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
q

The major drawback to market-based prices is that market prices are not always available for items transferred internally.

Transfers at Cost
q

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
q

When market prices cannot be used, versions of “cost-plusa-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
q

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. q It is transferred to Division B in a country with a 50% income tax rate. q An import duty equal to 20% of the price of the item is assessed. q Full unit cost is Rs100, and variable cost is Rs60 (either transfer price could be chosen).
q

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)