Know-How Exchange : Student Questions

Great answer from D4Demand. I won't try to top that.

What I would add is that there are standard accounting practices (at least in the US) which govern this kind of thing. For example, if you set an internal transfer price that includes some general corporate or administrative expenses, you have to be sure that those are not included in total company sales. Thus the transfer price really has to reflect only the "hard" costs, not any shared overhead or profit.

Without this limitation, a company would effectively double-count some portion of its profits when it rolls up division sales into the total corporate financial statements.

My experience is that transfer price is not nearly as fixed as what the prior two posts suggest. Adjusting a transfer price is one game that companies often do internationally to optimize their performance.

For example, if a company's profits are taxed heavily in country A (where you have an office that sells the product), but not in country B (where you make the product), you would use a high transfer price. To optimize profits, one which is high enough that the transfer price plus local sales and administrative expenses equals your sales price - so no profit in that country. This means you make all the profit in the lower tax country B, and none in A where it is taxed higher.

Companies don't have free reign with this - there are limitations in some countries. And governments know this game and watch for it (though not always effectively). But it definitely does happen.

In support of the henna gaijin posting, transfer pricing manipulation happens frequently with multinationals where prices are adjusted to maximize tariff concessions, government production or R & D grants, and tax benefits.

E.g. a company has losses in a division somewhere it cannot use up. By transferring goods or parts through that division and making a percentage on the way through, the losses is removed and the bottom line improves while producing no tax liability. Or maybe the tax liability moves to a lesser rate by switching the profit into a less onerous jurisdiction.

Hope this helps.

chrisb