Billing the US at cost: comfortable in Washington, costly across the Atlantic

There is a US rule that CFOs are particularly fond of. The services cost method, set out in §1.482-9(b) of the Treasury regulations, allows certain services between group companies to be charged at cost, without a markup. Payroll, accounts payable, general IT support, human resources. It is simple, it is predictable, and the IRS is limited to adjusting the amount to the correct cost.

My argument is this: for a group headquartered outside the US, billing at cost is often the cheapest answer for the wrong side of the border.

What the US rule actually allows

The method is not an unrestricted option. The service must appear on the list in Rev. Proc. 2007-13 or have a median market markup of 7% or less. It cannot be an excluded activity, such as production, distribution, research and development, or financial services. It cannot contribute significantly to the business's core competitive advantages. And the taxpayer must keep records demonstrating the intention to apply the method.

Once these requirements are met, the US side can rest easy. But the rule is American. It binds only the IRS.

The problem lies in the direction of the service

Imagine that the parent company's team, in São Paulo or Porto, processes payroll and pays suppliers for the US subsidiary. When billed at cost, the subsidiary deducts exactly what it paid, and the IRS has nothing to challenge.

Now look at the same service from the perspective of the parent's tax authority. A resident company worked for a related party and earned nothing from it. The OECD Guidelines, which Portugal and Spain follow and which Brazil's new regime has adopted since 2024, expect remuneration that includes a markup for the service provider. For low value-adding services, the OECD's simplified benchmark is 5% of costs.

If the parent's tax authority adds that markup, the group pays tax on it in the home country. On the US side, the deduction remains limited to cost. The markup is taxed once and deducted nowhere.

The treaty makes all the difference

Portugal and Spain have a treaty with the US and a mutual agreement procedure to resolve incompatible adjustments. It is slow, but it exists.

Brazil has no treaty with the US to avoid double taxation of income. There is no mutual agreement procedure or corresponding adjustment. If Brazil's Federal Revenue Service adds a markup and the IRS rejects it, the double taxation is permanent.

Who provides the service	Parent's country	Billing at cost is...
US subsidiary	Any	Generally safe on both sides
Parent	Portugal or Spain	Defensible in the US, open to challenge in the home country; a mutual agreement procedure is available
Parent	Brazil	The highest-risk scenario: no treaty, no correction

My position

When the parent company provides the services, I advocate a modest markup, documented through a simple comparables analysis, even if the services cost method were available in the US. In practice, something close to 5% for routine services.

The cost of that choice is small. The subsidiary deducts a little more, and the group prepares an analysis to justify the markup before the IRS. For low-margin services, a markup of this size is easy to support. The benefit is eliminating the risk of a markup being taxed at source and never deducted at the destination.

When the US subsidiary provides services to the parent, the logic is reversed. In that case, cost may be the right solution, provided the parent's jurisdiction accepts the deduction.

The right question

The usual question is, “Is this service eligible for the services cost method?” The right question is different: “In which country is the service provided, and does that country accept it being provided without a profit?” Transfer pricing always has two sides. A simplified rule on one side does not settle the transaction.

At Pactum, see the page on the transfer pricing study.