Transfer pricing refers to the practice of setting
prices of goods and services that are exchanged between related parties, such
as different subsidiaries of a multinational corporation. These related parties
may be in different countries, and transfer pricing is used to determine the
price at which goods or services are transferred between them.
The goal of transfer pricing is to ensure that the price set for the transfer of goods and services is fair and reflects the market value of those goods or services. However, there is often a risk that related parties may set artificially low or high prices for the transfer of goods and services to shift profits to jurisdictions with lower tax rates or to avoid taxes altogether.
To prevent this, many countries have established regulations
and guidelines for transfer pricing. These regulations generally require that
the transfer price be determined based on the arm’s length principal, which
means that the transfer price should be similar to what would be charged
between unrelated parties in a similar transaction. Companies are required to
document their transfer pricing policies and practices and to report them to tax
authorities. Failure to comply with transfer pricing regulations can result in
penalties, fines, and legal actions.