Nov 2018 Q1 c.
Intra-group trading within multinational is trending and is a very important part of business today. This intra-group trade is aimed at promoting global trade competitiveness. Within this competitive environment, companies within the group usually trade with each other and therefore maybe required to set fair and arm length prices for goods and services. Such prices may give benefits other than the mere value for goods and services.
Required:
Identify and explain THREE (3) objectives of transfer pricing. (6 marks)
View Solution
- Goal congruence: The prices should be set so that the divisional management desire to maximize divisional earnings is consistent with the objectives of the company as a whole. The transfer prices should not encourage sub-optimal decision-making. The system should be so designed that decisions that improve business unit profits will also improve company profits.
- Foreign exchange gains maximized and loses minimized
Transfer prices could be set between group members such that, foreign exchange losses are minimized and the gains maximized. This can be achieved by setting the transfer price in the subsidiary domestic country currency, where currency strengthens against other subsidiaries domestic country currencies. The group stand to gain, if profit from exchange gain transaction is repatriated to the group for consolidation as part of income it derived from its worldwide operations. - Performance appraisal: The prices should enable reliable assessments to be made of divisional performance. The prices form part of information, which should:
*Guide decision making
*Appraise managerial performance
*Evaluate the contribution made by the division to overall company profits.
*Assess the worth of the division as an economic unit.
*The transfer prices should be designed such that they help in measuring the economic performance - Divisional autonomy: The prices should seek to maintain the maximum divisional autonomy so that the benefits of decentralization (motivation, better decision-making, initiatives, etc.) are maintained. The profits of one division should not be dependent on the actions of other divisions.
- Outwit international repatriation laws
In some jurisdictions there are legislations that bar repatriation of profit beyond certain amount, In the United Kingdom, only 5% of the group profit or turnover can be repatriated. Group members can outsmart this law, by setting lower transfer prices for intra- group transactions, so that, profit loading on the under invoiced goods remains with the foreign subsidiaries which could be consolidated as part of the group profit. - Reduce tax liabilities on transactions
Transfer price can be set between group members such that the overall tax liabilities of the group is reduced, and so maximizes the group profit. For instances, group members can under invoice goods to a subsidiary in low tax bracket, so that, those goods attract the minimum tax liability and the group benefits thereon, when the profit from those subsidiaries are remitted to the group. - Avoid anti- dumping legislations
Governments of subsidiary countries normally pass anti- dumping legislation to discourage the consumption of certain goods. In this situation, to maximize the group’s profit, the transfer price should be at a level to outwit this legislation. Group members may quote high or low prices depending on the circumstances of the subsidiary country government anti- dumping legislation, if an inferior product is laced with low price, then invoice prices on those goods can be increased to outwit the cap of the legislation. - Reduce tariffs on goods in transit
To minimize customs duties paid by the group members especially, when the tax is based on the value of the export (ad-valorem), low transfer prices should be quoted for goods invoiced between subsidiaries. Where tariffs are the highest in a particular subsidiary country, the group member invoicing goods to the former, will quote a lower price to outwit high tariffs charged in that jurisdiction, aimed at maximizing, the overall consolidated profit of the group. (Any 3 points)