Transfer Pricing Strategy

As companies increase the number of worldwide subsidiaries, joint ventures, company owned distributing systems and other marketing arrangements the price charged to different affiliates becomes a preeminent question. Prices of goods transferred from a company’s operations or sales units in one country to its units elsewhere is known as intra company pricing or transfer pricing may be adjusted to enhance the ultimate profit of the company as a whole. The benefits are as follows:

1) Lowering duty costs by shipping goods into high tariff countries at minimal transfer price so that duty base and duty are low.
2) Reducing income taxes in high tax countries by overpricing goods transferred to units in such countries; profits are eliminated and shifted to low tax countries. Such profit shifting may also be used for dressing up financial statements by increasing reported profits in countries where borrowing and other financing are undertaken.
3) Facilitating dividend repatriation when divided repatriation is curtailed by government policy. Invisible income may be taken out in the form of high prices for products or components shipped to units in that country.

Government authorities have not overlooked the tax a financial manipulation of possibilities of transfer pricing. Transfer pricing can be used to hide subsidiary profits and to escape foreign market taxes. Intra company pricing is managed in such a way that profit is taken in the country with the lowest tax rate. For example, a foreign manufacturer makes a VCR for $50 and sells it to its US subsidiary for $ 150. The US subsidiary sell it to retailer for $200 but spends $50 on advertising and shipping so that it shows no profit and pays no US taxes. Meanwhile the parent company makes a $100 gross margin on each unit and pays a lower tax rate in the home country and no profit taken in the home country.

When customs and tax regimes are high companies have a strong incentive to trim fiscal liabilities by adjusting the transaction value of goods and services between subsidiaries. Pricing low cuts exposure to import duties, declaring a higher value raises deductible costs and thereby lightens the corporate tax burden. The key is to strike the right balance that maximizes savings overall.

The overall objectives of the intra company pricing system include maximizing profits for the corporation as a whole like a facilitating parent company control; and offering management at all levels, both in the product divisions and in the international divisions, an adequate basis for maintaining, developing and receiving credit for their own profitability. Transfer prices that are too low are unsatisfactory to the product divisions because their overall results look poor, prices that are too high make the international operations look bad and limit the effectiveness of foreign managers.

An intra company pricing system should employ sound accounting Techniques and be defensible to the tax authorities of the countries involved. All of these factors argue against a single uniform price or even a uniform pricing system for all international operations . Four arrangements for pricing goods for intra company transfer areas follows:

1) Sales at the local manufacturing cost plus standard markup.
2) Sales at the cost of the most efficient producer in the company plus a standard markup.
3) Sales at negotiated prices.
4) Arm’s length sales using the same pieces as quoted to independent customers.

Of the four the arm’s length transfer is most acceptable to tax authorities and most likely to be acceptable to foreign divisions, but the appropriate basis for intra company transfers depends on the nature of the subsidiaries and market conditions.

Source: International Marketing

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