| Transfer pricing is a complicated issue, but worth | | | | changed. |
| understanding on at least a basic level if you work at | | | | Given this scenario, a country with laws governing |
| all with multinational corporations. The price at which | | | | transfer pricing may require the company to adjust |
| one unit of a firm sells goods or services to another | | | | prices in order to ensure a fair division of their taxable |
| unit of the same firm. | | | | profits and prevent them from reducing taxable profits |
| The price that is assumed to have been charged by | | | | by artificial price management. |
| one part of a company for products and services it | | | | TP is often a contentious political issue in corporations |
| provides to another part of the same company, in | | | | and especially amongst senior level executives. This is |
| order to calculate each division's profit and loss | | | | because the level at which transfer prices are set |
| separately. | | | | may negatively influence their division profits and as a |
| Transfer pricing is the setting of prices in transactions | | | | result cause lower bonuses to accrue to the |
| that are not at 'arm's length'--for example, when one | | | | managers. |
| company sells goods to another company, but both | | | | A second dimension of TP is to attempt to allocate |
| companies have common ownership. There are | | | | profits and losses for each division in such a way that |
| several ways to determine the transfer price, including | | | | the corporate strategy of the overall corporation is |
| cost methods, market price methods, negotiation or | | | | supported in the optimal way. Thirdly, Transfer Pricing |
| even simply using an arbitrary figure. A goal of transfer | | | | can be manipulated for taxation reasons: by charging |
| pricing may be to maximize after-tax revenue by | | | | low transfer prices from a unit based in a high-tax |
| setting transfer prices that reduce the total tax paid. | | | | country that is selling to a unit in a low-tax country, a |
| For example a multinational company say in India | | | | firm can record a low profit in the first country and a |
| produces shoes for $100. They sell the shoes to | | | | high profit in the second. |
| another part of the corporation in Japan for $300, | | | | In my opinion, what the transfer pricing issue is all about. |
| which is the transfer price. They are then retailed for | | | | Revenue agencies want to assure that companies |
| $700 in Japan. Gross profit to the corporation is $600 | | | | based in their country are not engaged in complicated |
| ($700 - $100): $200 of the profit ($300 - $100) is | | | | transactions by which expenses are shifted to high-tax |
| earned in India, and $400 ($700 - $300) is earned in | | | | countries, while income is shifted to lower tax countries. |
| Japan. Assuming tax rates are 20% in India, and 50% | | | | Companies that do so have minimized taxable income, |
| in Japan, the taxes paid by the corporation are $40 | | | | while maximizing deductions on an aggregated basis. |
| ($200 * 20%) in India and $200 ($400 * 50%) in Japan | | | | What this means is that some companies may have |
| for a total tax liability of $240. The profit after-tax is | | | | failed to charge an arm's length price for transactions |
| $360 ($600 - $240). | | | | with a related entity in another country. |
| If the multinational corporation changes the transfer | | | | Companies -- at least those in the Europe. -- typically |
| price from India to Japan from $300 to $600, the gross | | | | have one of the final four international accounting firms |
| profit remains the same at $600. But, profit in India is | | | | do a transfer pricing study every few years. This helps |
| now $500 ($600 - $100) and in Japan $100 ($700 | | | | those companies document the amounts charged |
| -$600). Taxes paid in India are $100 ($500 * 20%), and | | | | between these related entities. If companies charge |
| in Japan are $50 ($100 * 50%) for a total tax liability of | | | | prices that are not at arm's length, then they will |
| $150. The after-tax profit has now increased to $450 | | | | nevertheless be taxed as if the transactions had been |
| ($600 - $150), although production costs have not | | | | at arm's length. |