A transfer price is the cost that is put on products and services rendered by a company to a division or subsidiary of the same company. This is done so that profits and losses of the different divisions can be calculated separately. In the event that another company and its subsidiaries are situated in different countries, transfer pricing will directly impact on taxes owed by the company and by extension, its profits. Proper transfer prices set by the top management should be able to custom the Multi-National enterprise before and after tax.
Transactions between concerned groups must be undertaken with emphasis being placed on a level of independence from one another. Section 482 of the internal revenue code in the United States states that any related party transaction must be priced at ‘arm’s length’ generally implying that any transaction must not be deemed to be what is not independent. The transfer price which is said to meet arm’s length standard are determined and audited by the Organization for Economic Co-operation and Development.
The Organization for Economic Co-operation and Development (OECD) standard states that the transfer price should be equal to the price two independent firms (two arm’s length) that are not controlled by the Multi-National Enterprise would trade the tax authority in a given country can set a transfer price, work out the new tax rate, check any penalties, if an organization with a lower transfer price exists. The arm’s length principle is stated in the associated enterprise article of the OECD mode/tax convention on capital and income. It states that where:
1. An enterprise of a contracting state participates directly or indirectly in the management, control or capital of an enterprise of the other contracting state or
2. The same persons participate directly or indirectly in the management, control or capital of an enterprise of a contracting state and an enterprise of the...