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In the past thirty years, the issue of transfer pricing has been elevated in importance for the corporation with the accelerated globalization of today's business process. More businesses than ever are establishing international divisions and transferring products, services, and intangible assets between them. This article reviews the basics of transfer pricing and examines through examples some of the challenges inherent in its process.

Transfer pricing is the price for goods and services that is charged to one division of a corporation from another division for the purpose of assessing profit and loss for each as accurately as possible. The basic challenge is to ensure that one division does not unfairly benefit from the transaction over the other by incorrect calculation of these charges.) The concept used to assess this amount is based on the "arms-length principle". This principle states that a corporation must base its price on the same rate it would charge an unrelated party for the product, such as a customer. This can be calculated relatively easily if the division sells the same product to others, or has access to information on pricing of similar products. Another concept that must be adhered to when assessing the proper transfer price is called the "best method" principle. Transfer pricing has multiple methods that can be utilized and a corporation is expected to use the most appropriate for getting the most precise results. (Benke and Edwards 10) A few examples of different methods:

Comparable Profits/Transactional Net Marginal

Cost Plus/Resale Price

Comparable Uncontrolled Price

Services Cost

Profit Split

Generally, a domestic corporation with no foreign divisions faces fewer challenges when dealing with transfer pricing. An example:

An electronics corporation produces a television using parts acquired from a subsidiary in the same country. The corporation must ensure that the subsidiary does not charge too much or too little for the part, thus preventing the transfer price to unduly influence profit of one division over the other.

The tax implications to each division are minimal, as the corporation will be assessed for tax purposes under the same rules of the host country. This example can become more complex if the services, products, or intangible assets transferred are not sold at arms length and have no relative comparisons available.

When dealing with transfer pricing in an international situation, additional challenges can occur. An example:

An electronics company in the United States produces televisions using parts that it acquires from a division in Korea and builds these products in a plant in China owned by another division. It then ships the television to the Europe for sale at a retailer that is another separate division. In the chain, the electronics company has four separate divisions that have to show a profit or loss, in different countries.

The addition of the three governing bodies can add the following challenges when assessing the proper transfer price, beyond the complexity of items with no relative comparison:

Potential for double taxation - When dealing with multiple governing bodies, taxation authorities may have different rules for apply the best method concept. In the example, the United States may prefer Transactional Net Margin method for the parts used in Korea when reporting, while Korea may require Cost Plus method when reporting. This disparity could occur between all four tax authorities leaving the possibility of additional taxes assessed versus the use of one method for all countries.(King 9)

Inability to accurately anticipate tax burden - Even when the arms length and best method principles are applied to the best of a corporation's ability, many taxing authorities reserve the right to require restatement of transfer pricing. This can create an environment of uncertainty as to financial results when the taxing authority can require this.(King 9)

Additional costs associated with reporting - When assessing transfer pricing, requirements of accuracy and methodology choices can add an additional cost for lawyers, and accountants in order to prepare the analysis required. In addition, taxing authorities reporting rules may require written in depth analysis for each transfer pricing decision.(King 9)

These are merely three examples of the challenges facing a corporation when dealing with transfer pricing on a global scale. There can be other challenges as well in the political and social arenas, such as public perception of unethical use of transfer pricing to benefit profitability, which have different non-monetary ramifications to the modern multinational.

King, Elizabeth. Transfer Pricing and Corporate Taxation:Problems, Practical Implications and Proposed Solutions. New York: Springer Science+Business Media, 2009. Print

Benke, Ralph L., James D. Edwards. Transfer Pricing:Techniques and Uses. New York: National Association of Accountants, 1980. Print

By Charles L Hamilton
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