Opportunities and challenges by multi-national companies in setting an appropriate transfer price - Essay Example

Transfer Price The corporate multinational enterprises usually experience quite a number of challenges in setting up an appropriate transfer price of goods and services between its subsidiaries. The main challenge usually comes when the transfer is to be carried out between corporate that are situated in countries that have conflicting tax jurisdiction. In this case, if the transfer price is not set right, one subsidiary usually ends up making losses while the other joy rides on the high profits. However, this situation created on both the transfer-out and the transfer-in corporate may have implications on the entire enterprise (Bowhill, 2008, pp 10).
One of such implications that come with inappropriate transfer pricing, as mentioned above, is the possibility of the transfer-in subsidiary making a loss or just no profit at all on the sale of the products received from the parent subsidiary. If for example the parent subsidiary manufactures a certain product at a cost of say $700 and transfers it to the distributer in another country at a cost $800, it shall have made a positive contribution of $100. Depending on the market price, the distributer may incur another variable cost of $100 and sell the product at $1000. In this case, the manufacturer has made a profit while the distributer has not. Therefore, one side will be motivated while the other will be demoralised. Nonetheless, both sides will be required to pay tax. There is, therefore, a need to set up an appropriate transfer price that does not favor one side of an enterprise.
The fact that these subsidiaries exist in different locations with different tax jurisdiction creates a complex puzzle for the MNE. It has always been a challenging task to come up with a plausible method of setting up the most appropriate transfer pricing that accommodates all these contrasting tax jurisdictions. In most host nations, when a subsidiary transfers goods to another, the local governments usually view the buy-in subsidiary as a target customer from whom to siphon revenues. This perception has led to mandatory taxation on the sales of such goods even if no considerable profit has been realised. It should be noted that the subsidiary from which the goods were transferred had also been taxed the authority under which it operates. Therefore, these two corporate have been taxed for the very product. This is called double-taxation. Double taxation is a liability to any MNE and may deter the realisation of net profit (ACCA, 2009).
The principle of Arm’s Length had been proposed to resolve the incidences of double taxation. Under this principle, the authority would treat the subsidiaries as separate entities and tax them fairly, with considerations of other market forces. Also, the goods that have already been taxed may be exempted from taxation. This has created a good opportunity for the multinational corporate enterprises to freely trade between different subsidiaries However, some MNE have taken the advantage of this opportunity by trying to avoid tax.
Another challenge in setting up transfer price has been in the methods and approaches of calculating the transfer price itself. Different MNEs use different approaches such as full cost and full cost plus in arriving at the transfer price. In as much these approaches may lead to profit realisation in both divisions of the MNE, they may sometimes lead to dysfunctional decision making when selling prices begin to fall. In summation, for a MNE to set an appropriate transfer price and become successful, it is always very important to consider performance measurement, motivation and investment decisions. These are always the major factors that create disparities in corporate multinational enterprises (Neighbour, 2002).
Bibliography
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