Transfer Pricing

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Transfer pricing is the setting of prices for goods, services, loans and intellectual property traded between companies in the same group, especially across countries, which determines where the group's profits are taxed.

Multinational groups trade constantly within themselves. A factory in one country may sell components to a sister company in another, or a subsidiary may pay royalties to the group company that owns its brand. The prices chosen move profit from one country to another.

For example, if a subsidiary in a high-tax country pays inflated royalties to a group company in a low-tax country, profits shrink where tax is high and grow where tax is low.

To prevent this, tax rules in most countries require intercompany prices to follow the arm's length principle: the price must be what independent companies would agree in similar circumstances. The OECD's transfer pricing guidelines set out methods for testing this, such as comparing with prices between unrelated companies or with the profit margins they earn.

Transfer pricing is one of the largest areas of international tax disputes. Companies must keep detailed documentation, and tax authorities may adjust prices and charge extra tax. Advance pricing agreements allow companies to agree methods with tax authorities beforehand.

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