Transfer Price

Transfer pricing is a key element in management reporting systems that decompose aggregate corporate profits into more finely grained profitability analyses by, for example: Organization (such as division, business unit or department) Geographic Region Product Client Segment Individual ClientIn large companies, multiple organizations often are involved in the manufacture and delivery of products and services to clients or customers. To analyze profits by organization, there thus needs to be a mechanism to attribute portions of the revenue streams earned by a given product to the various organizations involved in its manufacture and distribution. In similar fashion, the expenses incurred by various cost centers, such as information technology and back office operations departments, also must be attributed to the various organizations being credited with the revenues from the products with which these expenses are associated. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities.In managerial accounting, when different divisions of a multi-entity company are in charge of their own profits, they are also responsible for their own "Return on Invested Capital". Therefore, when divisions are required to transact with each other, a transfer price is used to determine costs. Transfer prices tend not to differ much from the price in the market because one of the entities in such a transaction will lose out: they will either be buying for more than the prevailing market price or selling below the market price, and this will affect their performance. Transfer prices are important especially for large, decentralized corporations where each division reports its own profits and losses separately. In vertically integrated firms, transfer prices play a central role for both managerial accounting and tax reporting purposes. Common to these purposes is that transfer prices ultimately determine the distribution of reported income across different segments (divisions) of the firm.Significance in MNCsTransfer pricing is a means by which related entities within a multinational company (MNC) transact business with each other and follow appropriate accounting principles that require that expenses be recorded where the corresponding revenues are generated the complication being that within a MNC certain functions attributable to a sale may not be performed in the jurisdiction in which the sale is made. Similarly, certain risks and the intellectual property that assist in generating the sale may be in different geographic locations. Each part of the MNC participating in the ultimate sale should receive an appropriate reward for its efforts in crystallising that sale. This in a nutshell is what transfer pricing is about recognising and rewarding the efforts of connected parties related to: The sale of tangible property Services provided Financing The use of intellectual propertyWhenever goods cross national borders within the channels of a multinational corporation (MNC), a transfer price must be calculated for tax purposes. When corporate tax rates differ on the two sides of the border, the MNC has an incentive to set its transfer prices in a way that reduces its tax burden by reporting higher profits in the country where corporate profits are taxed more lightly. The ability of MNCs to set transfer prices to minimize taxes, however, is circumscribed by the tax regulations of the home and host countries. In order to assist both MNCs and tax authorities to determine a suitable reward, the OECD introduced the concept of an arms length value, essentially something that applies to transactions between unconnected parties. Unfortunately, it is never that simple and the OECD guidelines contain a number of ways of determining the arms length value in different scenarios and suggest a variety of methods ranging from the simple cost plus method to the profit split method, this latter method being used primarily only if the other methods do not produce an appropriate result.Arriving at an arms length value can be very subjective and this is where a threat lies for many MNCs; tax authorities adopt the guidelines in different ways and do not always accept each method, instead picking those they consider appropriate and issuing their own requirements. There is therefore a lack of a consistent approach despite the existence of the guidelines. The requirements in one tax jurisdiction may also change as tax authorities see other jurisdictions achieve success in increasing their tax take or as the OECD refine their guidelines.The transfer price of multinational corporations can be divided into three kinds: (1) Capital circulation transfer price, which means that in the internal trade, multinational corporations improve the goods price imported from a parent or other subsidiaries in order to make the profit exported by the form of loan payment, then affect the cost of the related company and the profit level by the level of interest rates of borrowing funds. (2) Tangible assets transfer price, which means the allocation price of rental and transfer of tangible assets such as machines and equipments in the multinational corporations. (3) Intangible assets transfer price, which refers to the price that multinational corporations provide intangible assets such as management, technology and consulting service. Transfer price provides a lawful and effective means for the multinational corporations to overcome trade barriers, reduce the tax burden, reduce transaction risk and improve economic efficiency; and make the multinational corporations achieve a competitive advantage in the market. Therefore, transferring price strategy is the favorable leverage for the multinational corporations to realize the centralized control, unified deployment of human, finance and material all over the world, and also the necessary tool to realize their global strategy.