Transfer pricing is, in effect, the ways in which a company adjusts and sets the prices it charges between various companies. This sample essay from Ultius explores ways in which transfer pricing can affect the development of tax opportunities for companies, as well as discussing the downsides to the use of transfer pricing in the modern marketplace. Transfer pricing can be:

• Analyzed to determine how a company allocates its resources
• Defined as the practice of setting, analyzing, documenting, and adjusting the prices charged between companies for products, services, or property use

The following analysis will:

1. Determine the ways in which transfer pricing affects organizations
2. Analyze the way in which transfer pricing can provide tax planning opportunities for organizations
3. Explore the way transfer pricing can affect the personnel who work in an organization
4. Explain how the practices of transfer pricing are beneficial as certain ethical issues arise

Understanding transfer pricing

Transfer prices can provide tax planning opportunities for organizations. According to Stayon, in order to be able to obtain tax planning opportunities, organizations must work closely with the IRS in order to determine which method of transfer prices they must utilize in order to obtain the best tax planning opportunity. Company executives must prove their leadership ability and put careful foresight into the decisions that go into setting transfer prices.

“Current law allows considerable flexibility in setting the transfer price. Within the limits allowed, the price can be set to maximize taxable income for the entity with the lower marginal tax rate and to minimize taxable income for the entity with the higher marginal tax rate” (Stryon, 2007).

The appropriate method for setting transfer prices can be beneficial or damaging for an organization’s tax planning needs.

Methods and guidelines for transfer pricing

The United States treasury sets methods and guidelines for setting prices. If these guidelines are followed, tax deductions are provided to the organizations.

“If the taxpayer plans and properly documents the process used in setting the transfer price and the adjustments made to improve comparability, the taxpayer can effectively plan transfer prices to reduce taxes for the controlled group as a whole” (Stron, 2007).

By ensuring that their arrangements with other transactions are comparable, the organizations can qualify for the tax deductions provided by the IRS. They can also plan future tax planning initiatives. For example, Samsung's electronics division could benefit from transfer pricing by adjusting costs between its battery and microchip vendors. Setting these prices could reduce tax burdens for that year or future filings.

Negative consequences

Transfer pricing can also have important consequences for the personnel in an organization. The model of transfer pricing which an organization chooses to use can have consequences for the morale, compensation, and productivity of a company’s personnel. If transfer pricing is done in a manner which is effective and beneficial for the company, the profits of the company can be increased. However, if transfer pricing is done ineffectively it can have negative ramifications for the company.

“In these cases, inaccurate transfer prices may impede rather than stimulate the efficient allocation of resources. For example, if a transfer price is established at an arbitrary low level, divisions that purchase the transfer good may appear to be more profitable and thereby command a disproportionately large allocation of scarce resources” (Abdel-Khalik, 1974).

When the results of transfer pricing lead to success this leads to increased morale within the company which can lead to increased productivity, as happy workers equal efficient workers. With increased productivity and increased profits for the company can lead to increased compensation for the personnel of the company. If a company has additional money they may be more willing to increase the pay they give their personnel, which in turn motivates employees to perform better and increases profits. This demonstrates why it is crucial to engage in effective transfer pricing policies for organizations and also the management that drives these practices.

Downsides to transfer pricing

Transfer pricing is not all beneficial as the practice can lead to unethical conduct in business. The pursuit of profits from the methods of transfer pricing. As demonstrated earlier companies can use transfer pricing to create tax planning opportunities for themselves. However, the practice can also lead to abuse of the tax laws.

“There is evidence that multinational corporations take advantage of the detailed, subjective regulations which govern Internal Revenue Code Section 482, with regard to intercompany transfer pricing” (Hansen 1992).

By adjusting prices solely for the benefit of obtaining tax deductions the company could be seen as violating not just ethical business practice codes but also IRS regulations.

Transfer pricing can also lead to unethical business practices in that a company might unfairly set prices that are profitable for themselves while unprofitable for other companies. These practices may occur more often with wealthier companies engaging in services with poorer companies. (Watson, 1975). Transfer pricing can lead to a small business failing while a major corporation like Walmart continues to make a profit. Unethical practices can create a negative connotation for the practice of transfer pricing and lead to the creation of additional laws and regulations which may lead to the practice of transfer pricing being abolished.

Summarizing transfer pricing

As other business practices, the practice of transfer pricing needs to be conducted in an ethical manner. Transfer pricing practices need to take into account the benefit of not only the upper management within a company but also the personnel within the company and the other businesses with which the organization does business with. The methods of transfer pricing need to be analyzed thoughtfully as the right transfer pricing method can benefit a company or do harm to a company. The study of transfer pricing is important in analyzing the various ways in which organizations interact and do business with each other.

References

Abdel-Khalik, A. R., Lusk, E. J. (1974). Transfer pricing-a synthesis. The Accounting Review, 49(1), 8-23.

Garrison, Noreen Noreen, Eric. (2010). Managerial Accounting for Managers. McGraw Hill Education.

Hansen, D. R., Crosser, R. L., Laufer, D. (1992). Moral ethics v. tax ethics: The case of transfer pricing among multinational corporations. Journal of Business Ethics, 11(9), 679-686.

Stryon, Joey. (2007). Transfer Planning and Tax Planning. The CPA Journal. Retrieved from: [http://www.nysscpa.org/cpajournal/2007/1107/essentials/p40.htm]

Watson, D. J., Baumler, J. V. (1975). Transfer pricing: a behavioral context. Accounting Review, 466-474.