Global Finance 405Taxes and Transfer Pricing
A major issue surrounding transfer prices in the international arena is their ef-
fect upon the total tax burden of parent firms. The levels of income taxes and
tariffs vary considerably across countries. Corporate income tax rates range
from the middle teens up to 50% in some countries. This presents the possibil-
ity that transfer prices may be set in part to minimize a firm’s worldwide tax
bill. Establishing the reasonableness of international transfer prices is the prin-
cipal defense against a charge of transfer price manipulation.
Ignoring other factors bearing on the setting of transfer prices, assume
that the objective is to minimize worldwide income taxes. Assume that the in-
come tax rate of the parent is 40% and that of the foreign subsidiary is 30%.
Further, the parent is the manufacturer and transfers are made to the foreign
subsidiary. The total cost of the product is $100 per unit and it can be sold by
the foreign subsidiary at insignificant additional cost for an amount equal to
$150. Therefore, the total worldwide pretax profit to be recognized is $50.
While the parent would not have unlimited f lexibility in setting the trans-
fer price, tax minimization would call for recognizing as much of the profit as
possible in the earnings of the subsidiary. This is because the subsidiary’s tax
rate is only 30% while the parents is 40%. Tax minimization is accomplished by
setting a relatively low transfer price as illustrated in Exhibit 12.31.
EXHIBIT 12.30 Alternative transfer-pricing policies.
Company Transfer-Pricing PolicyArch Chemicals Inc. (1999) Prevailing market prices
Transfers between geographic areas are priced generally at
prevailing market prices.
Conoco Inc. (1999) Estimated market values
Transfers between segments are on the basis of estimated
market values.
Dow Chemical Company Cost and market-based prices
(1999) Transfers between operating segments are generally valued at
cost. Transfers of products to the Agricultural Products
segment from the other segments, however, are generally
valued at market-based prices.
Pall Corporation (2000) Cost plus a markup on cost
Transfers between geographic areas are generally priced on
the basis of a markup of manufacturing costs to achieve an
appropriate sharing of profit between the parties.
Tenneco Inc. (1998) Market value
Products are transferred between segments and geographic
areas on a basis intended to ref lect as nearly as possible the
market valueof the products.
SOURCES: Companies’ annual reports. The year following each company name designates
the annual report from which each example is drawn.