| Transfer pricing is the process that a multinational | | | | value of $1,500 but this time the taxable profit is only |
| company undergoes when transferring goods from | | | | $100, and when we take $100 x 30% we get $30. So |
| one division to another. This is required for the | | | | now instead of a total tax liability of $290 the tax |
| distribution of taxable profit in multiple countries, and to | | | | liability is now only $130; that is a savings of $160, if in |
| allocate profits and losses for each individual division of | | | | millions that is a hefty increase in profits. Unfortunately |
| the company. These policies determine revenue for | | | | for multinational corporations governments can figure |
| countries of both distribution and manufacturing, as well | | | | this out as well and instead of a $270 million income to |
| as the divisions themselves. | | | | country 'B' there is only a $30 million income. Since |
| The analysis of transfer pricing is most easily | | | | countries, businesses and people in general all would |
| examined mathematically. Say we have two countries; | | | | prefer to have more money than less and since |
| country 'A' and country 'B' country 'A' manufactures | | | | countries make the rules regulations for business, a |
| goods and country 'B' distributes said goods to a final | | | | mandated system is required by said countries to |
| customer. If taxes in country 'A' are 10% and taxes in | | | | collect appropriate tax revenues. |
| country 'B' are 30% when goods are transferred from | | | | There are various ways in which transfer price can be |
| 'A' to 'B' the tax is applied in country 'A' and is counted | | | | determined. There is the re-sale cost based approach |
| as an export for the nation's gross domestic profit | | | | in which the supplier charges the full cost of the |
| calculations. Now say the goods have a market value | | | | product to the receiver this allows a simplified |
| of $1,500 and cost $400 to produce. When the goods | | | | approach to transfer pricing. As mentioned earlier this |
| are shipped from country 'A' to 'B' they are priced at | | | | could be seen as an unfair distribution of the profit or |
| $600 so the tax in country 'A' is $200 x 10% which is | | | | wealth depending on viewing from the business or |
| $20 (profit multiplied by tax rate). Now these goods | | | | country perspective. There is the comparable |
| are retailed in country 'B' for $1,500 but since $600 of | | | | uncontrolled price method, in this school of thought the |
| that was cost the tax liability in country 'B' comes to | | | | two related financial institutions look for a comparable |
| $900 x 30% or $270. | | | | transaction between two unrelated financial entities |
| If pricing is done as this, country 'A' barley gets any | | | | and base the price off of that. Then we have the cost |
| profit to count towards taxation even if that is the | | | | plus method in which the company charges for the full |
| country that produced the good. Also the | | | | cost of the product plus a reasonable profit based |
| manufacturing division of the company produces a | | | | upon how business is running with the current market |
| very low profit margin on a product that is worth much | | | | conditions. Another approach to finding a suitable |
| more than the division is credited with. At the same | | | | transfer price is the variable cost based method, in |
| time country 'B' collects hefty taxes and the distributing | | | | which the supplier only charges the variable costs |
| side of the company has high profit margins; posting a | | | | incurred when producing the products. Once again this |
| better quarter than the manufacturing division even | | | | can easily be seen to be a problem. What it really boils |
| though they produced the same thing! This can have a | | | | down to is management's ability to negotiate with |
| negative impact on bonuses within a company leaving | | | | different divisions or to dictate the way things work to |
| some managers in the lurch and some in a very good | | | | a lower level of management from the top. The |
| mood. | | | | company policy is one of the most effective ways to |
| Now if the same entire process occurs and the | | | | set any standard for anything within a corporation. |
| company decides it wants to save on taxes the | | | | After all if a company cannot figure out a way in |
| goods will be sold in country 'A' at a value of $1,400 | | | | which it feels best to run its own business, then that |
| and the relating taxes are $1,000 x 10% or $100. The | | | | company is in trouble. |
| goods are once again sold in country 'B' for a total | | | | |