Transfer pricing concerns the terms that connected entities use when they conduct business with each other. The issue is of most importance for multinational groups that conduct business across international boundaries. The transfer pricing policy of such groups will often have a significant effect on the amount of profit or loss that is recognised in each of the countries in which they do business. For this reason, the issue of transfer pricing is of great importance both for multinational groups and for tax authorities around the world.
Not long ago, transfer pricing was a subject for tax administrators and one or two other specialists. But recently, politicians, economists and businesspeople, as well as NGOs, have been waking up to the importance of who pays tax on what in international business transactions between different arms of the same corporation. Globalisation is one reason for this interest, the rise of the multinational corporation is another. Once you take on board the fact that more than 55% of world trade takes place within multinational enterprises, the importance of transfer pricing becomes clear.
Transfer pricing refers to the allocation of profits for tax and other purposes between parts of a multinational corporate group. Consider a profitable Indian pharmaceutical group that buys active ingrediantmaterial from its own subsidiary in Singapore: how much the Indian parent pays its subsidiary – the transfer price – will determine how much profit the Singapore unit reports and how much local tax it pays. If the parent pays below normal local market prices, the Singapore unit may appear to be in financial difficulty, even if the group as a whole shows a decent profit margin when the completed computer is sold. Indian tax administrators might not grumble as the profit will be reported at their end, but their Singapore counterparts will be disappointed not to have much profit to tax on their side of the operation. This problem only arises inside corporations with subsidiaries in more than one country; if the Singapore company bought its ingrediant material from an independent company in singapore it would pay the market price, and the supplier would pay taxes on its own profits in the normal way. It is the fact that the various parts of the organisation are under some form of common control that is important for the tax authority as this may mean that transfers are not subject to the full play of market forces.
Transfer prices are useful in several ways. They can help an MNE identify those parts of the enterprise that are performing well and not so well. And an MNE could suffer double taxation on the same profits without proper transfer pricing.
