Question

How do multinational corporations utilize transfer pricing to manage your taxes?

1)In your answer ensure that you give reasons when you would transfer at a lower price.

2)In your answer ensure that you give reasons when you would transfer at a higher price.

Answer 1

Transfer pricing is basically used when one business unit sell product or service to another business unit with both the units coming under the purview of a single corporation.

1) When a business unit sell at a lower price to another business unit, then the profit for the buying unit becomes higher because of a lower cost of purchase. Now if the buying unit is in a tax geography having a lower tax rate as compared to the selling unit, then the total tax outgo for the coporation would be less as compared to if the price was set higher.

For example Business unit A has tax rate of 30% and Business unit B has tax rate of 20%.

Now if A sells B for $100, then tax for A is $30 and tax saving for B is $20, resultant net tax outgo is $10. Now if A sells B for $80, then tax for A is $24 and for B, tax shield is $16 with a net atx outgo of $8. So reduction in price is better.

2) Similarly if selling business unit has a lower tax structure than the buying business unit, then selling at higher price is more profitable from tax outgo stand point.