Ultimate Guide of Transfer Pricing

The Concept of Transfer Pricing:

Transfer pricing (TP) is the price of goods or services being sold or bought between divisions in the same group or entity. For the divisions that operate in the same jurisdiction, transfer pricing is set for performance management and motivation of division from the group or entity level. Sometimes it is set up to solve the conflict between divisions. However, for the group with many divisions operating in multinational countries, TP is set to comply with law and tax purposes.

To summary, the purposes of transfer pricing are:

  • To keep goal congruence among divisions: Pricing police are normally set to ensure that the decision making at the divisional level are retaining the benefit for both divisions and group as a whole. It is the risky when the decision making are delegate all the power to the divisional level since some division made at the division are benefit at the division but impair group profit.
  • To allow managers to retain autonomy: In the modern performance management, the decision making are delegated to the local manager as they know the situation more that group level. Transfer Pricing is part of modern performance management so that divisions could survive for themselves. Yet, not all of the power and decision are delegates.
  • To permit performance evaluation of division: Divisional performance management is very importance as it is affected the performances, reward and motivation of starts and managements at divisional level. This is one of the most importance parts of TP.
  • Tax Management: For the group companies that have many divisions that operate in different countries and corporate tax rates are different, transfer pricing that manage by group are very importance to make sure that the group pay too much tax or in others words, how the group could save tax.
  • Managing profit for minor shareholders: Well, it might be a bit difficult in this point, but some of the major shareholders are managing profit of the companies and they have the chance to manage the benefit of minor shareholder as well. Mostly through the pricing of goods or services transfer among the group.
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Types of Transfer Pricing:

The following are the five types of transfer pricing usually set by the group company and jointly set by the division.

  • Market Price Transfer Pricing: Marketing price is the type of transfer price policies that use available market price of the same or similar products or services in the market as the base price for charging. This type of pricing is fair for both transferring division and receiving division. Both division could compare the price that they are paid and receive to the market price; however, by using Transfer Price, the Transferring Division might not are not spend on transportation fee if they both are in the same country.
  • Adjusted Market Price Transfer Pricing: Adjusted Marketing Price is the type of TP policies that use the available price in the market and make adjustment for some type of expenses that not incurred as the outsider. For example, transport fee.
  • Marginal Costs Transfer Pricing: This kind of pricing is charge at the variable cost incurred at the transferring division. Such pricing might demotivate transfer division as some cost that incurred at their department is not considered. For example, fixed cost is not taking into account.
  • Full Cost Transfer Pricing: The price is charge based on the full cost that incurred at the transferring division. This type of TP have many disadvantages. First, it might be motivating the transferring division not to control the cost of products or services because all of the cost that incurred at the transferring division will be charged to the receiving division. Per group point of view, there is poor cost control and result wasted to the group. Another disadvantage is that the receiving division will be demotivate as they could control the cost that being charge to them.
  • Negotiate Transfer Pricing is the type of transfer price that Group Company delegates the power to its division to have the right to negotiate the prices. This type of TP strategy is almost of same to adjusting market as the prices are decided by both transferring and receiving division.
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Issues Need to Consider for International Transfer Pricing

Many of the group of companies now have many international divisions for market expansion and low-cost strategy. In such a situation, transfer pricing plays a significant role, and usually, there are many issues to consider.

The following are the five issues that need to consider when setting Transfer Pricing for International Division:

  • Exchange Rate Fluctuation: Some of the divisions are operating in the county that have low economic and highly fluctuate exchange rates. For example, the transferring division is operating in the high fluctuation exchange rate; the receiving division will incurred the loss of exchange rate. In such case, hedging currency might need to consider.
  • Taxation Rates: It is for obverse reasons operating in different countries, the group have to expose different tax rates, and the pricing have to set based on those tax rates to ensure that the group does not paid too much tax.
  • Import Duties: Some country try to control and manage the transfer price by setting the price for import or exports. It also the main factors that we need to consider when consider the transfer pricing strategy.
  • Fund Repatriation: The concept of fund repatriation is that the government wants to control the fund outflow from its country by investors through transfer pricing by charging the high prices products or services.
  • Anti-dumping legislation: Such concept that governments want to propose the local products by setting the market price for products export from the country. For example, some of the group companies open the production division in the low labor cost country and the product charge from those countries is at the low price.
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Written by Sinra