Classroom Exercises: Transfer Pricing in Multinational Corporations (MNC)

1. Inter-Land, Inc., transfers a product between its U.S. Division and its Danish division. The product sells
for $45 in the United States. The cost of shipping to Denmark is $3.20, and Danish duty is $9. The U.S.
division pays approximately $4.50 per unit for advertising and related selling expenses. Using the
comparable uncontrolled price method, calculate the transfer price.

2. The U.S. division of Inter-Land, Inc., purchases a product from the Danish division, which sells for $80
per unit in the United States. The U.S. division typically has a 25 percent markup on goods. Calculate the
transfer price under the resale price method.

3. Howell Company has a division in the United States that produces computerized thermostats for heating
units. These thermostats are transferred to a division in Luxembourg. The thermostats can be (and are)
sold externally in the United States for $30 each. It costs $2.35 per thermostat for shipping and $2.70 per
thermostat for import duties. When the thermostats are sold externally, Howell spends $3 per thermostat
for commissions and an average of $1 per thermostat for advertising.
a. Which Section 482 method should be used to calculate the allowable transfer price?
b. Using the appropriate Section 482 method, calculate the transfer price.

4. Assume that Valley Electronics transfers a component from a U.S. division to a German division for
$11.70. The landing costs are $2.50 per unit, and the avoidable commissions and advertising total $0.50
per unit. The component has a market price within the United States of $10. Is the company complying
with the comparable uncontrolled price method? Would the IRS be concerned if the transfer price is
greater than the market price after adjustments? Why or why not?

5. Assume that a manufacturing division in the United States transfers a component to a marketing division
for resale. The resale price is $8, the gross profit percentage (gross profit divided by sales) is 25 percent,
the landing costs total $1.20 per unit. Suppose that the actual transfer price (excluding landing costs) is
$4.50. Should the company continue transferring at $4.50?

6. Suppose that a U.S. division has excess capacity. A European division has offered to buy a component
that would increase the U.S. division’s utilization of its capacity. The component has an outside market in
the United States with a unit selling price of $12. The variable costs of production for the component are
$6. Landing costs total $2 per unit, and an internal transfer avoids $1.25 per unit of marketing costs. The
European division can purchase the component locally for $12.
a. Ignoring income taxes, what is the minimum price that the European division should pay for the
component (including landing costs)? The maximum price?
b. Assuming that the joint benefit is split equally, what is the transfer price?

7. Sprint, Inc., has a Pennsylvania-based division that produces electronic components, with a very strong
domestic market for circuit no. 222. The variable production cost is $140, and the division can sell its
entire output for $190. Sprint is subject to a 30% income tax rate.

Alternatively, the Pennsylvania division can ship the circuit to a division that is located in Mississippi, to
be used in the manufacture of a global positioning system (GPS). Information about the global positioning
system and Mississippi's costs follow.

Selling price: $380

Circuit shipping and handling fees to Mississippi: $10
Labor, overhead, and additional material costs of GPS: $120

a. Assume that the transfer price for the circuit was $160. How would Pennsylvania's divisional
manager likely react to a corporate decision to transfer the circuits to Mississippi? Why?
b. Calculate Pennsylvania income, Mississippi income, and income for the company as a whole if
the transfer took place at $160 per circuit.
c. Assuming that transfers took place at a price higher than $160, would the revised price increase,
decrease, or have no effect on Sprint's income? Briefly explain.
d. Assume that Sprint moved its GPS production facility to a division located in Germany, which is
subject to a 45% tax rate. The transfer took place at $180. Shipping fees (absorbed by the
overseas division) doubled to $20; the German division paid an import duty equal to 10% of the
transfer price; and labor, overhead, and additional material costs were $150 per GPS. If the
German selling price of the GPS amounted to $450, calculate Pennsylvania income, German
income, and income for Sprint as a whole.
e. Suppose that U.S. and German tax authorities allowed some discretion in how transfer prices were
set. Given the difference in tax rates, should Sprint attempt to generate the majority of its income
in Pennsylvania or Germany? Why?