This document provides an overview of transfer pricing. It defines transfer pricing as the price at which divisions of a company transact with each other. The document outlines several purposes of transfer pricing, including evaluating division performance and shifting profits between tax jurisdictions. It also discusses transfer pricing methods, influences on companies, disadvantages, and provides an example to illustrate how transfer pricing can benefit a company.
2. Outline:
Definition and Overview
Transfer pricing purposes
Transfer pricing – accounting
Transfer price -Methods Of Transfer Pricing
Influence of transfer pricing
Disadvantages of transfer pricing application
Transfer Pricing- Example
Conclusion
3. Definition and Overview
Transfer pricing is the price at which divisions of a company transact with each
other.
When business units or divisions within the organization buy goods and services
from one another, the value or amount recorded in a firm’s accounting records as
revenue to the selling unit and cost to the buying unit.
Any correction of transfer pricing in the case of international transactions can
only be done through Transfer Pricing Commission in General Directorate of
Taxation at the Ministry of Finance.
4. Transfer Pricing Purposes
Evaluating financial performance of different business units (profit
centers) of a conglomerate
Shift earnings from a high tax jurisdiction to a low-tax one
Enables multinational corporation's to attribute net profit (or loss) before
tax among the countries where it does business
Uses of Transfer pricing: a.)Reduces taxes paid
b.)Reduces tariffs
c.)Avoids exchange controls
5. Government Reactions
Governments are aware of risk that multinationals will
use transfer pricing to avoid paying income and other
taxes.
Most governments publish guidelines regarding
acceptable transfer pricing for tax propose.
Across counties these guidelines can conflict, creating
the possibility of double taxation when price accepted to
the country is disallowed by another.
The Organization for Economic Cooperation and
Development (OECD) developed transfer pricing
guidelines in 1979 that have been supplemented and
mandated several time since then.
6. Transfer Pricing- Accounting
If intra-company transactions are accounted for
at prices in excess of cost, appropriate
elimination entries should be made for external
reporting purposes. Examples of items to be
eliminated for consolidated financial
statements include:
• Intracompany receivables and payables.
• Intracompany sales and costs of goods sold.
• Intracompany profits in inventories
7. Methods Of Transfer Pricing
1. Market-based Transfer Pricing transfer price is determined by the market, based on the trading of
the same product or service in normal conditions.
•
2. Negotiated Transfer Pricing This method is based on an agreement between two division managers,
who determine an acceptable price to sell / buy products that circulate among them.
Main restrictions of this method are:
Negotiated price may not be optimal transfer price.
Conflicts may arise between the divisions.
Spent a lot of time for negotiations.
3. Cost-based Transfer Pricing In the absence of an established market price many companies base the
TP on the production cost of the supplying division.
Full (absorption) cost; either standard or actual. Popular because of its simplicity and clarity.
Cost-plus For transfers at full cost the buying division takes all the gains from trade while the supplying
division receives none. To overcome this problem the supplying division is frequently allowed to add a
mark-up in order to make a "reasonable" profit. The transfer price may then be viewed as an approximate
market price.
8. Influence of Transfer Pricing
1. Decision-making influence - the transfer price provides the necessary information that helps the
management of each division to make appropriate decisions regarding different issues
2. Evaluation of the performance of the division - the transfer price is an income for selling division
and a cost for the buying division
3. Coordination of the interests of managers and shareholders - Setting the transfer price should first
serve for the shareholder profit maximization, a goal that should be considered by managers.
4. Reducing the amount of income tax - selling products / services in different countries with different
tax regimes, benefits by shifting profits from high tax rate countries in the lower ones.
5. Promote and ensure the autonomy of the divisions - Setting transfer prices should be in line with
the realization of the overall objectives of the company, but it should not affect the autonomy of the
divisions, which operate as a separate entity.
9. DISADVANTAGES OF TRANSFER PRICING APPLICATION
Tax authorities, including:
1. Avoiding tax - companies operating in countries with different tax jurisdictions, deliberately use transfer prices to shift
much longer range of earnings in countries with lower corporate tax.
2. Reduced customs revenues - by moving goods from one place to another, a low transfer price reduces customer tax
obligation in countries with a high level of this tax, resulting in a reduction of income to the budget from this source.
B. Company itself:
1. Conflicting objectives - There are times when the use of a certain level of transfer price only serves for short-term
goals of the company and creates a problem for the long-term perspective. It should therefore encourage a careful decision
on prices which will transfer the goods / services from division to another.
2. An incorrect transfer price leads to inaccurate measurement of performance and lowers motivation
Managers
3. Risk to fiscal manipulation -transfer price is an instrument that can potentially be used in conditions where divisions of
the same company or related parties operate in countries with different tax regimes.
10. Transfer Pricing-Example
A Company has offered to purchase 90,000 batteries from the B Copmany
for $104 per unit. At a normal volume of 250,000 batteries per
year, production costs per battery are:
Direct materials
$40
Direct labor
$ 20
Variable factory overhead $ 12
Fixed factory overhead $ 42
Total
$114
The B Company has been selling 250,000 batteries per year to outside
buyers for $136 each. Capacity is 350,000 batteries/year. The A
Company has been buying batteries from outside suppliers for $130 each.
Should the B Company manager accept the offer? Will an internal transfer
be of any benefit to the company?
11. Transfer Pricing-Example
B manager should accept. There is surplus capacity.
So the relevant costs to the B Company is the VC =
$72 / battery.
The increased A to the B would be 90,000*($104 – 72)
= $2.88 M
The company would be better off with an internal
transfer. Currently paying $130 for batteries that
could be made internally for incremental cost of $72.
The company would save 90,000 * (130 – 72) = $5.22
M per year!
The TP range = max. of $130 to low of $72
12. Conclusion
The transfer price is the price that one division
of a company charges another division of the
same company for a product transferred
between the two divisions so there are no
cash flows between the divisions.
The transfer price becomes an expense for the
receiving manager and a revenue for the
supplying manager.
The transfer price is used for accounting
purposes (legal)
