TRANSFER PRICING

Various Transfer Pricing Methods

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Various Transfer Pricing Methods

Introduction

Transfer pricing is the method whereby different companies or different divisions of the same company transfer the cost or price of the intermediate product that has been traded or transferred between them. In this way, the product is essentially an intermediate good; however, it could also be a service that is being transferred. In addition, the bulk of transfer pricing involves the transfer of property between the two units. Also, the transfer pricing is done as a major transaction for inter-country trade. In this way, it is said that about 60% to 70% of the world trade involves transfer pricing or intra-multinational corporation transfers of property or services.

The transfer pricing also has wide implications for tax purposes. Companies engage in various kinds of transfer pricing to evade the taxes most of the times. In this way, one of the foremost purposes of transfer pricing is to set the transfer prices in such a way so as to minimize the corporate tax liability. Hence, a company will transfer an intermediate good to a subsidiary at an artificially lower price to suppress its reported profits in the tax returns to minimize the tax liability of the subsidiary. In addition, if a subsidiary of a company is operating in a tax haven with zero taxes then it will have the incentive to maximize its profits through transfer pricing that shows the highest margins. Therefore, transfer pricing is an effective tax manipulation tool other than the need for the businesses to trade intermediate goods, or services and property (Tax Justice Network, 2005).

Therefore, the laws require that the various transfer prices between the transacting parties may be recorded so as to show the arm's length transaction. The purpose of the arm's length principle is to ensure that the transaction has been done so as to put the transacting parties in a disassociated position. Such a transfer price is mostly the market price of the intermediate good or an attempt to develop the fair market price of the good in the presence of market imperfections (USTransfer Pricing, 2012).

Various transfer pricing methods

Market-based transfer prices

The market based transfer prices are used to transfer the intermediate product between various units at the prevailing current market price. It is clear that such a method will only be available when the intermediate good is a fairly homogeneous good and is readily available in the market. In this way, the intermediate good also has external suppliers who will supply the good at the prevalent market price (Drury, 2008).

The advantages of market-based transfer price are numerous. The foremost is that it is fairly easy to use. Next, market-based transfer price puts the divisions in such a situation that the transfer of the intermediate good has taken place. In this way, the supplying unit benefits by selling the intermediate good with built-in profit margin in the market price of the intermediate good. Therefore, the company benefits through intermediate sale of good. Finally, it will ...