Answer to Question #104673 in Management for Sushant

Question

What is transfer pricing? Explain with example the technique of transfer pricing.

Answer 1

Transfer Pricing

Transfer pricing is a significant concept in accounting, taxation, and management. Many contemporary organizations use transfer pricing to achieve their financial and non-monetary objectives (Talab, Flayyih, & Yassir, 2017). Transfer pricing refers to various strategies and principles for pricing transactions in multinational corporations under the same legal entity. Corporations under common control use transfer pricing to shift their profits from one firm to another. Shifting profits between related companies enable them to expand their market share, achieve profits tax benefits, and profitability (Talab, Flayyih, & Yassir, 2017). In other words, companies under the same legal entity use transfer pricing principles to allocate profits between/among its different subsidiaries in the corporation.

Transfer pricing in many countries relies on the arm's length principle to determine international pricing standards. Many countries have adopted intra-group pricing regulations through bilateral trade agreements and changes in local legislation. For instance, tax authorities in states or regions such as OECD use transfer pricing methods such as “The Resale Price Method” or “The Comparable Uncontrolled Price” (CUP) method to determine the prices for cross-border intragroup transactions (Talab, Flayyih, & Yassir, 2017). For example, the resale price method measures various factors between an independent corporation and compares them with controlled transactions in the independent company's subsidiaries.  

The explorations above suggest that transfer pricing provides several benefits to multinational corporations from a taxation perspective because it reduces tax liability (Talab, Flayyih, & Yassir, 2017). However, some regulatory authorities have argued that transfer pricing can promote tax evasion among multinational corporations and their subsidiaries. Transfer pricing exploits various tax regimes found in different nations to ensure greater profits for products or services produced in states or regions with lower tax rates. For instance, some corporations post lower expenditures on interrelated transactions to avoid tax imposition on products/services traded in the international market. 

Reference

Talab, H. R., Flayyih, H. H. & Yassir, N. M. Y. (2017). Transfer pricing and its effect on financial reporting: A theoretical analysis of global tax in multinational companies. International Business Management, 100(4), 921-928.