Transfer Pricing Essay

Market-based Transfer Price

Transfer pricing is defined in general as the pricing of items, including good and services that also are sold among related or associated legal entities within a particular company. For illustration, if a subordinate corporation sells the products to a certain parent company, the fees for the items paid by the parent corporation are regarded the transfer price. Fossati, Taxand and Bognandi (2020) argues that legal entities considered under the management of a single firm include business companies and branches controlled by majorities or directly owned mostly by parent organization. Some governments consider organisations to be under identical experimental conditions if family members serve on the company's board of directors. Corporations may use this characteristic of transfer pricing to allocate profits, primarily to ascribe a multinational company's loss and nett profit before taxes to the host countries. Transfer pricing is seen as an important technique since it leads to price fixing, especially within a company's division.

Transfer pricing provides a number of tax benefits, however most regulatory agencies are wary of its use only for the purpose of avoiding taxes. Companies might register the earnings from their goods and services in a foreign country if transfer pricing is used, which could have a lower tax rate than the one in which they are currently operating. In other instances, the transmission of services as well as consumer items from one country to another as part of an interconnected entrepreneurship transaction may allow an organisation to avoid imposing tariffs on offerings that are uniformly exchanged. This is especially true if the solutions are transferred on a global scale. Regulation of universal tax rules on such entities is the responsibility of the Organization for Economic Cooperation and Development, as well as particular auditing agencies in each universal location. Generally speaking, transfer prices are used largely when diverse organisations within a same organisation are treated and assessed as if they were separate companies that were operated independently.  Using transfer pricing, an organization can perform a wide range of commercial functions. Even in today's less-than-ideal economic climate, companies can lawfully avoid paying most income taxes by using transfer pricing, particularly when sales in one country are converted into profits in another (Pit 2019). As a result of the varying tax arrangements in different countries, transfer pricing might be more difficult.

Transfer pricing are designed by management to encourage goal congruence among all division managers involved in the transfer process. The mechanism of the external market may not always be applicable in establishing the unique transfer price of products and services in the context of the organisation. The technique used to calculate transfer pricing is mostly decided by the company's management. Negotiated, cost-based, and market-based transfer prices are all examples of this method.

Merits of Market Based Transfer Pricing

Market-based transfers are often based on the quoted price of a product or service that is same or comparable to the one being transferred.  Based on the actual price at which the providing division sells the intermediate items to third-party clients, this pricing has been established. Transfer pricing based on the market is appropriate for markets that are perfectly competitive. Individual buyers and sellers have little influence on the market price. Market-based transfer prices assist the firm in determining the divisional contribution to the overall company profit that is really made. The actual economic contribution to the firm will be represented by the divisional performance of the market price index.

As stated by Oktaviani and Tambunan (2021), a market-based transfer price is indeed a price that is determined by a marketplace here between supplier and the consumer. When there is a reasonably competitive outer market for products and services, the particular market prices serve as transfer prices in this situation. It is possible that the divisional performance will represent the economic influence of the whole division on most of the company's profits in instances when the transferred items are recorded at the current market values when the transfer is completed. Therefore, the divisional earnings are likely to be equivalent to the profits that might be determined if the divisions were separate entities.

The concepts of divisional profitability, like a consequence, might be immediately associated with the effectiveness of the same companies that operate in the same business types. The managers in charge of the selling and purchasing divisions are apathetic, particularly when it comes to doing trades with third parties or with each other in the same organisation (Singh 2021). This indicates that it is very difficult for a particular division to gain totally at the cost of the others. Using the notion of opportunity costs, economy transfer prices may be calculated and calculated again. As a result of this technique, it has been shown that the current value is the most effective transfer price in the present business climate. As a consequence of the selling division's capacity to sell the majority of its goods at market pricing, internal transfers at significantly lower prices may result in the division's financial situation deteriorating. Adapting market-based transfer pricing may help to resolve any disagreements that may develop, particularly between the selling and purchasing divisions. From the standpoint of an organisation, this arrangement is deemed perfect as long as all of the divisions are operating at maximum capacity. In accordance with (Global, Lesprit and Breen 2021), the use of this transfer technique prevents any losses or benefits that are principally based on the competence of the selling division. Some of the most significant difficulties associated with implementing this technique are excess manufacturing capacity and the inability to achieve the usual market price.

Limitations Of Market Based Transfer Pricing

Transfer pricing based on the market can be applied in a perfectly competitive market. It's the simplest to comprehend. It will assist the organisation simplify the process of evaluating employee performance. The firm will benefit from this strategy since it will assist to eliminate divisional strife. Because all divisions are judged on the same scale, transfer price that is determined by the market is typically in line with the surrounding environment. The corporation will be able to generate actual profits from each of its divisions as a result. There is an opportunity for the firm to make a genuine economic impact. If the company's devotional profitability can be measured against the profits of other businesses in the same industry, it will be able to see how it stacks up against the competition. Cost management and productivity improvement are both made possible via the use of market-based transfer pricing (Tambunan 2021). The organisation will achieve objective congruence by using industry transfer pricing. This pricing will aid the organisation in determining how much effort it is putting into management. Performance evaluations will be easier to submit with this information. For common, elevated, and high-cost services like transport and distribution, business transfer pricing works well.

Transfer price depending on the market has certain limitations. Perfect markets are very rare to come across, because there is no set market price (Global et al. 2020). As a result, establishing transfer pricing on the basis of the market is extremely difficult. Different purchasers will be offered a different price, discount, and loan conditions than one another. As a result, it is very difficult to determine the appropriate market price to utilise (Asongu, Uduji and Okolo-Obasi 2019). The market price is not always the most acceptable pricing since internal sales decrease the need for packaging, promotion, and delivery. When business transfer price is established, it is difficult to move resources from a reduced to an elevated division. Highly specialised items are not suited for transfer pricing based on market conditions. There is no ready market in which to set up transfer pricing, making the process more challenging.

A competitive market allows for the adoption of market-based transfer pricing. Using this strategy is the simplest way to comprehend the concepts involved. It will assist the organisation simplify the process of evaluating employee performance. There will be less tension inside the firm as a result of using this strategy. In most cases, transfer pricing based on the market tends to be in sync with the external environment (Tambunan 2021).  The corporation will be able to generate actual profits from each of its divisions as a result. There is an opportunity for the firm to make a genuine economic impact. With the support of comparable businesses, devotional profitability may be compared to obtain a true picture of the companies’ profits compared to other businesses in the same industry. In order to minimise costs and improve efficiency, a market-based transfer pricing system will be beneficial to the organisation.  The use of market-based corporate taxation will help the organisation achieve its goals (Asongu, Uduji and Okolo-Obasi 2019). Measurement of managerial effort will be easier with this pricing. Performance evaluations will be easier to submit with this information. When it comes to typical, high-volume, high-cost services like transportation and storage, the use of market-based transfer rates is an excellent option.

Using market-based transfer pricing has various drawbacks that need to be taken into consideration. There is no defined market pricing and it is very difficult to locate a great market. Therefore, establishing market-based transfer pricing is very challenging. Different purchasers may take advantage of a variety of pricing, discounts, and financing options (Oats and Tuck 2019). As a result, determining an appropriate market price is quite challenging. Internal sales may minimise the cost of packaging, promotion, or delivery, thus the market pricing may not be suitable. Market-based transfer pricing is not appropriate for highly specialised items. Transfer price cannot be established in a ready market (Cooper et al. 2017).  Moving resources from the a low priority department to a major priority department is challenging when market-based transfer price is established.

Negotiated transfer pricing is a price that is negotiated between the parties involved in the sale and purchase decision. This will be a negotiation between the market price and a cost-based pricing based on actual costs. Negotiated pricing are sometimes referred to as a "middle solution," particularly when compared to cost-based and market rates. In this transfer approach, the affiliated managers often use strategies and behave in a manner that is comparable to those employed by independent firms. The tactics to negotiation that are employed in trading from the outside markets may be the same as those used in dealing with the inside markets. There seems to be a probability that the negotiated price will be comparable to the market price if both buyers and sellers are prepared to enter into a deal and cooperate (CITRA and HARTO 2019). The method also generates another substantial conception, if all of the selling division's output proves to be difficult to sell in the external market, there is a possibility that the able to negotiate price will be lower than the price, and as a result, the divisions will start sharing the overall margin earned. A negotiated pricing may succeed if certain requirements are met. Outside sales and purchases are allowed, which helps to maintain order in the negotiation process. Success also needs the engagement and support of the organization's senior executives on a regular basis (Juranek, Schindler and Schjelderup 2018).  So, if there are any issues that cannot be resolved and when the process of negotiating leads to outcomes that are not ideal, then top management must step in and mediate. Furthermore, the effectiveness of the negotiated price is enhanced by the distribution to all participants of all accessible market data. That's because it gives negotiators more leeway when it comes to negotiating pricing. Consequences of negotiating pricing include divisional friction, an increase in management amount of time required to negotiate, and the possibility that one manager takes advantage of their counterpart.

All of the divisions are thought of as separate units because they have been negotiated transfer prices. Both the purchasing division manager and the selling division manager will have the option to do business outside of the organisation. They will have the flexibility to get their desired outcome, which will increase the manager's drive. This pricing strategy will assist the corporation in developing a business-like mentality among the various divisions of the company. The manager will be able to decide the most suitable transfer price for the divisions by using the negotiation transfer pricing tool. This will allow the manager to meet the needs of the division. In the long run, this strategy will be in the best interests of the whole firm. By using barging power, the corporation will be able to accurately assess the market and maintain its independence (Blouin, Robinson and Seidman 2018). As a result, the organisation will be better able to meet its aim of goal congruence. This price will also assist the management in avoiding distrust, bed falling, and unwelcome bargaining interest between the two parties.

Negotiated transfer pricing takes a long time to execute since it takes a long time to figure out the price. It will need a significant amount of management time and effort, as well as corporate resources. Because of the large number of management activities required, establishing negotiated transfer price will be costly. The negotiated transfer price will be determined by the manager's competence and capacity to bargain, which will vary from one manager to the next, among other factors (Challoumis 2018). One manager may be able to take advantage of the situation since he has access to confidential information, whilst the other managers do not have access to the information. Consequently, the agreed transfer price will be inaccurate as a consequence of the outcome.

Using negotiated transfer price, the whole division is treated as a separate entity. Both the purchasing division manager as well as the selling divisions manager will have the option to do business outside of the organisation. They will have the flexibility to get their desired outcome, which will increase the manager's drive. As Hamamura (2021) stated that, this pricing strategy will assist the corporation in developing a business-like mentality among the various units of the company. The manager should be able to decide the most suitable transfer price for the divisions by utilising the negotiate transfer pricing tool. This will allow the manager to meet the needs of the division. In the long run, this strategy will be in the best interests of the whole firm. By using barging power, the corporation will be able to accurately assess the market and maintain its independence (Oats and Tuck 2019). As a result, the organisation will be better able to meet its aim of goal congruence. This price will also assist the management in avoiding distrust, bed falling, and unwelcome bargaining interests between the two parties.

Negotiated transfer pricing takes a long time because it takes a long time to figure out the price. It will need a significant amount of management time and effort, as well as corporate resources. Because of the large number of management activities required, establishing negotiated transfer price will be costly (Friis 2020). The negotiated transfer price will be determined by the manager's competence and capacity to bargain, which will vary from one manager to the next, among other factors. One manager may be able to take advantage of the situation since he has access to confidential information, whilst the other managers do not have access to the information (Monden 2018) Consequently, the agreed transfer price will be inaccurate as a consequence of the outcome. 

Negotiated transfer price is the outcome of talks between the selling and purchasing departments. The benefits of negotiating transfer rates are many. In the first place, the divisions' autonomy and decentralisation are protected by this strategy. It's also safe to assume that managers in the various divisions in the organisation are much more knowledgeable than others with the transfer's possible costs and advantages A meeting of the company's management engaged in a potential transfer is held in order to discuss terms and circumstances of such a transfer. After all, a transfer fee must be agreed upon if they choose to go forward with transfer. As a general rule, we are unable to estimate the precise transfer price that they will agree to One thing we can count on, though, is that There are two conditions that must be met before the selling and purchasing departments consent to the transfer: (1) The selling division must see an increase in income as a consequence, and (2) the buying division must see a rise in their own earnings as a result. This may seem like a no-brainer, but it's critical to remember.

The market price will refuse to accept the transfer if indeed the transfer price is less than the selling division's cost. Similarly, if the transaction cost is set very high, the purchasing division will not be able to benefit from the transfer item. Both the lower and maximum price limits for every proposed transfer are established by the current circumstances of the selling division. The two division managers may agree on a transfer fee that is somewhere in the middle of these two ranges (Eden 2019). The appropriate price range for a transfer–the price range for a transfer within which the profitability of both eligible to participate divisions increase–is determined by these restrictions. When two divisions of the same business are involved in a transaction, it is called a transfer pricing transaction. These transactions may take several forms and take place across the organization's multiple divisions. More than two companies or, in other cases, more than two divisions of a single company might be involved in the majority of these transactions.

Transfer prices are an important aspect in reducing worldwide tariffs, levies, and taxes in multinational transfer pricing. For example, Cooper et al. (2017), suggests that transfer pricing might be created in the two primary subsidiaries of a particular holding company or at least two independent units of an organisational body to eliminate tariffs. Multinational transfer pricing is often plagued by this problem. This will play an important part in solving it. Another aspect is the evasion of monetary limits imposed by the government on profit repatriation by commercial groups. The transfer prices are set within two underpinning subsidiaries when the government imposes financial constraints on an organisation (Klassen, Lisowsky and Mescall 2017). As a result, in other countries, there may be limits on the transfer of profits and revenue.

The system is also affected by the general goal congruence. Customer happiness and profitability must be taken into consideration while determining transfer prices. In addition Cristea and  Nguyen (2016)  as pointing out the impact of inflation on international transfer pricing, There is a strong correlation between excessive inflation in a host country and fast repatriation of capital via overcharging for items and services. This is done mostly to avoid tying money to the weakening currency of the nation. This leads in penalties for evading import taxes and taxation as a consequence of this (Davies et al., 2018). Furthermore, the authors recommend that the taxpayer reach a progressive price arrangement with the relevant authorities in order to effectively protect their position. It's also important to keep the peace amongst factions. Because these rates are always determined in divisions, there are less divisional disagreements in the majority of the company's units.

Conclusion

In conclusion, the competitiveness of transfer pricing, as shown in this research, encompasses all major and small acts that are purposefully arranged for commercial organisations in order to avoid paying corporation taxes on the profits earned. When all of the components of transfer pricing are taken into consideration, including Negotiated Transfer prices, the objectives of the system, the fundamental transfer pricing methods, and the methods of determining transfer pricing, among other things, it becomes clear that the system is largely advantageous to corporations. In order to achieve maximum profitability, it is also essential for all firms to identify and manage any significant drawbacks and risks which may develop.

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