What does “transfer pricing” mean?

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What does “transfer pricing” mean?

In: Economics

Typically ‘transfer pricing’ is when you sell a product or partially finished product from one subsidiary to another. This is usually required when the subsidiaries are based in different countries.

It is often the case that a company might set up offshore factories or offshore manufacturing (or even manufacture in different subsidiaries). When you transfer the products, you have to record the transaction with a selling party and a buying party. The price that is charged is called the “transfer price”

The problem arises when the different countries have different tax regimes. In its simplest form, in a low income tax country, you will sell at a high transfer price or buy at the lowest transfer price. This allows a company to claim the “biggest” profit in the lowest tax regime. Conversely if you have a high tax regime, you’d transfer price into that country at the highest price possible to “lower” the profit in the high tax regime.

You actually have to justify (accounting-wise) to the tax authorities of course, which is why companies will sometimes register non-cash assets/IP etc in different countries (allowing them the ability to charge a royalty expense or goodwill/depreciation writeoff) or put high expense items in a high tax country and vice versa.