Transfer pricing is one of the top tax concerns for multinational companies. It describes all aspects of inter-company pricing arrangements for goods and services sold between legal entities within a corporate group.
Background and why it’s important
With the rise of globalisation, cross-border intra-company deals have become increasingly common. As a result, the Organisation for Economic Co-Operation and Development (OECD) and the United Nations Tax Committee have endorsed an “arm’s length” principle in setting transfer prices, meaning that a company should set them at the same level they would use if the other trading party were an outside company rather than part of the same entity. Companies are instructed not to use the pricing “creatively” to avoid taxes in the higher-tax jurisdiction.
In practice, the “arm’s length” rule, which many countries have enacted into law, is hard to enforce. It creates tension between companies, which want to minimize taxes and maximize revenues, and tax authorities, which want to maximize their own revenues.
In short, by charging above or below the market price, companies can use transfer pricing to transfer profits and costs to other divisions internally to reduce their tax burden. Tax authorities have strict rules regarding transfer pricing to attempt to prevent companies from using it to avoid taxes.
As multinational companies and their supply chains encounter ongoing challenges, transfer pricing can be an effective tool to reposition cash and ensure profits are allocated in a tax-efficient manner.
