|The setting of transfer prices for products (goods and services) moving between semi-autonomous divisions (cost or profit centres) within large organizations. The practice is most often associated with transnational corporations (TNCs) which respond to variable corporate tax regimes, tariff and other barriers to trade and exchange rates by setting prices for internal transactions between establishments located in different national locations in ways which minimize costs or maximize gains. For example, firms may charge high prices for semi-finished products moving for further processing to plants located in countries with high rates of tax in such a way as to reduce the tax take on profits generated by the work of such plants.
As the globalization of investment, production and trade proceeds, the possibilities for and, thereby, the extent of transfer pricing is likely to increase. Peter Dicken (1998, p. 347) points out that
[I]n general, the greater the differences in levels of corporate taxes, tariffs, duties, exchange rates, the greater will be the incentive for the TNC to manipulate its transfer prices.TNCs have a strong incentive to engage in transfer pricing and the very large, highly centralized, global TNC has the strongest potential for doing so. The problem, he goes on, is that
it has proved extremely difficult for governments (and researchers) to gather evidence on its â€¦ extent.Transfer prices are set by and within firms and are, at one level, purely managerial â€” having to do with the monitoring and control of individual cost and profit centres. But at another level, the judicious use of internal transfer pricing facilitates the avoidance of tax and the costs of trade barriers. Firms can optimize their financial relations with the geographies in which they are located and so minimize payment of tariffs, for example, or shift accounted profits from locations with high tax regimes to locations with low rates of corporate taxation. TNCs can also get around difficulties associated with fluctuating exchange rates which, on the open market, might tend to the over- or under-pricing of products in transactions taking place between establishments of the same TNC located in different currency spaces. By disembedding themselves in such ways, TNCs are able to reduce their costs and increase their profitability at the expense of the locations in which they operate.Â (RL)
Reference and Suggested Reading Dicken, P. 1998: Global shift: transforming the world economy, 3rd edn. London: Sage, ch 8.