TRANSFER PRICING

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Course Code: IBO – 06
Course Title: International Marketing Logistics
Assignment Code: IBO-06/TMA/2019-20
Coverage: All Blocks

IBO – 06 International Business Finance Solved Assignment for 2019-20

Q3.) (a.) What is transfer pricing? Explain with example the technique of transfer pricing.

Ans: Transfer pricing is an accounting practice that represents the price that one division in a company charges another division for goods and services provided. Transfer pricing allows for the establishment of prices for the goods and services exchanged between a subsidiary, an affiliate, or commonly controlled companies that are part of the same larger enterprise. Transfer pricing can lead to tax savings for corporations, though tax authorities may contest their claims. For example, if a subsidiary company sells goods to a parent company, the cost of these goods paid by the parent to the subsidiary is the transfer price.

The objective of Transfer Pricing is as follows:

1.) Maximizing overall after-tax profits.

2.) Reducing incident of customs duty payments.

3.) Circumventing the quota restrictions on imports.

4.) Reducing exchange exposure, circumventing exchange controls, and restricting profit repatriation so that transfer firm's affiliates to the parent can be maximized.

5.) Transferring of funds in locations so as to suit corporate working capital policies.

There are essentially two ways of negating Transfer Pricing i.e., for determining the arm's length price. These are; (i) Transactional Methods, (ii) Non-Transactional Methods.

i) Transactional Methods: These are called so as they generally intend to work out the transactions in specific detail to arrive at the arm's length value for each transaction in question and thus arrive at the overall recast profits figure when the transaction undertaken by the company have been bought at a fair value term. There are three methods collated in this transactional approach.

(a.) Comparable Uncontrolled Price Method: This method of setting transfer price is based on market forces and hence is considered as the best evidence of arm's length pricing. However, there are practical problems involved in using this method because of differences in quality, quantity, the timing of sales, and proprietary trademarks.

(b.) Resale Price Method: In the resale price method, considered as a second-best approach to arm's length pricing, first of all final selling price to an independent buyer is set and the appropriate mark-up for the distribution subsidiary is subtracted. This markup represents the distribution of the subsidiary's cost and profits.

The price so set is then employed as the intra-company transfer price for similar items. However, it is not easy to determine an appropriate mark-up, particularly when the distribution affiliate adds value to the item through subsequent processing or packaging or both.

(c.) Cost-Plus Method: The transfer price under cost-plus method is determined by adding suitable profit mark-up to the seller's full cost comprising direct cost and overhead cost. Allocation of overhead cost in computing full cost poses problem and involves subjectivity, especially when joint products are involved.

ii) Non-transactional Methods: These methods apply in a broader perspective wherein the overall figures of related entities are taken into account and adjusted to arrive at arm's length terms.

(a.) Profit Split Method: Under this method, the profits of related parties are collected and then split up between the two in a manner which in the opinion os the national authorities is right allocation of profits on the basis of commercial and productive activity carried out within their territory.

(b.) Transactional Net Margin Method: This method generally taken into account the margin that is earned by a related entity in question. This method takes into account the margin figures and seeks to adjust them on the basis of the real nature and depth of the operations in question. Once the margins are set, the profit levels are recomputed on an aggregated basis, and thus taxable amounts determined accordingly.