Globalization has allowed entrepreneurs to grow their enterprises across different borders. The number of multinational companies keeps rising, and business people seek opportunities in various parts of the globe. One aspect that makes it possible for multinational organizations to make money is transfer pricing, which is the cost of transactions between different divisions of the same entity. So answering the question what is transfer pricing? in detail should be an objective of any entrepreneur who intends to take his/her entity global.
Market conditions vary on a broad scale from one region to the next, and every organization must conduct transactions with these conditions in mind. The lack of regulations that was present in past transfer pricing prompted public concern, which resulted in the establishment of certain regulations like the Arm’s Length Rule. Regulations ensure that multinationals don’t use transfer pricing to evade tax. When analyzing what is transfer pricing and its impact on an organization, understand some of the best practices as well.
What Is Transfer Pricing?
Businesses with divisions in various parts of the world sometimes need to outsource goods, services, or intangible property within themselves. For example, a branch in the UK of one organization may need to buy raw materials from a company in the U.S of the same organization. The cost of doing business between the two entities is what transfer pricing is all about.
Another element that answers the question what is transfer pricing is the consistency to market conditions. The costs and conditions that apply to transactions between enterprises of the same entity should be equal to those existing between independent enterprises. Local governments have an interest in keeping profit allocation fair in the different divisions of the same company to prevent some firms paying less tax than they should.
Who Needs Transfer Pricing the Most
When wondering- what is transfer pricing; the question of who needs it is a logical one. Which enterprises should have these expenses? Any organization that has branches doing business with each other should have transfer costs that stick to the Arm’s Length Rule.
Take a phone manufacturing company in the U.S. that buys its computer chips from one of its subsidiaries in Korea. The phone manufacturers should buy (transfer pricing) the chips at the market price. This way, the Korean division registers its fair share of profits. Buying the chips at a lower price than market conditions allow means that the Korean company will record dismal revenues although the enterprise as a whole makes profits. Every company that conducts such transactions incurs transfer pricing.
How Much is Usually Spent on Transfer Pricing
After learning what is transfer pricing, you may want to estimate the several costs upfront, especially when expanding your corporation. It is hard to pinpoint what companies spend on transfer pricing because very many variables apply. Multinationals have different needs and can have divisions in any numerous businesses. The market conditions and prices will determine how much your company will spend on transfer pricing. Some of the market conditions that may influence your budget include fuel costs, taxes, and availability of goods/services. If one of your subsidiaries has a healthy supply of gravel when there is a shortage in the market, you have to factor in that shortage when buying.
Over the years, there have been many disputes regarding the transfer costs of multinationals such as Microsoft, Amazon, and Google. There are several inherent differences when it comes to calculating transfer pricing.
- The economic methods used when applying transfer pricing;
- The individual policies of a company are some of the issues that arise.
Multinationals have to make good faith efforts to comply with transfer pricing regulations of specific jurisdictions.
5 Effects of Transfer Pricing You Can Benefit From
1. Revise Your Expenses
When answering the what is transfer pricing” question, you have to look at the influence these expenses have in your company as well. Why are they so important?
- For one, it minimizes the practice of tax shifting, which is common among multinational enterprises. By paying a lower price for goods/services from a subsidiary of the same MNE, the profits will shift from the seller to the buyer.
- If the company with higher profit is in a place with low income taxes, then it means the tax liabilities go down. However, the company that sold the service/goods will be bleeding profits.
2. All Within Regulations
Transfer pricing regulations also influence where you expand your business. One reason the OECD established the Arm’s Length Rule is to ensure that some governments don’t take advantage of transfer pricing. This might be to entice organizations to move their business or continue doing business in their regions.
A nation can apply favorable taxes that make it more lucrative for MNEs to do business with them. It’s why the EU insists that tax authorities should ensure companies pay the taxes they owe and nothing less.
3. Performance Assessment
Performance assessment is another answer to the question what is transfer pricing’s role in an enterprise. Transfer prices act as performance indicators for multinationals. When running a global corporation, you want to ensure that every division is making money towards the bottom-line.
By looking at the transfer pricing numbers, you can tell how well or badly one of your subsidiaries is doing.
4. Evaluate Taxes
Transfer pricing can trigger double taxation, which is another huge concern for business people. Two companies within the same organization may end up paying taxes on two different occasions. This eats into your overall profits.
- MNEs must put together transfer pricing policies based on any one of the five methods provided by the OECD to avoid paying double tax.
- A parent company can also apply other measures such as arbitration agreements with its subsidiaries to avoid double taxation problems.
5. Specific Rules
Multinationals must comply with the Arm’s Length Rule regardless of the economic methods they use for their transfer pricing. Another impact that a corporation may feel is a penalty. This one may include significant monetary fines for failing to meet the necessary regulations.
Before expanding a business into a foreign region, learn the transfer pricing regulations provided for by the local tax authorities.
Multinationals present a number of management challenges and transfer pricing is one of the top ones for many. Understanding what is transfer pricing and its implications can help you avoid a lot of trouble.
Get experts on the subject to shed light on where your company stands. However, make sure this applies to the type of business and where you are doing it.
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