, or even turn negative.

Scenario 2: After Tariff Increase

As shown, the distributor incurs a loss, with the profit margin falling to -3%, directly conflicting with the LRD model which assumes a stable, positive return. This highlights a disconnect between policy and practicality, raising concerns around compliance, audit risk and financial sustainability.

Adjusting Transfer Pricing Strategies to Address Increased Tariffs

To ensure that TP policies remain reasonable and aligned with regulatory expectations, companies need to adjust their pricing models. The key question is: Who should bear the additional cost of tariffs?

Should the Additional Costs be Excluded from Profit Margin Calculations?

• TP principles are based on how independent parties would transact under similar circumstances. When faced with a sudden increase in tariffs, independent parties would likely renegotiate pricing rather than absorbing the full costs themselves.
• Simply excluding tariff costs from profit margin calculations is not a defensible solution, as it does not reflect actual market behaviour. Third-party transactions show that businesses typically adjust pricing structures or negotiate cost-sharing arrangements to cope with increased tariffs.
• Ignoring these costs when calculating profit margins would not only misalign with tax authorities' expectations but also contradict real-world commercial practices. Therefore, companies need to explore viable cost-sharing mechanisms to reflect an arm’s length outcome.
• The sharing of tariff impact between related parties is a key consideration for MNCs.  Although the allocation of tariff risk does not fully mitigate the overall tariff impact, it will be beneficial for the related parties involved.  

How would Third-Party Distributors React?

• Independent distributors in the U.S. would not willingly bear the full impact of higher tariffs. Instead, they would likely push back on suppliers to renegotiate terms.
• The response from third-party distributors depends on factors such as bargaining power, market competition and product demand elasticity.
• A fully independent distributor might negotiate for a reduced purchase price from the supplier or seek to pass some of the additional costs on to end customers. However, when price adjustments are not feasible, the supplier may need to absorb a portion of the increased costs to maintain the business relationship.

Benchmarking and Adjustments

• Benchmarking is critical to determining how independent parties share additional costs in comparable transactions. By analysing real-world data, companies can establish an appropriate profit margin that aligns with the interquartile range of similar market transactions.
• Given the added tariff burden, companies may need to adjust their TP model so that the U.S. entity operates with a slightly lower, but still arm’s length profit margin.
• In most cases, the principal (Singapore entity) may need to lower its selling price to the U.S. distributor to ensure that the overall TP model remains consistent with third-party transactions.

For example, as seen in the adjusted results below:

Strategic Considerations for Finance and Tax Leaders

In light of evolving trade dynamics and increasing tariff exposure, finance and tax professionals must take a proactive stance in evaluating their intercompany arrangements. Below are several key areas for reassessment and action:

Reassess Functional and Risk Allocations

• Re-evaluate how tariff implications impact the distribution of functions, assets, and risks across related entities. Ensure that the current delineation reflects economic substance and commercial reality.

Refresh Benchmarking and Market Analyses

• Validate the continued relevance of your existing benchmarking set. Assess whether third-party behaviors under similar economic pressures still align with your intercompany pricing framework.

Refine Intercompany Pricing Methodologies

• Adjust pricing models and policies to accommodate the incremental costs imposed by tariffs. This may include revisiting profit allocations or determining revised arm’s length ranges.

Update Intercompany Agreements and Supporting Documentation

• Revise legal agreements to clearly define how tariff costs are shared, ensuring contemporaneous documentation supports the updated TP position.

Operationalize the Changes

• Implement new pricing and contractual terms across relevant systems and establish processes to monitor compliance and performance.

Establish a Framework for Continuous Review

• Set up a recurring review process to adapt to ongoing policy shifts, supply chain changes, and evolving audit expectations.