by Transfer pricing is arbitrary pricing of exports and imports that may be greater than or less than the arm’s-length prices. It is basically the pricing of intra-corporate transactions. Different units of an MNC operate in different countries on the basis of vertical and horizontal linkages.
Price = Quantity of money received by the seller/Quantity of goods and services rendered received by the buyer
The term ‘price’ needs not be confused with the term ‘pricing’. Pricing is the art of translating into quantitative terms (rupees and paise) the value of the product or a unit of a service to customers at a point in time.
Companies operating in international markets have to identify:
1) The variables those are important in determining prices in international markets.
2) The best approach for setting prices worldwide.
3) The variance in prices across markets.
4) The level of importance that needs to be given to each variable.
5) The variance in prices across customer types.
6) The factors to be considered while determining transfer prices.
Objectives of Transfer Pricing:
1) Reducing incident of customs duty payments
2) Maximizing overall after-tax profits.
3) Circumventing the quota restrictions (in value terms) on imports.
4) Transferring of funds in locations so as to suit corporate working capital policies.
5) Reducing exchange exposure, circumventing exchange controls and restricting profit repatriation so that transfer firms affiliate to the parent can be maximized.
6) ‘Window dressing’ operations to improve the apparent (i.e., reported) financial position of an affiliate so as to enhance its credit ratings.
Types
1) Cost-Plus Pricing:
Companies that follow the cost-plus pricing method are taking the position that profit must be shown for any product or service at every stage of movement through the corporate system. While cost-plus pricing may result in a price that is completely unrelated to competitive or demand conditions in international markets, many exporters use this approach successfully.
2) Transfer at Cost:
Companies using the transfer-at-cost approach recognize that sales by international affiliates contribute to corporate profitability by generating scale economies in domestic manufacturing operations. This approach assumes lower costs lead to better affiliate performance, which ultimately benefits the entire organisation.
The transfer-at-cost method helps keep duties at a minimum. Companies using this approach have no profit expectation on transfer sales; rather, the expectation is that the affiliate will generate the profit by subsequent resale.
3) “Arm’s-Length” Transfer Pricing:
The price that would have been reached by unrelated parties in a similar transaction is referred to as “arm’s-length” transfer pricing. This approach requires identifying an arm’s-length price, which may be difficult to do except in the case of commodity-type products. The arm’s-length price can be a useful target if it is viewed not as a single point but rather as a range of prices. The important thing to remember is that pricing at arm’s length in differentiated products results not in pre- determinable specific prices but in prices that fall within a pre- determinable range.
4) Market-Based Transfer Price:
A market-based transfer price is derived from the price required to be competitive in the international market. The constraint on this price is cost. However, there is a considerable degree of variation in how costs are defined. Since costs generally decline with volume, a decision must be made regarding whether to price on the basis of current or planned volume levels. To use market-based transfer prices to enter a new market that is too small to support local manufacturing, third-country sourcing may be required. This enables a company to establish its name or franchise in the market without investing in bricks and mortar.
5) Tax Regulations and Transfer Prices:
Since the global corporation conducts business in a world characterized by different corporate tax rates, there is an incentive to maximize system income in countries with the lowest tax rates and to minimize income in high-tax countries. Governments, naturally, are well aware of this. In recent years, many governments have tried to maximize national tax revenues by examining company returns and mandating reallocation of income and expenses.
