What is a 'Transfer Price'
A transfer price is the price at which divisions of a company transact with each other, such as the trade of supplies or labor between departments. Transfer prices are used when individual entities of a larger multi-entity firm are treated and measured as separately run entities. A transfer price can also be known as a transfer cost.
BREAKING DOWN 'Transfer Price'In managerial accounting, when different divisions of a multi-entity company are in charge of their own profits, they are also responsible for their own return on invested capital (ROIC). Therefore, when divisions are required to transact with each other, a transfer price is used to determine costs. Transfer prices tend not to differ much from the price in the market because one of the entities in such a transaction loses out; they start either buying for more than the prevailing market price or selling below the market price, and this affects their performance.
Regulations on transfer pricing ensure the fairness and accuracy of transfer pricing among related entities. Regulations enforce an arm’s-length rule that states that companies must establish pricing based on similar transactions done between parties not of the same related company but at arm’s length.
Documentation Required for Transfer Pricing
Transfer pricing is closely monitored within a company’s financial reporting and requires strict documentation that is included in financial reporting documents for auditors and regulators. This documentation is closely scrutinized; if inappropriately documented, it can lead to added expenses for the firm in the form of added taxation or restatement fees. These prices are closely checked for accuracy to ensure that profits are booked appropriately within arm’s-length pricing methods and associated taxes are paid accordingly.
Transfer prices are often used when companies sell goods within the company but to parts of the company in other international jurisdictions. This type of transfer pricing is common. Approximately 60% of the goods and services sold internationally are done within companies as opposed to between unrelated companies.
Transfer pricing multinationally has tax advantages, but regulatory authorities frown upon using transfer pricing for tax avoidance. When transfer pricing occurs, companies can book profits of goods and services in a different country that may have a lower tax rate. In some cases, the transfer of goods and services from one country to another within an interrelated company transaction can allow a company to avoid tariffs on goods and services exchanged internationally. The international tax laws are regulated by the Organization for Economic Cooperation and Development (OECD), and auditing firms within each international location audit financial statements accordingly.