May 2017 Q5 b.
One of the key considerations for multinational companies is to decide on the price at which goods and services are transferred from one member of a group to another.
Kofas Ltd has been operating in four countries: Ghana, Nigeria, UK and USA. The parent company and the subsidiaries have decided to use transfer pricing policy.
Required:
You have been approached as a consultant to advise on the internal and external factors that will facilitate the transfer of goods and services from one member of the group to another. (10 marks)
View Solution
INTERNAL FACTORS
- Overall Goal Congruence:
Transfer prices should help achieve overall goal congruence with regard to profit/income and customer satisfaction. When divisional managers have the authority to decide whether to buy or sell internally or on the external market, the transfer price can determine whether managers’ incentives align with the incentives of the overall company and its owners. The objective is to achieve goal congruence, in which divisional managers will want to transfer product when doing so maximizes consolidated corporate profits, and at least one manager will refuse the transfer when transferring product is not the profit-maximizing strategy for the company. - Better Performance Evaluation:
Transfer prices may be set between two subsidiaries of a holding company and/or two units of a corporate body in such a way to evaluate performance of each division. Transfer pricing can evaluate performance by coordinating production, sales and pricing decisions of the different divisions (via an appropriate choice of transfer prices). The transfer price will affect not only the reported profit of each center, but will also affect the allocation of an organization’s resources. Transfer prices make managers aware of the value that goods and services have for other segments of the firm. Transfer pricing allows the company to generate profit (or cost) figures for each division separately. - Avoidance of Divisional Conflicts:
Transfer prices are set among the units in such a way that general co-ordination between units are promoted, the implementation of appropriate procedures to ensure, as far as possible, uniformity in the classification and application of costs are maintained and divisional conflicts among different units are reduced. - Better cash management.
- Competitive advantage.
EXTERNAL FACTORS
- Transfer Prices as a Tool to Minimize Worldwide Taxes, Duties and Tariffs:
Transfer prices may be set between two subsidiaries of a holding company and/or two units of a corporate body in such a way to minimize the taxes, duties and tariffs on their overall profit. For example, suppose, tax rate on profit in country X is lower than in country Y. The subsidiary in Y will then under invoice its export to the subsidiary in X. The profit at the latter subsidiary will be inflated, but that will bear a lower tax burden. - Avoidance of Financial Restrictions on Profit Repatriation Imposed by Government:
When in a country, financial restrictions on profit repatriation is imposed by Government, transfer prices is set among two subsidiaries by over invoicing its imports. In some countries there may be restriction on repatriation of income and dividend/profits. Goods are sought to be transferred to subsidiaries in these countries at more than the price otherwise settled at arm’s length. - Inflation:
If a country hosting a subsidiary, has a high rate of inflation, early repatriation of fund is done by overcharging goods, exported to it so that money may not be tied up in a currency that depreciates. However, the tax and fiscal authorities of the host countries are vigilant. They impose penalty for manipulated evasion of taxation or import duties. To safeguard the position, the taxpayer may enter into an advanced pricing agreement with the related two tax authorities. - Lesser foreign exchange risks.
