Transfer pricing in International Business

Transfer pricing is the arbitrary pricing of exports and imports, which might be more or less than arm’s length rates. It’s essentially the price of intra-corporate transactions. Different components of a multinational corporation operate in different countries via vertical and horizontal links.

Price is calculated as the ratio of money paid by the seller to the quantity of products and services obtained by the buyer.

The word ‘price’ should not be confused with ‘pricing’. Pricing is the art of expressing the worth of a product or unit of service to clients in quantitative terms (rupees and paise) at a given moment.

Companies operating in foreign marketplaces must determine the characteristics that impact international market pricing.

2) The most effective method for fixing pricing internationally.

3) Price variability among marketplaces.

4) The amount of significance assigned to each variable.

5) Price variations between consumer categories.

6) The things to consider while setting transfer pricing.

Objectives of Transfer Pricing:

1) Reducing the incidence of customs duty payments

2) Maximizing total after-tax earnings.

3) Getting around import quotas (in value terms).

4) Transferring cash to places that align with business working capital rules.

5) Minimizing exchange risk, avoiding exchange regulations, and limiting profit repatriation so that transfer businesses affiliated with the parent may maximize their profits.

6) ‘Window dressing’ procedures to improve an affiliate’s apparent (i.e., reported) financial status in order to increase its credit rating.

Types

1) Cost-plus pricing.

Companies that use the cost-plus pricing strategy believe that profit must be proven for every product or service that moves through the corporate structure. Many exporters effectively adopt cost-plus pricing, despite the potential for a price that is unconnected to competition or demand situations in international marketplaces.

2) Transfer at Cost: The transfer-at-cost method acknowledges that worldwide affiliate sales boost company profitability by creating economies of scale in local production. This method implies that decreased costs lead to improved affiliate performance, which helps the overall business.

The transfer-at-cost mechanism helps to keep duties to a minimum. Companies that use this technique have no profit expectation from transfer sales; instead, the affiliate is expected to make the profit via later resale.

3) “Arm’s-length” Transfer Pricing: This refers to the price achieved by unrelated parties in a comparable transaction. This strategy requires determining an arm’s-length price, which may be difficult to establish unless in the case of commodity-type items. The arm’s-length price may be an effective objective if seen as a range of prices rather than a single point. The crucial thing to remember is that pricing at arm’s length in differentiated items yields prices that fall within a predetermined range rather than exact prices.

4) Market-Based Transfer Price: The market-based transfer price is determined by the price needed to compete in the foreign market. This pricing is limited by cost. However, there is a lot of variance in how costs are defined. Because expenses normally fall with volume, a choice must be taken as to whether to price based on present or projected volume levels. To employ market-based transfer pricing to enter a new market that is too small to sustain local production, third-country sourcing may be necessary. This allows a corporation to build its brand or franchise in the market without having to invest in physical assets.

5) Tax Regulations and Transfer Pricing:

Because the global company operates in a globe with varying corporate tax rates, there is an incentive to increase system revenue in countries with the lowest tax rates while minimizing income in countries with higher taxes. Governments are fully aware of this. In recent years, several governments have attempted to maximize national tax collections by reviewing firm reports and demanding income and spending reallocation.