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Unformatted text preview: Chapter 11 - International Transfer Pricing CHAPTER 11 INTERNATIONAL TRANSFER PRICING Chapter Outline I. Two factors heavily influence the manner in which international transfer prices are determined: (a) corporate objectives, and (b) national tax laws. There are a variety of cost, especially tax, minimization objectives that MNCs might attempt to achieve through international transfer pricing. However, MNCs must be careful to comply with national tax laws in setting international transfer prices. II. The three bases commonly used for establishing transfer prices, both for domestic and international transactions, are: (1) cost-based transfer prices, (2) market-based transfer prices, and (3) negotiated prices. Theory suggests that different pricing methods are appropriate in different situations. III. There are two types of objectives to consider in determining international transfer prices: (a) performance evaluation and (b) cost minimization. A. Transfer prices affect the reported profit of both parties to an intercompany transaction; revenue for the seller and an expense for the buyer. To fairly evaluate performance, transfer prices should be acceptable to both the buyer and the seller, otherwise dysfunctional behavior can occur. B. Cost minimization objectives can be achieved by top management using discretionary transfer pricing. Possible objectives include minimization of worldwide income tax, minimization of import duties, circumvention of repatriation restrictions, and improving the competitive position of foreign subsidiaries. C. The objectives of establishing transfer prices to form a basis for fair evaluation of performance and at the same time minimize one or more types of cost through discretionary transfer pricing often conflict with one another. IV. National tax authorities have guidelines regarding what is an acceptable transfer price for tax purposes. These national laws often are based on OECD guidelines. The basic rule is that intercompany transactions should be made at an arms length price. V. Section 482 of the U.S. Internal Revenue Code requires intercompany transactions to be carried out at arms length prices. A. Section 482 gives the IRS the power to audit and adjust taxpayers international transfer prices if they are not found to be in compliance with Treasury department regulations. B. The IRS also may impose a penalty of up to 40% of the underpayment in the case of a gross valuation misstatement. VI. U.S. Treasury Regulations establish specific guidelines for determining an arms length price for sales of tangible property, licenses of intangible property, intercompany loans, and intercompany services. 11-1 Chapter 11 - International Transfer Pricing A. The best method rule requires taxpayers to use the method that under the facts and circumstances provides the most reliable measure of an arms length price. The two primary factors to be considered in determining the best method are (a) the degree of...
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- Spring '11