13.

7 Transfer Pricing Transfer pricing is a method of pricing of goods and services between parent and subsidiary or between two subsidiaries. It is a technique used to transfer funds from one location to another. It helps in positioning the funds at a desired location. It is a pricing technique for inter-corporate transactions. There are different subsidiaries of an MNC that operate in some or different countries that may be linked due to vertical or horizontal linkages. Example 13.1: A garment manufacturing unit may be buying the raw material from its subsidiary. This is a vertical linkage. Raw material will be charged at a transfer price from the subsidiary. Determination of transfer prices Transfer prices are set on the basis of arms length prices. These are the prices prevailing in transactions between unrelated parties engaged in similar or the same trade under similar conditions in the open market. There are two components involve (a) Market price (b) Cost of production When a firm can sell its output either to its subsidiary or to any other firm in the market, it is an open market. When there is an open market, arms length price is equal to the market price. Figure 13.1 gives an example of an open market. Subsidiary A Subsidiary B Parent Subsidiary C Subsidiary D Figure 13.1 Example of Open Market

Source: Compiled by Author Transfer Price = Market Price Subsidiary A will sell its product to Subsidiary B at the market price, because if Subsidiary B does not buy from it, it can sell the product to other companies in the market. If it sells at less than the market price, it will be decreasing its profit. Here, we can clear the concept of the uncontrolled market price and resale price. Uncontrolled market price: It is the direct way of calculating arms length price. Uncontrolled sales are made to an unrelated party outside the firms own network. Resale price is the price at which the product that has been bought from a subsidiary is resold to an independent buyer. The reseller margin (cost + profit) will be deducted to find the arms length price. This method is used when a comparable uncontrolled market price does not exist or the reseller margin is not much. A multinational company can help achieve the goal by shifting profits from high-tax to low-tax jurisdictions. For example, take Hungary, with a corporate tax rate of 16 per cent, and France, with a tax rate of 35 per cent. An MNC with divisions in these two locales will benefit by shifting more profit toward Hungary and less to France. Each division is controlled by corporate headquarters, which can set a transfer price to benefit the entity as a whole

Financial Reporting
The types of frequency of reports depend on the nature of the business and its situation. For example, if the business is in some sort of crisis, management, bankers, etc., may require frequent reports of various types. In the case of corporations, your board typically will require regular financial reports at each board meeting. When your business just gets started, the chief executive might prepare and present financial reports to the board. When the business develops, a board finance committee can be a big help. The committee, led by the board treasurer, ensures that reports are complete and helps present them to other members of the board.

The board may require a cash flow statement, profit and loss statement and balance sheet at each meeting. They also may request descriptions of finances for upcoming, major initiatives. They may request information prior to filing taxes. They will certainly need to see any results from financial audits.

Budget
An estimate of costs, revenues, and resources over a specified period, reflecting a reading of future financial conditions and goals. One of the most important administrative tools, a budget serves also as a (1) plan of action for achieving quantified objectives, (2) standard for measuring performance, and (3) device for coping with foreseeable adverse situations.

Transfer Pricing Methods Traditional Transaction Methods 2.1.1 ComparableUncontrolled Price The Comparable Uncontrolled Price (CUP) method comparesthe price charged for property orservicestransferred in a controlled transaction to the price charged for property orservices transferred in a comparable uncontrolled transaction in comparable circumstances. It should be observed that the CUP method is also used in practice with respect to royalties. The CUP method applies to controlled transactions of property and services. CUPs may be found as internaltransactions or as externaltransactions. Resale Price Method The resale price method is one of the traditional transaction methods that can be used to apply the arms length principle. The resale price method focuses on the related sales company which performs marketing and selling functions as the tested party in the transfer pricing analysis. Cost Plus Method In a controlled transaction involving tangible property, the cost plus method focuses on the related manufacturing company as the tested party in the transfer pricing analysis. The cost plusmethodmay also be used in the case ofservicesrendered. The cost plus method begins with the costsincurred by the supplier of property (orservices) in a controlled transaction for property transferred or services provided to a related

purchaser. An appropriate cost plus mark up is then added to this cost, to make an appropriate profit in light of the functions performed, risks assumed, assets used and market conditions. The cost plus method is used to analyse transfer pricing issues involving tangible property or services both under the OECD Transfer Pricing Guidelines and the US transfer pricing regulations. It is most useful where it is applied to manufacturing or assembling activities and relatively simple service providers. The cost plus method focuses on the related party manufacturer or service provider as the tested party in the transfer pricing analysis. The method evaluates the armslength nature of an intercompany charge by reference to the gross profit mark up on costs incurred by suppliers of property (or services) for tangible property transferred (or services provided). It compares the gross profit mark up earned by the tested party for manufacturing the product or for providing the service to the gross profit markups earned by comparable companies