Transfer pricing enables related business entities to set prices between themselves to ensure an even tax burden among themselves, and is subject to stringent rules and regulations.
Studies indicate that these regulations may also have unintended repercussions; inaccurate transfer pricing could lead to profit shifting and deprive countries of essential tax revenue.
Tax Compliance
Many countries impose regulations requiring companies to adopt arm’s length pricing principles, which ensure within-firm prices match what unrelated parties would charge in a market transaction, thus increasing transparency and minimizing disputes with tax authorities.
transfer pricing has the potential to undermine tax compliance and diminish government revenues through reduced income tax revenue. Companies that fail to abide by tax regulations run the risk of being audited and facing fines; additionally, any underreporting profits or profit shifting activities could mean losing tax incentives altogether.
Literature on transfer pricing indicates a need for additional research that analyzes its impact and implications for developing nations. According to studies by de Mooij and Liu (2020), MNC affiliate investment falls 11% due to transfer pricing laws, prompting alternative policy approaches and rigorous empirical investigation to better understand MNCs’ transfer pricing practices.
Market Power
Setting an appropriate transfer price is a critical element of profit allocation processes for multinational companies. Any missteps here could have devastating tax repercussions, including penalties, interest payments and double taxation; they may also harm global competitiveness and the company’s image.
multinational firms typically employ the mark-up pricing strategy of adding a margin or markup to the selling price, typically measured as its marginal cost plus profit markup. The higher this mark-up is, the greater its market power will be.
Studies highlight the need for further analysis and legislative responses to transfer pricing manipulation by multinational corporations (MNCs) in developing nations. For instance, de Mooij and Liu (2020) investigate how MNC transfer pricing regulations might adversely impact real investment in an economy by restricting MNCs’ opportunities to shift profits for tax purposes. They argue that gradual adjustments to transfer pricing rules make MNCs more likely to manipulate their prices, making audit harder and potentially increasing tax avoidance risk.
Internal Motives
Due to the global economic crisis, transfer pricing has gained more widespread attention as an issue that compromises tax bases and prevents revenue collection in developing nations. Furthermore, profit shifting through transfer pricing practices such as corporate inversions has become an increasing concern as businesses relocate to foreign nations with lower tax burdens while accessing earnings earned abroad tax-free.
Transfer prices have an impactful effect on how much income tax a multinational corporation must pay in different countries by determining the price at which one corporate subsidiary sells goods or services to another corporate subsidiary, with this process necessitating compliance with national and international tax regulations as well as comprehensive documentation.
Studies on transfer pricing’s effects on multinationals (MNCs) have illuminated its complexity. Studies investigate sensitivity of MNC profits to tax rates, how MNCs manipulate transfer prices to shift taxable earnings, adherence to transfer pricing regulations affect MNC behavior, as well as effectiveness of current transfer pricing restrictions in preventing MNCs from exploiting their size and resources to avoid paying taxes.
Risk Management
Research on this subject shows that companies must strike a balance between tax reduction, compliance with transfer pricing regulations, and profit maximization. To accomplish this successfully requires maintaining transparency about unit costs while avoiding margin stacking and setting cost type specific markups within complex value chains. Furthermore, having an established documentation process helps mitigate audit risk for transfer pricing audits.
Erroneous transfer pricing practices expose companies to substantial additional taxes, penalties and double taxation liabilities. This can force companies to dedicate resources to complying with transfer pricing laws even though this could reduce profits and market power.
Studies (Flanagan 2017 and Sebele-Mpofu et al, 2021) suggest that companies prioritize profit shifting over tax compliance (Flanagan (2017) and Sebele-Mpofu et al, 2021). Furthermore, de Mooij and Liu (2020) conducted research into how transfer pricing affects other economic outcomes, such as earnings management; their findings underscored the need for alternative regulations, global comparisons and rigorous empirical investigation of this issue.
