When a company uses selective prices for internal transactions, for instance, between two subsidiaries. As companies increase the number of worldwide subsidiaries, joint ventures, company-owned distributing systems and other marketing arrangements, the price charged to different affiliates becomes a key question.
Transfer pricing is determined by:
- Market conditions
- Economic conditions;
- The level and type of competition in overseas markets
- Exchange rates
- Price controls
- Tax burdens
The objectives of the transfer pricing system include:
ØMaximising profits for the corporation as a whole
ØFacilitating parent-company control
ØOffering management at all levels, both in the product divisions and in the international divisions
Four arrangements for pricing goods for intracompany transfer are:
- Sales at the local manufacturing cost plus standard mark-up
- Sales at the cost of the most efficient producer in the company plus a standard mark-up
- Sales at negotiated prices
- Arm’s length sales using the same prices as quoted to independent customers: this one is the most acceptable to tax authorities and most likely to be acceptable to foreign divisions.
The most appropriate basis for intracompany transfers depends on the nature of the subsidiaries and market conditions.