Multinational Transfer Pricing

1
Multinational Transfer Pricing

• Parent company owns a foreign subsidiary
• Entity parent or subsidiary
• One entity supplies the other a component
• Transfer price is price paid to the supplier by
  the entity that receives the component
• Consolidated firm parent cum subsidiary
• Aim minimize consolidated firm taxes

2
Minimize consolidated taxes

• Tax rule transfer price must equal the
  arms-length price, otherwise transfer price is
  deemed an illegal tax dodge (evasion)
• However, arms-length price is not a specific
  value but a range of values (GlaxoSmithKline)
• Some scope for tax avoidance exists
• Higher tax entity should pay more/receive less
  lower tax entity should pay less/receive more
• Succinct rule High pays high! Low pays low!

3
Absence of taxes

• Entity a pays b transfer price
• Proposed shift a pays X per unit more
• For consolidated firm, shift is of no consequence
  absent taxes akin to moving a coin from one
  pocket to another pocket
• But if taxes present a would have a higher tax
  shield, b would have a higher tax liability
• Higher tax entity should pay more/receive less
  lower tax entity should receive more/pay less

4
Tax gain per unit calculation

• Entity a pays b transfer price
• Proposed shift a pays X per unit more
• Ta tax rate of entity a
• Tb tax rate of entity b
• Tax gain per unit from shift X (Ta Tb)
• Gain XTa (tax shield from increased expense) but
  lose XTb (more tax liability)

5
Parent buys from subsidiary

• Current transfer price 4.50
• Arms length price in range (4 , 6)
• Parent Tp 40, subsidiary Ts 25
• Increase transfer price X 1.50
• Consolidated firms tax gain per unit 1.50
  (40 - 25) 0.225

6
Parent buys from subsidiary

• Current transfer price 4.50
• Arms length price in (4 , 6)
• Parent Tp 25, subsidiary Ts 40
• Decrease transfer price X -0.50
• Consolidated firms tax gain per unit -0.50
  (25 - 40) 0.075

7
Subsidiary buys from parent

• Current transfer price 4.50
• Arms length price in (4 , 6)
• Parent Tp 40, subsidiary Ts 25
• Decrease transfer price X - 0.50
• Consolidated firms tax gain per unit
• -0.50 (25 - 40) 0.075

8
Subsidiary buys from parent

• Current transfer price 4.50
• Arms length price in (4 , 6)
• Parent Tp 25, subsidiary Ts 40
• Increase transfer price X 1.50
• Consolidated firms tax gain per unit
• 1.50 (40 - 25) 0.225

9
Negative Behavioral Implications

• Tax-minimizing transfer pricing
• High-tax entity low profits
• Low-tax entity high profits
• Incentive system managers pay based on entity
  profits
• High-tax entity manager System is unfair!
• Solution incentive pay based on consolidated
  (not entity) profits