Bài giảng môn Kế toán, kiểm toán - Chapter 12: International transfer pricing

Chapter Topics

Transfer prices, corporate objectives, national tax laws

Cost minimization and performance evaluation

U.S. transfer pricing rules

Five specific methods to determine arm’s-length prices

Advance pricing agreements (APAs)

Enforcement of transfer pricing regulations

 

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Chapter 12: International Transfer PricingChapter TopicsTransfer prices, corporate objectives, national tax lawsCost minimization and performance evaluationU.S. transfer pricing rulesFive specific methods to determine arm’s-length pricesAdvance pricing agreements (APAs)Enforcement of transfer pricing regulations12-2Learning ObjectivesDescribe the importance of transfer pricing in achieving goal congruence in decentralized organizationsExplain how the objectives of performance evaluation and cost minimization can conflict in determining international transfer pricesShow how discretionary transfer pricing can be used to achieve specific cost minimization objectivesDescribe governments’ reaction to the use of discretionary transfer pricing by multinational companiesDiscuss the transfer pricing methods used in sales of tangible property12-3Learning ObjectivesExplain how advance pricing agreements can be used to create certainty in transfer pricingDescribe worldwide efforts to enforce transfer pricing regulations12-4IntroductionTransfer pricingDetermination of price on the exchange of goods or services between related partiesAlso referred to as intercompany transactionsUpstream transfers go from subsidiary to parent, while downstream transfers are from parent to subsidiaryTransfers also occurs between different subsidiaries of the same parentSignificant proportion of international transactions are intercompany transfers (In 2012, represented 42% of U.S. total goods trade)12-5Decentralization and Goal CongruenceDecentralized companies are organized by division and division managers have significant authorityDecomposes problems into smaller piecesPermits local decision making which provides more responsibility for division managersAn agency problem can occur since division managers make decisions in their self-interestManager’s self-interest can vary with the best interests of the companyAn effective accounting system can alleviate this agency problem by providing incentives to division managers to act in the interests of the organizationThis is referred to as goal congruenceThese concepts are relevant to both multinational and purely domestic companies12-6Performance Evaluation, Cost Minimization, and Transfer PricingPerformance evaluation systemsTransfer prices directly affect the profits of the divisions involved in an intercompany transactionSome are based on divisional profitsEffectiveness of these is influenced by the fairness of transfer pricesEffectiveness of these affects the satisfaction of managers12-7Performance Evaluation, Cost Minimization, and Transfer PricingCost minimizationProfit maximization and, by extension, cost minimization are important corporate objectivesManipulating transfer prices between countries is one way for multinational enterprises to achieve cost minimizationThis is referred to as discretionary transfer pricingThe most common approach is to minimize costs by shifting profits to lower tax rate jurisdictions12-8Performance Evaluation, Cost Minimization, and Transfer PricingCost minimization – ExamplePadre Inc., a U.S. company, has two subsidiaries, Hijo and Hija. Hijo is located in Chile and Hija in the U.S. The tax rate is 17 percent in Chile and 35 percent in the U.S. Hijo transfers 100 units of cosa to Hija at a negotiated transfer price of $10 per unit. The cost per unit is $5 for Hijo, and Hija sells the units in the U.S. at $15 per unit. Padre intervenes to set the transfer price at $13 per unit.12-9Performance Evaluation, Cost Minimization, and Transfer PricingCost minimization – ExampleDivisional profits under the negotiated transfer price: Hijo Hija PadreSales $1,000 $1,500 $1,500Cost of goods sold 500 1,000 500Gross profit $ 500 $ 500 $1,000Income tax effect 85 175 260After-tax profit $ 415 $ 325 $ 74012-10Performance Evaluation, Cost Minimization, and Transfer PricingCost minimization – ExampleDivisional profits under the discretionary transfer price: Hijo Hija PadreSales $1,300 $1,500 $1,500Cost of goods sold 500 1,300 500Gross profit $ 800 $ 200 $1,000Income tax effect 136 70 206After-tax profit $ 664 $ 130 $ 79412-11Performance Evaluation, Cost Minimization, and Transfer PricingCost minimization – ExampleCorporate profits under the discretionary transfer price are $54 greater relative to the negotiated priceThis results from shifting $300 of pre-tax profits from the U.S. to ChileThe overall tax rate decreases from 26 to 20.6 percentThe performance evaluation objective is better served by the negotiated transfer priceThe cost minimization objective is better served by the discretionary price12-12Performance Evaluation, Cost Minimization, and Transfer PricingConflicting objectives and a solutionThe previous example illustrates how cost minimization and performance evaluation can conflictDual pricing is one solution to this conflictUnder dual pricing, the official transfer price used for tax purposes is the discretionary transfer priceA separate set of records used for performance evaluation use the negotiated transfer price12-13Performance Evaluation, Cost Minimization, and Transfer PricingOther cost minimization objectivesWithholding taxes on dividends can be effectively avoided via setting favorable transfer pricesThe same can be done to avoid profit repatriation restrictionsThis essentially changes cash flows from dividends to intercompany revenues and expensesMinimization of import duties(Tariffs)Increase cash flows out of a devaluing currencyEnhance the competitive position of a foreign operation12-14Interaction of Transfer Pricing Method and ObjectivesTransfer pricing method (cost-based or market-based) depends on specific environmental variablesCost-based methods are preferred when the following variables are importantDifferences in income tax ratesMinimization of import dutiesForeign exchange controls and risksRestrictions on profit repatriation Risk of expropriation and nationalizationMarket-based methods are preferred when the following variables are importantInterests of local partnersGood relationship with local government12-15Government ReactionsGovernments are aware of risk that multinationals will use transfer pricing to avoid paying income and other taxesMost governments publish guidelines regarding acceptable transfer pricingThe guidelines typically use the notion of an arm’s-length priceArm’s-length price is the price that would be agreed upon by unrelated parties12-16U.S. Transfer Pricing Rules (IRC Section 482)Allows the Internal Revenue Service to audit international transfer pricesPenalties of up to 40% of the underpayment of taxes (on a gross valuation misstatement) can be imposed on violatorsApplies to both upstream and downstream transactions, and transactions between two subsidiaries of the same parentImportant because most MNCs are either headquartered in or have significant business activities in the U.SU.S. transfer pricing reforms have influenced other countries’ regulations12-17U.S. Transfer Pricing Rules (IRC Section 482)A “best-method rule” requires the use of arm’s-length conceptPrimary factors to consider are the degree of comparability to uncontrolled transactions and the quality of the underlying analysisThe IRS provides for correlative relief to help in situations where the IRS agrees with a company’s transfer pricing but a foreign government does not12-18Sale of Tangible PropertyTreasury Regulations require the use of one of five specified methods to determine the arm’s-length price Comparable uncontrolled price methodResale price methodCost-plus methodComparable profits methodProfit split method12-19Sale of Tangible PropertyComparable uncontrolled price methodWidely considered the most reliable measure when a comparable uncontrolled transaction existsTransfer price is determined based on reference to the company’s sales of the same product to an unrelated buyerReference to transactions between two unrelated parties for the same product are acceptableIf an uncontrolled transaction is not exactly comparable, an adjustment is allowable12-20Sale of Tangible PropertyResale price methodGenerally used when the affiliate is a sales subsidiary and simply distributes finished goodsTransfer price is determined by deducting gross profit from the price charged by the sales subsidiaryGross profit is determined by reference to uncontrolled partiesThe most important factor in choosing this method is the similarity in function of the affiliated sales subsidiary and the uncontrolled reference company12-21Sale of Tangible PropertyCost-plus methodMost appropriate when comparable uncontrolled transactions don’t exist and sales subsidiary does more than simply distribute finished goodsTransfer price is determined by adding gross profit to the cost of productionGross profit is determined by reference to uncontrolled partiesFactors influencing the comparability of uncontrolled transactions include: complexity of manufacturing process, procurement activities, and testing functions12-22Sale of Tangible PropertyComparable profits methodUnderlying principle is that similar companies should earn similar returns over a period of timeOne of the two related parties in the transactions is chosen for examinationTransfer price is determined via reference to an objective measure of profit of an uncontrolled company involved in comparable transactionsTypical measures of profit include: ratio of operating income to operating assets and gross profit to operating expenses12-23Sale of Tangible PropertyProfit split methodTreats the two related parties as one economic unitProfit from the eventual sale to an uncontrolled party is allocated between the related partiesAllocation is based on relative contribution of each partyContribution is determined by functions performed, risk assumed, and resources employedThere are actually two versions: comparable profit split method and residual profit split method12-24Sale of Tangible PropertySummaryAny particular transfer pricing method used can result in a range of transfer pricesCompanies can use discretion to set prices within the range in order to achieve cost minimization objectivesCompanies can also use discretion in determining the “best” methodSection 482 does provide detailed guidance on factors to consider in determining comparability to uncontrolled transactionsTaxpayer must provide contemporaneous (within 30 days) documentation justifying method selected, covering at least eight specified items (e.g. an analysis of the economic and legal factors as well as an explanation of why one method was selected over alternatives)Substantial reporting and record-keeping requirements12-25Licenses of intangible propertySection 482 lists six categories of intangibles, including: patents, copyrights, trademarks, franchises, and methods and proceduresFour methods are available for setting transfer prices:Comparable uncontrolled transaction methodComparable profits methodProfit split methodUnspecified methodsPricing of intercompany loans and intercompany services are also transfer pricing situations12-26Advance Pricing Agreements (APA)It is an agreement between a company and the IRS regarding an acceptable transfer pricing methodA unilateral agreement is between a taxpayer and the IRS, while a bilateral agreement involves the IRS and one or more foreign tax authoritiesThe primary advantage is assurance that their approach will not be challengedThe primary disadvantage is the time and cost involved in arriving at the agreement12-27Advance Pricing Agreements (APA)Some specifics of national APAsThe U.S. began its APA program in 1991An increasing number of other countries have subsequently established programsIn the U.S., of a total of 42 agreements executed in 2011, approximately 62 percent involve foreign parent companiesThe computer and electronics product manufacturing industry have been the leading users of APAs12-28Worldwide EnforcementTax authorities view transfer pricing as a “soft target”To avoid lengthy, complicated disputes and increased scrutiny by local authorities a company may just pay the additional taxIn 2010, an Ernst & Young survey showed that more than two thirds of MNC respondents had experienced a transfer price audit somewhere in the world since 2006More than 25% of completed audits resulted in a tax adjustment, with penalties imposed in almost 20% of those cases12-29Worldwide EnforcementThere are a number of documented cases of companies, both U.S. and foreign, deemed to have underpaid taxes in the U.S.Some of these cases reflect obvious attempts by companies to evade U.S. taxes by manipulating transfer pricesIn one case, a U.S. subsidiary sold bulldozers to its foreign parent for $551 eachFrom 1998-2005, over 60 percent of U.S. and foreign multinationals paid no U.S. income taxThere is a worldwide trend toward strengthening transfer pricing rules12-30End of Chapter 1212-31

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