Transfer pricing, or TP, refers to determining the prices of goods, services, or intangible assets transferred between affiliated companies, often operating in different countries. Affiliated companies refer to when either one of the companies is a minority shareholder of another company. We can also refer to any two companies as affiliated companies when they are owned and controlled by a third entity.

For instance, Bank of America has a lot of affiliates, including Merrill Lynch, U.S Trust, and Balboa.

What are the Different Concepts of Transfer Pricing?

One must understand the following concepts to get in-depth knowledge about how TP works:

Arm’s Length Principle

It is the cornerstone concept in Transfer pricing. It refers that any transaction between related/ affiliated parties has been conducted as if they are independent parties at arm’s length. Here, arm’s length means under the same conditions as the open market.

Related Parties

Transfer pricing or TP applies to related companies/ parties. It means that the parties in question, such as subsidiaries, parent companies, and affiliated parties, are under the same control. They are often part of large multinational corporations.

Comparable Uncontrolled Price

It is one of the most basic and straightforward methods of calculating/ determining Transfer pricing. It refers to comparing transfer prices between two related parties with those of two unrelated parties under the same conditions.

Cost Plus Method

This method determines the transfer price by adding an appropriate profit margin to the costs incurred by the selling entity in producing the goods or providing services.

Profit Split Method

This method allocates profits between related parties according to their relative contributions. The contributions are the addition to the value chain or the overall profitability of the multinational group.

Resale Price Method

The resale price method determines the transfer price by subtracting an appropriate profit margin. In this concept, the advisories or experts deduct the margin from the resale price of the goods and services procured from a related party.

Why Transfer Pricing is Significant for International Trade

Multinational corporations have a large network of subsidiaries, affiliates, and branches across various jurisdictions in the global economy, making the facilitation of transfer pricing critical for two main reasons:

Taxation

Transfer pricing ensures direct involvement in allocating profits between different entities of the same group. Proper transfer pricing management has significant implications for tax planning and compliance with tax laws in each jurisdiction. Top 10 accounting firms in Australia, like PwC Australia and KPMG Australia, deal with transfer pricing and offer advisory on different tax implications.

Customs Duties and Risk Management

Different countries have different regulations and transfer pricing guidelines that companies must adhere to for conducting business. Compliance with these regulations is essential to avoid penalties and disputes with tax authorities.

In cross-border trade, transfer pricing affects customs import/export duties because they are often calculated on the declared value of goods transferred between related parties.