Transfer pricing is one of the most important decision to be taken by a transnational corporation. Every TNC has a well established department to determine appropriate transfer pricing. A TNC is expected to take care of following factors while determining its transfer pricing:
- Corporate tax rates.
- Import duties.
- Remittances of profits.
Corporate Tax Rates:
The objective of a TNC is to minimize its global tax liability. To accomplish this, the parent corporation will like to show more profits in that country where the tax rate is the lowest. Let us take an example. A parent corporation is in USA when a tax on corporate profit is 40%. It has two subsidiaries at Canada and Hong Kong with tax rate at 30% and 10% respectively. If there is some intra-unit trade, it would be advantageous for the company to charge lower prices for sales made by the Canadian subsidiary to the Hong Kong unit as it will reduce the profits of Canadian unit and boost profits of the Hong Kong unit. Conversely when the Hong Kong unit makes sales to the Canadian unit, it will jack up the prices. Thus the country with the higher tax rate stands to lose tax revenues. Many governments have enacted laws to prevent such manipulations to the extent possible.
If there are high import duties, the motivation to indulge in export pricing is strong. Suppose, the parent company in USA has a subsidiary in Indonesia which imposes a 50 per cent ad volarem duty on the components being supplied by the parent unit. By stating a lower price, the TNC can save substantial amount of customs duty. But here too, there is a danger. The customs authorities may refuse to accept such artificially lowered prices and jack up prices for customs valuation and duty assessment purposes.
Remittances of Profits:
Many countries in the developing part of the world, impose some restrictions on the amount of dividend payments an TNC will be allowed to take out of the country. Transfer pricing manipulation can circumvent the restrictions on the remittance of dividends. Sale prices of the parent to the subsidiary will be raised while the sales price of the subsidiary to the parent will be reduced. This is the standard method adopted by many firms. There are also interesting variations. In one case, one multinational enterprise having manufacturing capacity in Colombia used to ship the goods to a subsidiary in Mexico, which in turn resold it to the parent firm in USA. The intermediate sale to the Mexican unit was made to
facilitate remittances of profits to USA as there were no such restrictions in Mexico.