Responsibility Accounting

-Transfer Pricing

Nuwan Gunarathne
Department of Accounting
[[email protected]]

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 Session outline
• Discuss various transfer pricing
methods and their implications;
• Apply various transfer pricing
methods in different scenarios;
• Discuss international transfer pricing;
• Evaluate the tax implications of
transfer pricing

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3
JKH

4
 JKH

IC

IC

CC CC RC

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6
 C

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C

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External
sales
C

Internal
sales

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 Pricing the transfer of
goods
- Transfer pricing

• The price at which goods or services are

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Purpose of transfer prices

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 Setting/deciding the
transfer price
• Market based transfer price
• Marginal cost based transfer price
• Incremental cost + fixed fee based
transfer price
• Full cost based transfer price
• Dual rate transfer price
• Negotiated market based transfer price

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 PRICING BASES
• Cost based pricing Market based
pricing
-
 Dual pricing
• Two separate transfer prices are
used

• Receiving division pays at variable

• Supplying division receives at market

IN OUT
Rs. Rs.
External sales 32,000 96,000
Costs of production 48,000 40,000

Note :
Cost per unit of IN’s output is Rs. 60 of which variable
costs is
Rs.36
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 Calculate divisional and group using the
following transfer pricing bases

• Market based
• Full cost based
• Full cost + 25% margin
• Marginal cost based
• Two part tariff (Incremental cost + fixed fee of Rs.
4,000 p.a.)
• Dual price based

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Tutorial - Q1

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 Tax Implications &
Multinational Transfer
Pricing
If a group has subsidiaries that
operate in different countries with
different tax rates the overall tax
burden of the group can be reduced
by manipulating the transfer prices
between the subsidiaries

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  Low rate of tax on profit
 Low withholding tax on dividends
 No exchange controls
 A stable economy
 Good communication links
 Strategically located

Division Division
A B
(Country (Country
A) B)
Tax rate = Tax rate =
10% 40%

Increase Reduce profit

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  Low rate of tax on profit
 Low withholding tax on dividends
 No exchange controls
 A stable economy
 Good communication links
 Strategically located

Division Division
A B
(Country (Country
A) B)
Tax rate = Tax rate =
10% 40%

Increase Reduce profit

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 Tax havens
• Cayman islands
• Andorra
• The Bahamas
• Cyprus
• Liechtenstein
• Luxembourg
• Mauritius
• Monaco
• San Marino
• Seychelles

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 Tax hevens
• https://www.youtube.com/watch?v=JRlndgfIp
b4

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 Prevention of tax evasion
by in cross boarder
transactions
• OECD has drawn up guidelines to
standardize the national approaches
to transfer pricing. (OECD Model Tax
Convention)
• Requires to adopt the arm’s length
principle

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An ‘ arm’s length ’ price

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An ‘ arm’s length ’ price

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 An ‘ arm’s length ’ price
• A price that would have been arrived
at by two unrelated companies
acting independently

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 An ‘ arm’s length ’ price
• A price that would have been arrived
at by two unrelated companies
acting independently
Ex:
 Comparable uncontrolled prices (CUPS)
 Cost plus
 Resale price
 Comparable profits
 Profit split
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 Activity 2
CF Multinational transferred 10,000 units of product Z from its manufacturing
division in the USA to its selling division in the UK during the year just ended.

The manufacturing cost of each unit of product Z was $150 (60% of which
was variable cost). The market price for each unit of product Z in the USA
was $270. The USA division’s profit after tax for its sales to the UK division
for the year just ended was $900,000.

The UK division incurred marketing and distribution costs of £30 for each unit
of product Z and sold the product of £200 a unit. The UK tax rate was 30%.
(Exchange rate: £1 = $1.5)

I.What is the tax rate in the USA if product Z had been transferred at the USA
market price?

II.What is the UK division’s profit after tax if the transfers had been made at
variable cost?

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