According to a new survey by Ernst & Young that transfer pricing is the most important international tax issue that multinational enterprises (MNEs) now face. Transfer pricing involves the price at which transactions between units of multinational companies take place, including the intercompany transfer of goods, property, services, loans, and leases. Transfer Pricing has attracted increasing worldwide attention.
The significance of the issue is obvious when we recognize that transfer pricing (1) is conducted on a relatively larger scale internationally than domestically (2) is affected by more variables than are found in a strictly domestic setting (3) varies from company, industry to industry, and country to country, and (4) affects social, economic and political relationships in multinational business entities and sometimes, entire countries
Governments around the world require transfer pricing methods base on the arm’s-length principle. That is a multinational ‘s business in different countries are taxed if they were independent firms operating at arm’slength from each other. The complex calculation of arm’s-length prices is less relevant today for global companies because fewer of them operate this way. An arm’s-length price is one that an unrelated party would receive for the same or similar item under identical or similar circumstances.
Acceptable arm’s-length pricing method include (1) comparable uncontrolled pricing (2) resale pricing (3) cost-plus pricing, and (4) other pricing methods. An emerging consensus among governments views arm’s-length pricing as the appropriate standard in calculating profits for tax purposes. However, countries vary in how arm’s-length pricing is interpreted and implemented, As a result, it is somewhat fluid concept internationally
Transfer Pricing schemes designed to minimize global taxes often distort the multinational control system. When each subsidiary is evaluated as a separate profit center, such pricing policies can result in misleading performance measures that generally lead to conflicts between subsidiary and enterprise goals. The international transfer pricing system must also attempt to accomplish objectives that are irrelevant in a purely domestic operation
These objective include (1) worldwide income tax minimization (2) minimization of worldwide import duties (3)avoidance of financial restrictions, (4) managing currency fluctuations, and (5) winning host country government approval. It is unlikely that a MNC will be able to accomplish all objectives with a single transfer pricing strategy. Priorities usually include the minimization of worldwide income taxes and import duties.
Advance Pricing Agreement (APAs), or they are called an Advance Pricing Arrangement (United Kingdom),and Preconfirmation System (Japan), are a mechanism whereby a multinational and a taxing authority voluntarily negotiate an agreed transfer pricing methodology that is binding on both parties. These agreements reduce or eliminate the risk of a transfer pricing audit, saving time and money for both the multinational and the taxing authority. The agreements are binding for a fixed period of time, for example 3 years in the United State.