Transfer Pricing in the Technology Sector: A Sector Deep Dive

The technology sector is the umbrella category that encompasses software, Software-as-a-Service (SaaS), digital platforms, and emerging artificial intelligence businesses. This article focuses on the software sub-segment, where SaaS has become the dominant business model, and treats artificial intelligence as an emerging set of issues at the end.

For most groups in the software sub-segment, transfer pricing analysis differs from the standard playbook in three respects: most of the value lives in intangibles rather than in routine functions, value creation is typically distributed across multiple jurisdictions, and stock-based compensation is large enough relative to operating costs that its tax treatment matters in ways it does not in other sectors.

Mapping the Tech Value Chain

A useful starting point for a software or SaaS group’s transfer pricing analysis is to map the group’s activities into four buckets: intellectual property (IP) creation, IP ownership and exploitation, customer-facing functions, and support functions.

IP creation covers the engineering and product development functions that produce the software itself. These activities are often distributed: a US headquarters function alongside engineering teams in countries such as India, Israel, Eastern Europe, or Canada. IP ownership and exploitation refers to the entity that holds legal title to the IP and bears the entrepreneurial risk associated with its commercialization, frequently the US parent in a venture-funded software group. Customer-facing functions include sales, marketing, and customer success activities, often organized into regional hubs. Support functions cover back-office activities such as finance, IT, and human resources.

Each location’s transfer pricing characterization depends on which bucket its activities fall into. Routine functions, including contract software development, regional sales support, and back-office services, can typically be benchmarked using TNMM or CPM against comparable independent companies. The IP-owning entity bears the residual non-routine return: the profit that remains after each routine function has been compensated at an arm’s length level. A common analytical error is to apply TNMM to the IP-owning entity itself, which produces a reliable benchmark only for the routine portion of that entity’s activities, not for the value of the IP.

The Routine Versus Non-Routine Return Problem

The distinction between routine and non-routine returns is more consequential in technology than in most other sectors because the non-routine layer is so large. A software group’s value typically resides in the IP it owns rather than in the cost of producing that IP, and benchmarking the IP-owning entity against comparable companies tends to produce results that do not reflect the entrepreneurial nature of its position.

The practical implication is that a software group’s transfer pricing file usually requires more than a single benchmarking study. The routine functions in each jurisdiction can be benchmarked against comparable independent service providers or comparable distribution functions. The IP-owning entity’s return is whatever remains, and supporting that residual position requires a different analytical framework, often involving cost-sharing arrangements, profit split methodology, or comparable uncontrolled transactions for licensing.

Cost-Sharing and Cost Contribution Arrangements

When IP is developed across multiple jurisdictions in a software group, cost-sharing or cost contribution arrangements are a common structural choice. Under Treas. Reg. §1.482-7, a US qualified cost-sharing arrangement (CSA) allows two or more controlled participants to share the costs and risks of developing intangibles in proportion to their reasonably anticipated benefits, with each participant receiving rights to exploit the resulting IP in a defined geographic territory. The OECD framework provides for analogous cost contribution arrangements (CCAs) under Chapter VIII of the 2022 Transfer Pricing Guidelines.

The technical regime for cost-sharing is specialist. Key issues include the valuation of platform contributions (pre-existing IP brought into the arrangement), the buy-in or buy-out payments required when participants enter or exit, the periodic adjustments that may apply if outcomes diverge significantly from projections, and the treatment of stock-based compensation in the cost base. Mid-market software groups using CSAs typically engage outside transfer pricing assistance for the structuring and ongoing administration of the arrangement.

SaaS Benchmarking Challenges

SaaS-specific business models produce several practical complications when applying TNMM or CPM. Standard comparable sets drawn from traditional service providers or wholesale distribution often do not fit a SaaS tested party cleanly, because the underlying economics are different: high upfront customer acquisition costs, long customer lifetimes, deferred revenue accounting, and operating losses during high-growth phases that do not necessarily indicate poor performance. The choice of profit-level indicator must reflect these features. The operating margin can be misleading for a SaaS company in a growth phase, and analysts may need to consider alternative indicators or to apply specific normalization adjustments.

Multi-year averaging is particularly important in this context. Year-on-year results for SaaS comparables can be volatile because of the gap between cash collected and revenue recognized, the timing of customer acquisition spending, and the impact of stock-based compensation on reported operating income. A study that relies on a single year’s data is more vulnerable to challenge than one that uses three-year averages and discloses the normalization choices made.

Three Tax-Policy Topics That Hit Tech Hardest

Three current policy topics affect technology groups disproportionately and warrant specific attention.

Stock-based compensation in cost-sharing. The treatment of stock-based compensation (SBC) in CSA cost pools has been a contested area for two decades. The Ninth Circuit’s 2019 decision in Altera, which the Supreme Court declined to review in 2020, upheld the validity of the Treasury Regulation requiring that SBC be included in the costs shared under a qualified CSA. The current regulation at Treas. Reg. §1.482-7(d)(3) is substantively the same as the version litigated in Altera. The IRS has continued to enforce SBC inclusion since then, and post-Altera guidance signals that adjustments will be pursued where SBC has been excluded. Because SBC commonly represents a substantial percentage of operating costs at venture-funded software groups, the practical effect on cost-sharing arrangements is significant.

Hard-to-value intangibles. Software IP is frequently transferred between group entities at a point when its commercial value is uncertain, and the value can subsequently turn out to be materially different from what was projected. The OECD Hard-to-Value Intangibles (HTVI) provisions, set out in the 2022 Transfer Pricing Guidelines, authorize tax authorities to use ex post outcomes as evidence of the appropriateness of the original valuation, with periodic adjustments where outcomes diverge significantly from projections. The US has analogous commensurate-with-income provisions under IRC Section 482. The practical implication for software groups is that contemporaneous documentation of projections, assumptions, and the methodology used to value transferred IP is more important than in sectors where outcomes are less variable.

Pillar Two and the global minimum tax. The OECD’s Pillar Two framework imposes a 15% effective minimum tax on the income of multinational groups with consolidated revenues of at least €750 million. Technology groups have been disproportionately affected because historical structures often included low-tax IP holding entities. The framework has continued to evolve: in January 2026, the Inclusive Framework agreed a Side-by-Side package that, beginning with fiscal years starting on or after January 1, 2026, exempts US-headquartered groups from certain Pillar Two top-up taxes where the US tax system qualifies as a Qualified Side-by-Side Regime. The interaction between Pillar Two and existing transfer pricing positions remains an active area, and structures designed around the pre-Pillar Two environment may not produce the same after-tax results going forward.

Artificial Intelligence: Emerging Issues

The AI sub-segment raises transfer pricing questions for which authoritative guidance is still sparse. Where in the value chain is AI value created: in training data acquisition and curation, in model architecture and weight development, in fine-tuning for specific applications, or in deployment infrastructure? Who owns the resulting model weights, and what is the appropriate compensation for the entity that hosts the GPU compute used in training? When training data is licensed or scraped under disputed legal authority, how is the associated risk allocated between group entities? These questions can be approached using the existing analytical framework, but they cannot yet be answered with confidence by reference to settled tax authority practice. Software and SaaS groups operating in or adjacent to AI should expect this to be an active area for guidance over the next several years.

CompPress provides standardized transfer pricing comparable company benchmarking studies sourced from SEC EDGAR filings, with interquartile ranges computed under both OECD and US Section 482 methodologies. The library covers eleven service and distribution categories under the TNMM/CPM framework. To learn more about pre-built and custom benchmarking reports, visit [comppress.com].