TRANSFER PRICING

4/21/2017
INSTITUTE OF MANAGEMENT
SCIENCES,UNIVERSITY OF LUCKNOW
NAVAZISH ABBAS
What is a 'Transfer Price'
A transfer price is the price at which divisions of a company transact with each other, such
as the trade of supplies or labor between departments. Transfer prices are used when
individual entities of a larger multi-entity firm are treated and measured as separately run
entities. A transfer price can also be known as a transfer cost.

BREAKING DOWN 'Transfer Price'

In managerial accounting, when different divisions of a multi-entity company are in charge
of their own profits, they are also responsible for their own return on invested capital
(ROIC). Therefore, when divisions are required to transact with each other, a transfer price
is used to determine costs. Transfer prices tend not to differ much from the price in the
market because one of the entities in such a transaction loses out; they start either buying
for more than the prevailing market price or selling below the market price, and this affects
their performance.

Regulations on transfer pricing ensure the fairness and accuracy of transfer pricing among
related entities. Regulations enforce an arms-length rule that states that companies must
establish pricing based on similar transactions done between parties not of the same
related company but at arms length.

Documentation Required for Transfer Pricing

Transfer pricing is closely monitored within a companys financial reporting and requires
strict documentation that is included in financial reporting documents for auditors and
regulators. This documentation is closely scrutinized; if inappropriately documented, it can
lead to added expenses for the firm in the form of added taxation or restatement fees.
These prices are closely checked for accuracy to ensure that profits are booked
appropriately within arms-length pricing methods and associated taxes are paid
accordingly.

Transfer prices are often used when companies sell goods within the company but to parts
of the company in other international jurisdictions. This type of transfer pricing is common.
Approximately 60% of the goods and services sold internationally are done within
companies as opposed to between unrelated companies.

Transfer pricing multinationally has tax advantages, but regulatory authorities frown upon
using transfer pricing for tax avoidance. When transfer pricing occurs, companies can book
profits of goods and services in a different country that may have a lower tax rate. In some
cases, the transfer of goods and services from one country to another within an interrelated
company transaction can allow a company to avoid tariffs on goods and services
exchanged internationally. The international tax laws are regulated by the Organization for
Economic Cooperation and Development (OECD), and auditing firms within each
international location audit financial statements accordingly
Current Transfers
Current transfers are current account transactions in which a resident entity in one nation
provides a nonresident entity with an economic value, such as a real resource or financial
item, without receiving something of economic value in exchange. Current transfers are
transactions where the originator does not receive a quid pro quo in return; this absence of
economic value on one side is represented in the balance of payments by one-sided
transactions called transfers. Current transfers affect the current account and are separate
and distinct from capital transfers, which are included in the capital and financial account.
Current transfers include workers remittances, donations, tax payments, foreign aid and
grants.

BREAKING DOWN 'Current Transfers'

Current transfers include all transfers that do not have the following characteristics of capital
transfers:

1. Transfers of ownership of fixed assets;

2. Transfers of funds linked to acquisition or disposal of fixed assets; and
3. Forgiveness by creditors of liabilities without any counterparts being received in
return

Current transfers are classified into two main categories general

government and other sectors.

General government transfers include the following:

Transfers in cash or kind backed by international cooperation between

governments of different economies, or between a government and an
international organization;
Cash transfers between governments for financing current expenditures by
the recipient government;
Gifts of food, clothing, medical aid, etc. as relief efforts after a natural
disaster;
Gifts of certain military equipment; and
Current taxes on income and wealth, and other transfers such as Social
Security contributions.
Other sectors transfers include the following:

Workers remittances by migrants (someone who stays in another nation

for more than a year) who are considered residents of other countries;
Transfers in cash and kind for disaster relief;
Regular contributions to charitable, religious, scientific and cultural
organizations; and
Premiums and claims for non-life insurance.