Transfer price: Overview, definition, and example
What is a transfer price?
Transfer price refers to the price at which goods, services, or intellectual property are sold between different divisions, subsidiaries, or entities of the same parent company. It is the internal price set by the parent company for transactions that occur within the corporate group, rather than between external buyers and sellers. Transfer pricing is commonly used in multinational corporations to allocate revenue and expenses across various parts of the business.
Transfer prices can be set based on several methods, including market-based prices, cost-based pricing, or negotiated prices, depending on the specific circumstances and the company’s strategy.
Why is transfer price important?
Transfer prices are important because they affect the allocation of profit across different parts of a business, especially when there are tax or regulatory considerations involved. Setting the correct transfer price ensures that each division or subsidiary reports a fair share of profits or losses and that the company’s financial statements are accurate.
For multinational companies, transfer pricing is particularly important as it can impact tax liabilities in different jurisdictions. Tax authorities often scrutinize transfer prices to ensure that companies are not using them to shift profits to low-tax regions, which could result in tax avoidance or evasion.
Understanding transfer price through an example
Imagine a large multinational company, XYZ Corp., that has a subsidiary in the United States and another in Europe. The European subsidiary manufactures electronic components, which it sells to the U.S. subsidiary. The transfer price is the price at which the components are sold from the European subsidiary to the U.S. subsidiary.
If XYZ Corp. sets a transfer price of $100 per unit for the components, the U.S. subsidiary will purchase the components at that price. The U.S. subsidiary can then sell the components at a higher price in the U.S. market. The European subsidiary will report revenue from the sale of these components based on the $100 transfer price, while the U.S. subsidiary reports the cost of the components as $100, impacting the profits of each division.
In another example, a software company might have a subsidiary that develops software and another subsidiary that markets and sells the product. The transfer price for the software might be set at the cost of development plus a markup, reflecting the cost of production and a reasonable return on investment.
An example of transfer price clause
Here’s how a transfer price clause might appear in an intercompany agreement:
“The transfer price for goods provided by the Manufacturer Subsidiary to the Distributor Subsidiary shall be set at the cost of production plus a 10% markup. This price shall be reviewed annually to ensure that it aligns with current market conditions and relevant tax regulations.”
Conclusion
Transfer price is the price set for transactions between divisions, subsidiaries, or units of the same parent company. It plays a critical role in determining how revenue and expenses are allocated within the organization, and it can have significant tax implications, especially for multinational corporations. Understanding and properly setting transfer prices ensures that the company complies with legal and tax regulations, while also ensuring accurate financial reporting and fair allocation of profits across the business units.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.