Transfer pricing

Transfer Prices

Transfer Price is the price one subunit charges for a product or service supplied to another subunitOf 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 transferpricing to minimize their worldwide

taxes, duties, and tariffs.

Transfer Costing- Methods

1Market Based

2Cost Based

3Negotiated

Market-Based Transfer Prices

Transferring at Market Priceis best if

1 Perfectly Competitive Market2 Interdependence of Subunit is Minimal3 No additional Cost-benefits to company

Market-Based Transfer Prices

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

Transfers at Cost

About half of the major companies in the world transfer items at cost.

Transfers at Cost

Variable costs

Full cost

Dual Pricing

Variable-Cost Pricing

When market prices cannot be used, versions of “cost-plus-a-profit” are often used as a fair substitute.

Variable-Cost Pricing

In situations where idle capacity exists,variable cost would generally be thebetter basis for transfer pricing andwould lead to the optimum decisionfor the firm as a whole.

Negotiated Transfer Prices

Companies heavily committed to segment autonomy often allow managers to negotiate transfer prices.

Dysfunctional Behavior

Virtually any type of transfer pricing policycan lead to dysfunctional behavior – actionstaken 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.

It is transferred to Division B in a country with a 50% income tax rate.

An import duty equal to 20% of the price of the item is assessed.

Full unit cost is Rs100, and variable cost is Rs60 (either transfer price could be chosen).

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

a) Tax regimesb) Local Market conditionsc) Market Imperfectionsd) Joint-venture partner

Criteria’s for Transfer Pricing

Key drivers behind transfer pricing

in Foreign Countries:

Market Conditions CompetitionProfit for the affiliateTax 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)