Transfer pricing is an accounting practice that represents the price (based on market prices) that a parent company charges another division, subsidiary, or holding company, for goods and services rendered. For example, a textile manufacturer has two subsidiaries, A (a cotton supplier) and B (a textile manufacturer). Subsidiary A sells cotton to subsidiary B (as well as other companies) at the same market price.
Transfer pricing transcends domestic transactions as it can also be utilised internationally. Multinational corporations (MNCs) are legally permitted to utilize this transfer pricing method to distribute earnings between their various subsidiaries and affiliated companies. MNCs can conduct effective and legal transfer pricing by taking advantage of different tax regimes in different countries and raising transfer prices for goods and services produced in countries with lower tax rates.
Transfer pricing comes with many benefits that make it a tool for businesses to generate profit, avoid increased tax impacts, etc. In this article, we will explain how your business will benefit from this price transaction mechanism.
1. It Enhances Transparency
Transfer pricing enables fair and transparent deals between parent companies and their divisions, subsidiaries, departments, or holding companies. In the absence of this pricing model, parent companies could manipulate the prices of goods and services arbitrarily, leading to revenue loss and, subsequently, stagnation in the company’s overall growth. The division, subsidiary, department, or holding company that is (for example) charged exorbitant prices for their purchases would naturally suffer losses, even though the purchases are made with its parent company.
Fair and transparent transfer pricing will be able to discourage the effect of “mispricing”, which can also lead to animosity between divisions, subsidiaries, departments, or holding companies when a particular division experiences revenue losses, subsidiary, department, or holding company, as a result of “price manipulation” by the parent company.
2. It is Cost-Effective
With reasonable and acceptable transfer pricing policies, both parties (i.e., the parent company and the divisions, subsidiaries, departments or holding companies) can experience cost savings in their dealings with each other. The price charged for goods or services acquired from another department under the same parent company should generally be fair in relation to the market price, as whatever the price of goods or services offered to “outside” companies is also applied to similar transactions to another department under the same parent company.
3. Ensures Product Availability
Another benefit of this pricing mechanism is the reduction in reliance on outside suppliers. Since the production chain from raw materials, manufacturing to finished products are all under the same parent company, the stock is readily available as and when required. Everything is under one roof! There is no need to make purchases from other companies, wait for the stock to arrive (and experience late deliveries from suppliers), or be exploited by outside suppliers in other ways.
4. Reduces Duty Costs
High duty costs are detrimental to companies with international businesses dealings, but this is inevitable as some countries have high tariff rates. This can affect a business as high duty costs for imports lead to a rise in costs of goods/services, which can affect the company’s profit margin in the long run. With adjustments in transfer pricing (e.g., low transfer prices are applied when a country has high tariff rates), the duty base of the transfer is decreased.
5. Reduces Income and Corporate Taxes
Another benefit of implementing the transfer pricing mechanism is that it can reduce income and corporate taxes in high-tax countries where companies are likely to experience low-profit margins. To make up for this, they adjust the price of their goods and services (by overpricing them) when transferring to countries with low tax rates. This will enable companies to obtain higher profit margins to continue to stay in business.
In a Nutshell
Transfer pricing is a tool for every MNC. It encourages transparency between parent companies and their divisions, subsidiaries, and holding companies; is cost-effective; ensures easy availability and accessibility of stock; reduces duty costs, income and corporate taxes, etc. In order to make the most of the benefits of transfer pricing, there is accounting software that may help you with it. It might also come with features for small company bookkeeping that can help you keep accurate financial records of your business’s different divisions, subsidiaries, or holding companies. Accounting processes have never been so easy and efficient! For more information, feel free to get in touch with us.