transfer+pricing


 * Transfer Pricing**

Michelle Bennett Abel Ernstberger

For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary, with the choice of the transfer price affecting the division of the total profit among the parts of the company. This has led to the rise of transfer pricing regulations as governments seek to stem the flow of taxation revenue overseas, making the issue one of great importance for multinational corporations.
 * Transfer pricing** refers to the pricing of goods and services within a multi-divisional organization, particularly in regard to cross-border transactions.

Source: http://en.wikipedia.org/wiki/Transfer_pricing

Additional Information -

Transfer pricing describes all aspects of intercompany pricing arrangements between related business entities, including transfers of intellectual property; transfers of tangible goods; services and loans and other financing transactions.

Inter-company transactions across borders are growing rapidly and are becoming much more complex. Compliance with the differing requirements of multiple overlapping tax jurisdictions is a complicated and time-consuming task.

At the same time, tax authorities from each country are imposing stricter penalties, new documentation requirements, increased information exchange and increased audit/inspection activity.

Division managers are provided incentives to maximize their own division's profits. The firm must set the optimal transfer prices to maximize company profits or each division will try to maximize their own profits leading to lower overall profits for the firm. Double marginalization is when both divisions mark up prices in excess of marginal cost and overall firm profits are not optimal.

Overall profits of a firm are maximized when NMRd = MRd - MCd MCu NMRd = net marginal revenue to downstream division MRd = marginal revenue to downstream division MCd = marginal cost to downstream division, MCu marginal cost to upstream division Therefore, from this you can see that profits are maximized when the transfer price is set at the upstream divisions marginal cost. Pt = MCu Total MC = MCd + Pt or MCd + MCu Downstream division profits maximized at MRd = MCd + Pt. This is also the same as MRd - MCd MCu.

Example: Company X produces car engines in a plant in Michigan and puts together the entire car in Indiana. Each of these locations are a division of the company that has to meet their own profit margins. Company X tells the engine division in Michigan that they must make a profit of $500 per engine. They also tell the final assembly division in Indiana that they must make a profit of $2,000. The engine division in Michigan wants to set a price in which they will make the required profit. However, if they set this price too high then the Indiana division will not make their required profit and the total company will have less of a profit. Each division must set a transfer price in which the company will be the most profitable and not based on each division being the most profitable.

1) True or False: Firms should set the transfer price at an amount greater than the upstream divisions margainal cost.
 * QUESTIONS:**

2) Transfer pricing is a. The price set when a company sells a good to a consumer. b. The price set for a good between 2 different organizations. c. The price set for a good between different divisions in the same organization. d. The price set for a good between 2 different consumers.

3) Transfer pricing can be used for which of the following types of goods? a. Intellectual property b. Tangible property c. Financing transactions d. All of the above

4) Can transfer pricing affect taxes? a. Yes b. No

1) False; Firms should set the transfer price at an amount equal to the upstream divisions marginal cost or the firms profits will not be maximized.
 * ANSWERS:**

2) C; Transfer pricing is defined as the pricing of goods between divisions within a multi-divisional organization.

3) D; Transfer pricing can be used for many different types of items between multi-divisional organizations.

4) A; Transfer pricing is often used in a way between cross-border divisions to decrease taxes. There are now many tax laws to try and prevent some of the taxation avoidance. This is becoming very complicated.