Characteristics of a Good Transfer Pricing
Transfer pricing documents are essential whenever a business is divided into multiple departments, divisions, or branches. The purpose of such a document is to note the transfer pricing and transactions that involve the flow of goods or services between different divisions.
A multinational company typically has powerful accounting systems that can easily record such transactions. The transfer price is typically negotiated between the divisions and imposed by the head office. As a result, it has a significant impact on business performance and strategic decisions.
However, it is important to note that transfer pricing is an internal accounting practice. It does not affect the overall profitability of an organization but plays a vital role in determining the performance of each division of a business.
It is critical to set the correct transfer price so it can motivate the divisional managers and supervisors to enhance performance. Therefore, it is important to get familiar with the characteristics of good transfer pricing. Otherwise, a poorly set transfer pricing can cause the managers to make bad business decisions, negatively impacting the profits.
Following are the characteristics of good transfer pricing:
1. Ensure Divisional Autonomy
It is important to have divisional autonomy in a medium and large-scale company because having multiple divisions also ensures decentralization in decision-making. It simply means that specific divisions of a business have specific managers and teams to run a division and make strategic decisions.
Having good transfer pricing ensures divisional managers have the autonomy to make business decisions to the best of their abilities and work to maximize profits. It will definitely improve managerial motivation to keep working for the betterment of the company.
2. Goal Consistency
The ultimate goal of setting a transfer price should be to ensure the organization’s best interest. It brings much-needed consistency in the goals of different managers and the overall objectives of the organization. Goal consistency and divisional autonomy are both extremely important to ensure a firm’s success in the long run.
3. Transparency and Fairness
It is important to set a transfer price after careful consideration and thorough discussions. The business divisions must agree that the transfer price is fair and transparent so that it does not adversely affect the performance evaluation of any one part of the business.
4. Documentation
Transfer pricing document is essential to record the movement of products and services and transfer price. It should be made clear to the different branches and departments of a company that the decided transfer price will be used to record the movement of products and services.
This thorough transfer pricing document can also help you in accounting procedures and claiming Singapore tax incentives.
5. Reduce Global Tax Liability
Using transfer pricing policies has become essential for multinational companies to ensure they can move profits easily and minimize global tax liability. It is a major goal of having transfer pricing policies in place to ensure the organizations can operate in multiple countries without bearing too much tax.
However, it is also important to note that management and executives should never try to exploit these policies because there is strict international legislation to prevent fraud involving organizations using the transfer pricing policies to divert profits.
Strategies to Set a Good Transfer Price
Generally, a transfer price should match the amount that the buyer would pay an independent or the amount paid by an independent to the seller. These are called arm’s length suppliers and arm’s length customers.
Unrealistic transfer pricing can create various issues in a company due to potential misuse and lower profits to avoid taxes in a country with strict tax laws. However, when an organization follows the law and creates a comprehensive transfer pricing document, it should have no issue qualifying for Singapore tax incentives and exemptions in international territories.
Both market-based and cost-based approaches are popular for setting the transfer price. In a market-based approach, the market price is equal to the optimum transfer price. A market-based approach is used when a competitive market exists for a product.
On the other hand, in the cost-based approach, the transfer price is decided on the basis of the production cost of the upstream division.
In a Nutshell
In short, transfer price and transfer pricing documents play an integral role in companies having multiple departments, divisions, and branches. Organizations should pay special attention to deciding a good transfer price having the characteristics discussed above so that they can enjoy the benefits of transfer pricing like Singapore tax incentives.
