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MULTINATIONAL

Transfer Pricing

Transfer Price

A Transfer Price is the price charged when one segment of a company provides goods or services to another segment of the company. The transfer price creates revenues for the selling subunit and purchase costs for the buying subunits, affecting each subunits operating income. These operating incomes can be used to evaluate subunit performance and to motivate their managers.

OBJECTIVES OF MULTI-NATIONAL TRANSFER PRICING

Minimizing Taxes and tariffs.
Minimizing exchange risks.

Increasing share of profit from Joint ventures.

Bypassing profit repatriation restrictions.

Optimizing managerial performance evaluation and reward systems.

Cost Minimization Objectives and Related Transfer Prices Objective

Transfer Pricing Rule

Low price High price Low price

Minimize income Tax

Transfer to lower tax rate country Transfer to Higher tax rate country

Minimize import duties

Protect foreign cash flows from currency devaluation Avoid repatriation Improve competitive position

High price High price Low Price

What Transfer Price to apply?

In a well designed Transfer-Pricing system, optimizing subunit performance leads to optimizing the performance of the company as a whole. What Transfer Price to charge between the segments?

If price is set too high, this may encourage potential users to buy these services from outside the organization, or if they must use these resources, they may sub-optimize the use in order to cut costs.

Approaches used to set Transfer Prices

Negotiated Transfer Prices: Allow the managers involved in the transfer to negotiate their own transfer price. Cost-Based Transfer Prices: Set Transfer prices at cost. Market-Based Transfer Prices: Set Transfer prices at the Market Price

Comparison of Different TransferPricing Methods

Criteria
Achieves Goal Congruence Useful for evaluating subunit performance Motivates management effort

Market price
Yes, when markets are competitive Yes, when markets are competitive Yes

Cost-based
Often, but not always yes

Negotiated

Difficult unless transfer price exceeds full costs Yes, when based on budgeted costs; less incentive to control costs if transfers are based on actual costs No, because it is rulebased Useful for determining full cost of products and services; easy to implement.

Yes, but transfer prices are affected by bargaining strengths Yes

Preserves Subunit Autonomy Other factors

Yes, when markets are competitive No market may exist or markets may be imperfect or in distress

Yes, because it is based on negotiations between units Bargaining & negotiations take time& may need to be reviewed repeatedly.

METHODS OF DETERMINING THE ALP

(a)Comparable Uncontrolled Price Method ('CUPM') (b) Resale Price Method ("RPM')
(c) Cost plus method ('CPM') (d) Profit Split Method ('PSM')

(e) Transactional Net Margin Method ('TNMM')

General Guideline for Transfer-Pricing Situations

There is no Transfer-pricing method that meets all the criteria.

Penalties
Penalties have been provided as a disincentive for noncompliance with procedural requirements are as follows: (a) Penalty for Concealment of Income - 100 to 300 percent on tax evaded. (b) Failure to Maintain/Furnish Prescribed Documentation 2% of the value of the international transaction. (c) Penalty for non-furnishing of accountants report - INR 100,000 (fixed). The above penalties can be avoided if the taxpayer proves that there was reasonable cause for such failures.
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Conclusion

Transfer pricing is a globally evolving area and with practice and further experience it will be fine-tuned. Transfer pricing is not an exact science. It is a matter of judgement and finding an answer. CMAs have an important role to play to make this more refined, accurate, and comparable.

REFERENCES

TRANSFER PRICING: TECHNIQUES AND USES -Ralph L. Benke & James Don Edwards
MANAGEMENT ACCOUNTANT JOURNAL - MAY 2012 INTERNATIONAL ACCOUNTING -Shahrokh M. Saudagaran www.accounting4management.com/international_aspects_of _transfer_pricing.htm

THANK YOU

JAI SAI RAM

AN OFFERING AT HIS LOTUS FEET