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Transfer Pricing Alert

March 8, 2011

Supply & Demand Chain this week carries a useful article on transfer pricing, with a warning that Governments are becoming increasingly energized by investigations into tax avoidance.

At a time of recession and public expenditure cuts, it is no wonder that Governments will be looking at every opportunity to raise revenues. Higher taxes will also increase the inclination of international corporations to become creative in their tax minimization techniques. The benefits of effective tax planning are enormous and with so much activity now undertaken offshore, the chances to take advantage of low-tax regimes abound.

Transfer pricing is of course the price or charge that applies when goods or services are transferred between different parts of the same enterprise. Tax authorities fear that such transfers could be manipulated to avoid taxes and therefore generally insist on an ‘arm’s-length’ principle. “The arm’s-length standard requires that the amount charged by one related party to another for a given product or service must be the same as it would be if the parties were not related. An arm’s-length price is the price that independent companies would pay for the same good or service purchased under the same or comparable circumstances.”

This apparently simple principle is in fact very complex, since many factors can be used in determining what is truly ‘the same’. In addition, many companies may embed royalties or other charges into the price, and of course those royalties tend to be payable to a low-tax jurisdiction (for example, most software companies register ownership of their software products in a tax-friendly offshore location).

For companies with multinational operations and clients, there are also interesting opportunities to decide where title to goods will pass, or (in an internet age) where services will be provided. The implications of who takes ownership, where and when, can have significant impact on the eventual price and profitability.  That isn’t simply because of taxes on income; the effect of charges such as import or export duties or sales taxes such as VAT are also of major significance. For example, I recall one deal in which I was involved where, by providing goods on consignment to the customer and retaining title until the eventual point of installation, total cost was reduced by more than 30%.

Not all companies have close links between their contract and financial staff, so the commercial opportunities from price and tax optimization are sometimes missed. Equally, this disconnect may result in substantial exposures if the terms of inter-company trade are not fully understood, or if actions by a particular country organization could lead to unexpected tax liabilities.

Knowledge in this area has always been important for a rounded contracts or commercial professional. Today, as the risks increase and Governments become more vigilant, it is essential.

3 Comments
  1. Peter permalink

    “For example, I recall one deal in which I was involved where, by providing goods on consignment to the customer and retaining title until the eventual point of installation, total cost was reduced by more than 30%.”

    Are you able to elaborate on this please Tim? If you retain title as consignor, you need to insure. Will that not offset your reductions?

    Regs
    Peter

    • Yes, there could indeed be some offset, but the combined savings for customer and supplier are far greater. For example, a typical transfer price will be around 50% of the eventual sales price. So throughout the process, taxes, duties, insurance costs while shipping etc are being levied on only half the ultimate value.

  2. Peter permalink

    Ah yes I understand; thank you for coming back on that. “Value for customs purposes.” Difficult to position certain transactions on that basis: e.g. capital goods are containerised and not transacted on a”sale or return” basis.

    It works with commodity items though, yes I see that.

    Thanks again.

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