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18/05/2018 09:35:57 AM

Transfer pricing - Define and true example

Transfer pricing is one of the most important issues in international tax.

Transfer pricing happens whenever two companies that are part of the same multinational group trade with each other: when a US-based subidiary of Coca-Cola, for example, buys something from a French-based subsidiary of Coca-Cola. When the parties establish a price for the transaction, this is transfer pricing.

In decentralized organizations, much of the decision-making power resides in its individual subunits. In these cases, the management control system often uses transfer pricesto coordinate the actions of the subunits and to evaluate their performance. As you may recall from the opener, a transfer priceis the price one subunit (department or division) charges for a product or service supplied to another subunit of the same organization. If, for example, a car manufacturer has a separate division that manufactures engines, the transfer price is the price the engine division charges when it transfers engines to the car assembly division. The transfer price creates revenues for the selling subunit (the engine division in our example) and purchase costs for the buying subunit (the assembly division in our example), affecting each subunit’s operating income. These operating incomes can be used to evaluate subunits’ performances and to motivate their managers. The product or service transferred between subunits of an organization is called an intermediate product. This product may either be further worked on by the receiving subunit (as in the engine example) or, if transferred from production to marketing, sold to an external customer.

In one sense, transfer pricing is a curious phenomenon. Activities within an organization are clearly nonmarket in nature; products and services are not bought and sold as they are in open-market transactions. Yet, establishing prices for transfers among subunits of a company has a distinctly market flavor. The rationale for transfer prices is that subunit managers (such as the manager of the engine division), when making decisions, need only focus on how their decisions will affect their subunit’s performance without evaluating their impact on company-wide performance. In this sense, transfer prices ease the subunit managers’ information-processing and decision-making tasks. In a well-designed transferpricing system, a manager focuses on optimizing subunit performance (the performance of the engine division) and in so doing optimizes the performance of the company as a whole

A true example that shows how Google used transfer pricing to its advantage:

The regional headquarter of Google is in Singapore and it has a subsidiary in Australia. The sales and marketing support services are provided by the Australian subsidiary to users and Australian businesses and also provides research services to Google worldwide. The billing for Australian activities is done in Singapore and the payment is received from the Google entities.

In 2012-13 Google Australia earned $46 million as profit on revenues of $ 358 million. The corporate tax payment was A$7.1 million, more so, as they had claimed a tax credit of $ 4.5 million.

Ms. Maile Carnegie, the Managing Director of Google Australia was asked to respond on why Google Australia did not pay more corporate tax in Australia. She Replied by saying that the lion’s share of the taxes was paid to the country where they were headquartered. She was talking about the intellectual capital that Google owns which drives their business and it was owned outside of Australia.

Google declared that it paid US$ 3.3 billion as tax globally in 2014 on revenues of US$ 66 billion. The effective tax rate came up as 19%, while the statutory federal rate of 35% applied on Google in the US. Had Google been paying most of the tax in US, it would follow that it was not paying much taxes on the revenues that is generated from other countries.

In 2013, in Singapore US$ 4 million was paid by Google in corporate tax on undisclosed revenues from the Asia – Pacific countries as well as Australia. Compared to this, Google Australia made a payment of A$7.1 million as tax, and they did not account for most of that revenue that was booked in Singapore.

Moreover, the details of the sources of revenue that was generated from Australia was not provided by Google.

It was seen that some of the multinational companies were involved in tax minimisation using the tax incentives that were offered in accordance with the overseas jurisdiction to them which led to the evasion of tax in Australia.