406 Planning and Forecasting
The tax authorities of countries are well aware that multinationals have
strong incentives to shift profits into low-rate counties. Recent years have seen
governments increasingly willing to challenge tax computations that they be-
lieve are based upon the use of unreasonable transfer prices. Therefore, the ex-
ample above simply shows how total tax payments can be inf luenced by
alternative transfer prices. The degree of f lexibility shown above may or may
not be available.
Notice, in the above example that no change in policy would result if the
foreign country also had an ad valorem tariff. Worldwide taxes would still be
minimized by a low transfer price because this would also minimize the tariff.
However, circumstances would differ if the parent’s income tax rate were less
than that of the subsidiary. Setting a high transfer price would cause more of
the profit to be taxed at the lower income tax rate of the parent. But, this ben-
efit is offset to some extent by the higher tariff in the subsidiary’s country. The
analysis would need to be extended to include tariffs in the total taxes to be
minimized.
Other Inf luences on Transfer Pricing Policy
and Potential Conf licts
Factors other than tax minimization also bear on the establishment of transfer
prices. An effort to build market share or to respond to severe price competi-
tion might call for low transfer prices. However, this could be in conf lict with
a tax minimization objective if income tax rates in the country receiving the
transferred goods (transferee country) were higher than the income tax rates of
the country from which the transfer was made (transferor country).
Transfer pricing policy may sometimes be employed to circumvent re-
strictions on the repatriation of profits by charging high transfer prices. This
effectively involves taking out profits in the form of payments for the goods
EXHIBIT 12.31 International transfer pricing and tax
minimization.
Low Transfer Price High Transfer Price
Parent revenue $110 $140
Cost 100 100
Pretax profit 10 40
Income tax (40%) 4 $ 4 16 $16
Subsidiary revenue 150 150
Cost (transfer price) 110 140
Pretax profit 40 10
Income tax (30%) 12 12 3 3
Worldwide tax $16 $19Composite tax rate 32% 38%