A significant volume of global trade nowadays consists of international transfers of goods and services, capital and intangibles within a multinational company; such transfers are called “intercompany,” transactions. Evidence shows that intercompany trade is growing steadily and accounts for more than 30% of all international transactions. You may be asking, what is transfer pricing and why should I care about it?
Transfer pricing is the general term for the pricing of cross‐border, intercompany transactions between related parties and refers to the setting of prices at which transactions occur involving the transfer of property (tangible or intangible), capital or services between associated enterprises.
To better understand the effects and complexities of transfer pricing, here is an example:
A water bottle manufacturer in country A (“A”) distributes its water bottles through a subsidiary in country B (“B”). A’s water bottle production costs are $100, and sets the transfer price at $120. Subsidiary B pays $120 for the product and sells the product at $125, and covers its distributions costs of $5. The global profit is $20, where A had an individual profit of $20, and B no profit. Companies pay tax based on profit.
B is audited by country B’s tax administration, and they noticed that the distributor itself is not showing profit: the $120 transfer price plus the country B’s $5 distribution costs are exactly equal to the $125 retail price. Country B’s tax administration wants the transfer price to be shown as $110 so B shows $10 profit that would be liable for tax.
Here lies a major problem, the parent company already paid tax in country A on the $20 profit per water bottle shown in its accounts. Furthermore, since it is a group, it is liable for tax in the countries where it operates and in dealing with two different tax authorities it is not possible to just cancel one out against the other. Likewise, the group should not be made to pay the tax twice. As a result, the multinational company can end up suffering double taxation on the same profits or be required to get into a competent authority process, which is long and complicated process. Additionally, the company might be required to pay penalties in country B.
Though the above explanation of transfer pricing sounds logical, arriving at an “arm’s length” transfer price, is a complex task that needs to consider different factors in order to characterize transactions and find the appropriate compensation.
As the transfer pricing arena continues to demonstrate a high degree of change and flux (BEPS), global coordination and centralization is becoming ever more important for multinational companies. Hopefully, this example provides a better perspective on the complexities around setting the transfer price and how foreign regulations can drive even more coordination around intercompany transactions. Before you consider to take on this as well as other global initiatives, consider the benefits that can be achieved utilizing our subject matter professionals and presence around the globe. To learn more about how RSM can assist you with your other business needs, contact RSM’s management consulting professionals at 800.274.3978 or email us.