Transfer Pricing

The pricing of exchanges of goods among different units of the same corporate body is known as transfer pricing. 

The main objective of adopting transfer pricing is to facilitate exchange of goods and services between a company and its foreign subsidiary or affiliate.

Transfer price may be defined as the price charged for goods for services supplied by the parent corporation to the subsidiary or vice-versa or by one subsidiary to another.

The basic objective of a TNC is to maximize group profits. This may necessitate showing, on paper, more or less profit being earned by one unit than what has been actually realized.

This brings us to the manipulation of transfer prices as a deliberate policy of a TNC. A TNC can use transfer pricing for following purposes:

(i) Transfer pricing is used to reduce tax incidence. Through appropriate transfer pricing TNCs reduce high direct and indirect taxation not only in host countries but also in home country.

(ii) Transfer pricing is used as a marketing technique. Transfer pricing may support a market position of a product or enhance its market share.

(iii) Transfer pricing may be used by a TNC to reduce the profit sharing by the collaborator with it.

(iv) Transfer pricing is also used to insulate the adverse impact of volatile exchange rate. Following are the alternative methods applied in transfer pricing:

Transfer at Cost Method: The first alternative methods is to exchange goods and services at cost. This method is based on the assumption that lower costs lead to better performance by the affiliate. This keeps duties at the receiving end to the minimum. Manufacturing unit does not make any profit on the transfer sale. However, the receiving unit is expected to make profit, because its cost is minimum. This policy is rarely used now a days.

Transfer at Cost Plus Method: Cost plus method attempts to add some amount or percentage to the cost of the product. 

This method recognises the principle that profit must be shown for every product or service at every stage of movement. This method is acceptable to both-transferor and transferee-divisions.

Transfer at Market Price Method: Under this method, transfer is made on foreign market price. It may, therefore, be too low for the selling subsidiary and the production cost may not be covered.

This method enables a company to establish its name or franchise in the new market without undertaking production there.

Transfer at Arm’s Length Price: The other extreme in transfer pricing is to charge the international division the same price any buyer outside the firm pays.

This price favours the producing division because it does as well on internal as on external sales. Arm’s length price method uses the same prices as quoted to independent customers.

This method creates problem when the product has no external buyers or is sold at different prices in different markets.

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