Purpose of transfer pricing

Modus operandi of transnational transfer pricing for window dressing 56 transfer product when doing so maximizes consolidated corporate profits, and at least one manager will refuse the transfer when transferring product is not the profit-maximizing strategy for the company. 3 When multinational firms transfer product across international borders, transfer prices are relevant in the calculation of income taxes, and are sometimes relevant in connection with other international trade and regulatory issues. The following table provides examples. Table 1 Examples of transfer pricing purpose An external market price is available No external market price is available The downstream division will sell “as is”: The West Coast Division of a supermarket chain transfers oranges to the Northwest Division, for retail sale. A pharmaceutical company transfers a drug that is under patent protection, from its manufacturing division to its marketing division. The downstream division will use the transferred product in its own production process: An oil company transfers crude oil from the drilling division to the refinery, to be used in the production of gasoline. The Parts Division of an appliance manufacturer transfers mechanical components to one of its assembly divisions. The transfer generates journal entries on the books of both divisions, but usually no money changes hands. The transfer price becomes an expense for the downstream division and revenue for the upstream division. Following is a representative example of journal entries to record the transfer of product: 1 Upstream division: a. Intercompany accounts receivable 9,000 Revenue from intercompany sale 9,000 b. Cost of goods sold–intercompany sales 8,000 Finished goods inventory 8,000 To record the transfer of 500 cases of Clear Mountain Spring Water, at 18 per case, to the Florida marketing division, and to remove the 500 cases from finished goods inventory at the production cost of 16 per case. 2 Downstream division: Finished goods inventory 9,000 Intercompany accounts payable 9,000 To record the receipt of 500 cases of Clear Mountain Spring Water, at 18 per case, from the bottling division in Nebraska

6. T

raditional transaction methods 6.1 The OECD Guidelines refer to the following methods as “traditional transaction method” 1 Comparable uncontrolled price method CUP; 2 Resale price method RPM; and 3 Cost plus method CP method or C+.

6.2 These are described below and are different from the transactional profit methods

1 Profit split method; and 2 Transactional Net Margin Method TNMM. The OECD Guidelines prefer the use of the traditional transaction methods, whereby the other methods Modus operandi of transnational transfer pricing for window dressing 57 should be used as methods of last resort for example when there is no data available or available data cannot be used reliably. However, the Guidelines stress there is no best-method rule: a taxpayer is only required to show that the method used delivers a reasonable at arm’s length result and is not required to disprove the use of each other method than the method used.

6.3 Transfer pricing options