19. Transfer Prices A. The Transfer Price Problem A.1 What is a Transfer Price?

19.1 When there is a international transaction between say two divisions of a multinational enterprise that has establishments in two or more countries, then the value of the transaction to the exporting division will be equal to the value of the transaction for the importing division. Thus when the multinational enterprise works out its profits worldwide for the quarter when the transaction took place, the export value will equal the import value and hence will cancel out, leaving the company’s overall profits unchanged, no matter what price it chooses to value the transaction.1 The price chosen to value the transaction is called a transfer price. Hence, at first glance, it appears that the multinational firm could choose the transfer price for the transaction to be practically anything. However, in a world where there are taxes on international transactions and where the rates of business income taxation differ across countries, then as will be seen below, the situation is actually worse: in this situation, the multinational will have definite financial incentives to choose strategically the transfer price to minimize the amount of taxation paid to both jurisdictions. It is this element of strategic choice that casts doubt on the usefulness of simply collecting transfer prices just as if they were ordinary prices between unrelated parties. 19.2 This chapter is devoted to an exposition of alternative transfer pricing concepts to suit different purposes and advice to statistical agencies on possible methods for collecting the type of transfer price to suit their primary purpose.2 In the remainder of section A, some background information detailing the importance and complexity of pricing intra-firm trade will be presented and then a brief outline of the remainder of the chapter will be presented