Transfer Pricing
Transfer pricing of goods and services.
For example, goods from the production division may be sold to the marketing
division, or goods from a parent company may be sold to a foreign subsidiary,
with the choice of the transfer price affecting the division of the
total profit among the parts of the company.
This has led to the rise of transfer pricing regulations as governments
seek to stem the flow of taxation revenue overseas, making the issue
one of great importance for multinational corporations.
Although there is sound
economic theory behind the selection of a transfer pricing method, the
fact remains that it can be advantageous to arbitrarily select prices
such that, in terms of bookkeeping, most of the profit is made in a
country with low taxes, thus shifting the profits to reduce overall
taxes paid by a multinational group.
However, most countries enforce tax laws based on the arm's length principle
as defined in the OECD (Organization for Economic Co-operation and Development)
Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations,
limiting how transfer prices can be set and ensuring that that country
gets to tax its "fair" share. In the United States, the pricing of transactions
between related parties that are reported for tax purposes are governed
by Section 482 of the Internal Revenue Code and the regulations there
under.
It should be noted that
tax agencies, such as the IRS in the United States, often differ in
interpretation of transfer pricing policy with their corresponding national
customs agency, such as the Bureau of Customs and Border Protection
in the United States.
In many cases the objectives of these agencies in assessing a multinational's
transfer pricing policies are opposed to each other. (An introduction
to this interagency dilemma can be found in the 2007 article in the
World Commerce Review entitled: "Transfer Pricing, Customs Duties, and
VAT Rules: Can We Bridge The Gap?" by Liu Ping (World Customs Organization)
and Caroline Silberztein (OECD Centre for Tax Policy and Administration)
From the corporation's
position, running afoul of such regulations can prove to be a costly
mistake, as illustrated by GlaxoSmithKline's announcement on September
11, 2006 that they had settled a long-running transfer pricing dispute
with the US tax authorities, agreeing to pay $3.1 billion in taxes related
to an assessed income adjustment due to improper transfer pricing.
However, proper use of the regulations also provides a method of protecting
against double taxation, provided that the transactions are carried
out between divisions in countries bound by bilateral tax treaties.
In the GlaxoSmithKline case, however, the company has indicated that
they will not pursue competent authority negotiations for the relief
of U.S.-U.K. double taxation.
Application of the Arm's
Length Principle
Although there are discrepancies in the specifics of each country's
laws concerning the application of the arm's length principle, the fact
that they are primarily based in the OECD Guidelines means that, although
such a strategy carries a greater taxation risk than solutions tailored
to each country, global transfer pricing policies can be effectively
used to determine an appropriate range representing the arm's length
price for transactions carried out across a global enterprise.
However, different countries may accept different methods of calculating
the transfer price (i.e. Japan requires that the three "traditional"
methods, outlined below, be systematically discounted before allowing
the use of alternative methods, while the United States accepts the
most appropriate method regardless), so care must be taken in such circumstances.
In addition, some countries may have immature transfer pricing regimes
or apply the arm's length principle in different ways—Brazil, for example,
does not apply the arm's length principle despite the existence of transfer
pricing legislation.
|
