Transfer pricing

Transfer Prices

Transfer Price is the price one subunit charges for

a product or service supplied to another subunit
Of the same Organization
Transfer Pricing- 4 criteria's

1Goal Congruence

2 Management Effort

3 Subunit Performance Evaluation

4 Subunit Autonomy
Purpose of Transfer Pricing

Multinational companies use transfer

pricing to minimize their worldwide
taxes, duties, and tariffs.
 Transfer Costing- Methods

1Market
Based
2Cost
Based

3Negotiated
Market-Based Transfer Prices

Transferring at Market Price

is best if

1 Perfectly Competitive Market

2 Interdependence of Subunit is Minimal
3 No additional Cost-benefits to company
 Market-Based Transfer Prices
● The major drawback
to market-based prices
is that market prices
are not always
available for items
transferred internally.
 Transfers at Cost
● About half of the major companies in the
world transfer items at cost.
Transfers at Cost

Full cost
Variable costs
Dual Pricing
 Variable-Cost Pricing
● When market prices
cannot be used,
versions of “cost-plus-
a-profit” are often
used as a fair
substitute.
Variable-Cost Pricing

In situations where idle capacity exists,

variable cost would generally be the
better basis for transfer pricing and
would lead to the optimum decision
for the firm as a whole.
Negotiated Transfer Prices
● Companies heavily
committed to
segment autonomy
often allow
managers to
negotiate transfer
prices.
Dysfunctional Behavior

Virtually any type of transfer pricing policy

can lead to dysfunctional behavior – actions
taken in conflict with organizational goals.
Factors affecting
Transfer prices.
 Multinational Transfer Pricing
Example
● An item is produced by Division A in a
country with a 25% income tax rate.
● It is transferred to Division B in a country
with a 50% income tax rate.
● An import duty equal to 20% of the price of
the item is assessed.
● Full unit cost is Rs100, and variable cost is
Rs60 (either transfer price could be chosen).
Multinational Transfer Pricing
Example

Which transfer price should be chosen?

Rs100 Why?
Multinational Transfer Pricing
Example

Income of A is Rs40 higher:

25% × 40 = (Rs10) higher taxes
Income of B is Rs40 lower:
50% × 40 = Rs20 lower taxes
Import duty paid by B:
20% × 40 = (Rs8)
∴ Net savings = Rs2
Global Pricing Considerations
Criteria’s for Transfer Pricing

a) Tax regimes
b) Local Market conditions
c) Market Imperfections
d) Joint-venture partner
Key drivers behind transfer pricing
in Foreign Countries:

Market Conditions
Competition
Profit for the affiliate
Tax Rates
Key drivers behind transfer pricing
in Foreign Countries:

Economic conditions
Import Restrictions
Customs Duties
Price Controls
Exchange Controls
Setting Transfer Prices

a) Arm’s length prices:

use of market mechanism as a cue
for setting transfer prices.
b) Cost-based pricing (adds a mark-up)