What is transfer pricing?

Transfer pricing refers to the pricing of goods, services or intangible property transferred between different units or subsidiaries of a multinational company. It involves setting a price for these transfers, which can affect the allocation of profits between different tax jurisdictions.

The principles of transfer pricing are designed to ensure that multinational companies are taxed fairly, and that profits are not artificially shifted between different countries to avoid taxes. These principles are set out by the Organisation for Economic Co-operation and Development (OECD) and are widely accepted around the world.

One of the key principles of transfer pricing is that transactions between related companies should be conducted on an arm’s length basis. This means that the price for the transfer should be the same as if the two companies were not related. In practice, this can be difficult to determine, and there are various methods used to establish an arm’s length price, such as comparable uncontrolled price, resale price, cost plus and transactional net margin method.

Another principle is that multinational companies should maintain appropriate documentation to support their transfer pricing policies. This documentation should include a detailed description of the transactions, an explanation of the transfer pricing method used, and an analysis of how the transfer pricing was determined.

For example, imagine a multinational company with a subsidiary in Vietnam that sells goods to its parent company in another country. The transfer price for these goods should be based on the market value of the goods in Vietnam, rather than an artificially low price to shift profits to the parent company. This would ensure that Vietnam receives the appropriate amount of tax revenue.

Another example could be a multinational company that licenses its intellectual property to a subsidiary in a low-tax country. The transfer price for this license should be based on the market value of the intellectual property, rather than an artificially high price to reduce the tax liability of the parent company.

In conclusion, transfer pricing is an important issue for multinational companies operating in different tax jurisdictions. Adhering to the principles of transfer pricing can help ensure that companies are taxed fairly and that profits are not artificially shifted between different countries. It is important for companies to maintain appropriate documentation and seek professional advice when determining transfer prices to comply with regulations and avoid penalties.

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