Transfer pricing is a fiscal system of intercompany pricing, whereby a price is charged by a subdivision of an international operating organization to another division within the conglomerate for delivered goods or services rendered. Transfer pricing is not just applicable to continuously expanding multinationals, it also occurs on a much smaller scale; for instance when a small- or medium-sized enterprise (SMEs) operates in the border region of the Netherlands with the use of a subsidiary or permanent establishment in Germany or Belgium, intercompany pricing matters might present itself.
The primary feature of transfer pricing is that when goods are delivered or services are performed to the benefit of another subdivision of the organization, the conditions of the transaction are not determined by the free market. The transaction conditions do not directly influence the total generated profit of the organization, however they do impact the generated profit of the various subdivisions of that organization in the several fiscal jurisdictions in which that organization is active. This makes it interesting to allow for the highest generated intercompany profit to take place in a jurisdiction with a relatively low effective tax rate and thereby reducing the organization’s consolidated net profit and consolidated tax burden.
Transfer pricing is therefore an excellent management control tool to effectively assess through corporate analysis where the profit centers reside within the organization and if there are inefficient functioning centers within the organization, commonly known as the ‘bleeders’. Nevertheless, there are limitations to the full utilization of intercompany pricing. There is a social-economic boundary that causes management and employees of subdivisions that make a relatively marginal profit to resist against transfer pricing, since the system might frustrate promotions and performance remuneration. Moreover, there is a fiscal limit to intercompany pricing, which determines the permitted mathematical methods of transfer pricing. Consequently, these methods are ordained by (international) law in the principle known as arm’s length. Doing business at arm’s length entails a requirement that bodies of organizations, which are connected to each other through capital, management or corporate governance, with respect to their mutual legal relation agree to not deter from a (transfer) price, which would have been agreed upon, if the parties had been independent and operating in a free market.
Transfer pricing has more than one application; it can be applied to determine the price for the sale of products or the provision of services between subdivisions of a multinational concern. However, transfer pricing is also used as the price for placing immaterial goods at a subdivision’s disposal or the lending of liquid capital. Moreover, transfer pricing does not only play a role in international trading, it also is of vital importance within a fiscal unity, in particular the settlement of losses. It can also make a difference in the economic relation between taxed and tax-exempted entities.
“The price of greatness is responsibility.”Winston Churchill (30/11/1874 – 24/01/1965), English Statesman
Van Clamsfield International Ltd. provides robust advice and knowledge in reference to the following transfer pricing applications:
In some instances, transfer pricing has been given a bad reputation due to misuse by powerful corporations operating in developing countries, in which there existed little knowledge of transfer pricing techniques. Off course, this is not a method of business interaction that is supported by Van Clamsfield International Ltd. Instead, Van Clamsfield International Ltd. advocates a fair remuneration for the various corporate subdivisions and with that ensuring a fair payment of taxes to the local tax authorities. Of all world trade, 60% takes place within multinational concerns. When applied correctly, transfer pricing can – within reasonable limits - provide fiscal optimization of the corporation’s profits.