Transfer Pricing

Transfer pricing is a tax planning technique that involves manipulating the prices of goods, services, and intangible assets between related companies to avoid paying taxes in one jurisdiction and shifting profits to another.

How Transfer Pricing Works:

1. Related companies: Two or more companies that are controlled by the same parent company are involved.
2. Artificial pricing: Prices for transactions between the related companies are artificially inflated or deflated to create an imbalance.
3. Tax avoidance: The company with the artificially low prices pays less tax, while the company with the artificially high prices pays more tax.

Types of Transfer Pricing:

• Intangible assets: Prices of patents, trademarks, and other intangible assets are manipulated.
• Financial instruments: Prices of loans and other financial instruments are adjusted to create tax advantages.
• Manufacturing and distribution: Prices of goods and services are altered to shift profits between locations.
• Services: Prices of services, such as management consulting and accounting, are adjusted.

Example:

A multinational company manufactures electronics in Country A and sells them to a subsidiary in Country B. If the company artificially inflates the price of the electronics in Country B, it can reduce its tax liability in Country A and increase its tax liability in Country B.

Legality:

Transfer pricing is not necessarily illegal, but it is considered aggressive tax avoidance and can be challenged by tax authorities. The Organisation for Economic Co-operation and Development (OECD) has released guidelines to address transfer pricing issues.

Impact:

• Tax avoidance: Transfer pricing can result in significant tax avoidance, especially for multinational corporations.
• Distortion of market prices: Artificial pricing can distort market prices, leading to unintended consequences.
• Economic inequality: Transfer pricing can exacerbate economic inequality, as it can disproportionately benefit wealthy individuals and corporations.

Conclusion:

Transfer pricing is a complex tax planning technique that involves manipulating prices between related companies to avoid taxes. It is a controversial issue with both legal and ethical implications.