Transfer Pricing: the Stranger in our midst

For years, the author scratched his head and raised his eyebrow whenever this 'stranger' (if the author may call it) is mentioned. Transfer Pricing (TP) is a term that reveals too little about its personality but yet, portrays a sophisticated corporate image. Governments pay prudent scrutiny on TP and MNCs pay a similar attention to it. What is the secret of this stranger that seduces such attention?

TP is simply the act of pricing of goods and services or intangibles when the same is given for use or consumption to a related party (e.g. a subsidiary). There can be either market-based, i.e. equivalent to what is being charged in the outside market, or non-market based. The reasons for the pricing could be internal (e.g. to monitor manager's performance by putting a cost to imported inputs) or external (e.g. taxes and tariffs issues) (Mayank K Agrawal, Transfer Pricing A Beginner's Perspective).

Understanding the interesting character of TP, it is not surprising that MNCs may manipulate TP to its advantage. It is this TP manipulation that Governments are discouraging. TP manipulation is basically fixing transfer price on non-market basis which generally results in saving the total quantum of organization's tax by shifting accounting profits from high tax to low tax jurisdictions (Mayank K Agrawal, Transfer Pricing A Beginner's Perspective). The implication is moving one nation's tax revenue to another.

It is not only corporate tax differential that induces organizations to manipulate TP. Other reasons include High Customs Duty, Restriction on Profit Repatriation and Ownership Restrictions.

The effect of TP manipulation on a nation limits not only to lower tax revenue, but also lead to distortion in Balance of Payments between the host and home country, and level of attractiveness towards Foreign Direct Investments (FDI). Nations such as Singapore and Hong Kong which have no TP controls become much more attractive for FDI.

In short, TP arises in the global economy with sourcing and consuming destinations being different, with organizations operating in different nations, and most importantly, due to varying tax and other laws in different countries. As more organizations are going global, including many local corporations in Malaysia, TP has risen up as an important aspect in corporations, whether we are familiar with it or not. Unsurprisingly, the author intends to get cozy with TP and perhaps, fall in love with this stranger in our midst.