Although transfer pricing is not a new issue and has been much discussed, doubts and misinterpretations about it have been very common, to the point that the idea has proliferated that they represent a negative practice. As we know, these prices are simply transfer prices agreed within an organization for the transfer of assets, and services both tangible and intangible. We must remind that at the time, companies were focused on their core activities as well as to external
customers and little attention was paid to their areas of support. These areas were considered cost centers and not being part of the main business, and were expected only to recover the costs incurred. When various management concepts evolved, and developing information technology was expected to recover additional costs, these units also started generating income, beginning to be treated as profit centers. In this regard, Horngren, Foster and Datar (1996) in their book “Cost Accounting: A
Managerial Approach” define transfer pricing as a price that a unit, segment, department, division, etc. charge for a product or service provided to another subunit of the same organization. From a tax point of view, the above dynamics and fragmentation of these business units into separate legal entities, often located in different jurisdictions as a result of globalization has meant that the profits generated by these units are taxed at different jurisdictions, and as a result, the
transfer prices agreed within these business groups became very important for the tax authorities where these groups operate. In the end, business groups could transfer, voluntarily or involuntarily, profits between tax jurisdictions. It is worth mentioning that the existence of different income tax rates in different jurisdictions, product of the sovereignty of nations, and tax competition, create an incentive for the accumulation of such profits in the jurisdiction or jurisdictions with
lower tax rates. In this regard, the United Nations Practical Manual on Transfer Pricing for Developing Countries, hereinafter UN Handbook, defines transfer pricing in paragraph B.1.1 .6, as follows: “Transfer pricing is the general term for fixing cross-border prices of intra-firm transactions between related parties. The transfer pricing, thus refers to the pricing for transactions between associated companies involving the transfer of
property or services.” Given the impact, from a tax point of view, that the prices agreed between companies in a multinational group transfer might have in each jurisdiction as a result of the various transactions of a taxpayer with other companies in the same corporate group that are not domiciled in the same territory, the different countries have developed regulations to prevent a decrease in tax revenue as a key element, establishing the principle of market value, of independent operator and the arm´s length principle. Concerning the arm´s length principle, the OECD Guidelines applicable to the transfer pricing for multinational enterprises and tax administrations (OECD Guidelines) in paragraph 1.2 underlines the following:
In essence, this means that the transactions between related parties or partner companies should be conducted under terms consistent with those which would have agreed with independent parts or in independent conditions. Although, as mentioned above, the arm´s length principle has become the key element in the transfer pricing regulations in different jurisdictions, the OECD Guidelines recognize the difficulties that their application could present. In this regard, paragraph 1.2 of the guidelines also states that:
Meanwhile, both the model tax convention on income and capital of the OECD (OECD Model) and the United Nations (UN Model) in the first paragraph of Article 9 mention the following with respect to the determination of transfer pricing adjustments:
The Arm’s Length principle has been commonly adopted in several jurisdictions in Latin America as well as in the rest of the world, as a reference to ensure that as a result of transactions between companies, and their respective transfer pricing, the taxable income of taxpayers in their territories is not affected negatively.
Disclaimer. Readers are informed that the views, thoughts, and opinions expressed in the text belong solely to the author, and not necessarily to the author's employer, organization, committee or other group the author might be associated with, nor to the Executive Secretariat of CIAT. The author is also responsible for the precision and accuracy of data and sources. What is a transfer price and why is it used?Transfer pricing allows for the establishment of prices for the goods and services exchanged between subsidiaries, affiliates, or commonly controlled companies that are part of the same larger enterprise. Transfer pricing can lead to tax savings for corporations, though tax authorities may contest their claims.
What is meant by transfer price?What Is Transfer Price? Transfer price, also known as transfer cost, is the price at which related parties transact with each other, such as during the trade of supplies or labor between departments.
How does cost based transfer price method help managers to determine transfer prices?Under the cost-based method, the transfer price is determined based on the production cost plus a markup if the upstream division wishes to earn a profit on internal sales. Finally, upstream and downstream divisions' managers can negotiate a transfer price that is mutually beneficial for each division.
What is transfer pricing in managerial economics?Transfer pricing refers to the prices of goods and services that are exchanged between companies under common control. For example, if a subsidiary company sells goods or renders services to its holding company or a sister company, the price charged is referred to as the transfer price.
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