TRANSFER PRICES

Transfer prices are the amounts charged by one segment of an organization for a product or service that it supplies to another segment of the same organization.

PURPOSE OF TRANSFER PRICING

To communicate data that will lead to goalcongruent decisions. evaluate segment performance and thus motivate managers toward goal-congruent decisions.

To

GENERAL TRANSFER PRICING RULE

T.P = VARIABLE COST OF PRODUCT PLUS ANY SPL OUTLAY DUE TO TRANSFER + OPPORTUNITY COST TO THE COMPANY DUE TO TRANSFER

METHODS OF TRANSFER PRICING

Market-based transfer prices. Full-cost based transfer prices. Negotiated transfer prices.

MARKET-BASED TRANSFER PRICES

The transfer price equal to the price in the external market. TRANSFER PRICE = MARKET PRICE When the production division has no excess capacity and perfect competition prevails, the general transfer price rule and external market price will yield the same transfer price.

If the production division has excess capacity and perfect competition does not prevail, then the two methods will given different transfer prices

FULL COST-BASED TRANSFER PRICE

Under this method transfer price is equal to variable cost of the product plus an allocated portion of the fixed overheads. Transfer price based on full cost run the risk of causing dysfunctional decision making behaviour. This happens because the buying division perceives the fixed cost to the company as a whole as variable cost to the buying division .

NEGOTIATED TRANSFER PRICE

Division managers actually negotiate the price at which the transfer will be made. Sometimes they start with market price and make adjustments for various reasons. This method is used sometimes when no external market exists for the product.

ADVANTAGES OF TRANSFER PRICING

Decisions are better and more timely because of the managers proximity. To local conditions. Top managers are not distracted by routine, local decision problems. Managers motivation increases because they have more control over results. Increased decision making provides better training for managers for higher level positions in the future.

DISADVANTAGES OF TRANSFER PRICING

Lack of goal congruence among managers in deferent parts of the organization. Insucient information available to top management, increased costs of obtaining detailed information.

Lack of coordination among managers in deferent parts of the organization.

FACTORS AFFECTING TRANSFER PRICING

Internal factors: Performance Measurement and Evaluation External Factors: Accounting Standard Income Tax Custom Duty Currency Fluctuations Risk of Expropriation

Transfer Price Regulations : Transfer Price Regulations International OECD formulated Guidelines on transfer pricing. They serve as generally accepted practices by the tax authorities India The Finance Act 2001 introduced the detailed TPR w.e.f. 1st April 2001 The Income Tax Act AS-18 Other Relevant Acts Accounting Standard 18 : Accounting Standard 18 Requires disclosure of any elements of the related party transactions necessary for an understanding of the financial statements.

Related Parties : Related Parties Control by ownership 50% of the voting right Control over composition of board of directors Power to appoint or remove the directors Control of substantial interest 20% or more interest in the voting power AS-18 and Transactions : AS-18 and Transactions Purchase and sale of goods; Rendering or receiving services; Agency arrangements; Leasing arrangements; Transfer of research and development; Licence aggrements; Finance Guarantees and collaterals; Management contracts.

Income Tax Act and TP : Income Tax Act and TP Finance Act 2001 substituted the old section of 92 of the ITA by sections 92,92A to 92 F. These sections are the backbone of Indian TPR. These sections define the meaning of related parties, international transactions, pricing methodologies etc.

CRITERIA WHILE MAKING TRANSFER PRICING DECISIONS

Tax regimes Local Market conditions Market Imperfections Joint-venture partner

KEY DRIVERS BEHIND TRANSFER PRICING IN FOREIGN COUNTRIES:

a)

Market Conditions Competition Profit for the affiliate Tax Rates

b)

c)

d)

KEY DRIVERS BEHIND TRANSFER PRICING IN FOREIGN COUNTRIES

e) Economic conditions f) Import Restrictions

g) Customs Duties
h) Price Controls i) Exchange Controls

SETTING TRANSFER PRICES

a) Arms length prices: use of market mechanism as a cue for setting transfer prices.
b) Cost-based pricing (adds a mark-up)