Chapter 19 – Strategic Performance Measurement—Investment Centers
4. Laws limiting the kind of tax-planning opportunities alluded to above in (3) differ across countries. The
19-53 (Continued)
Section 482 of the Internal Revenue Code (IRC) addresses the issue of setting international transfer
prices by companies subject to the U.S. income tax. For both tangible and intangible property
transfers, Section 482 requires that the transfer price be set at an amount equal to the amount that
would be charged by an unrelated third party in a comparable transaction. Regulations pertaining to
§482 of the IRC indicate that transfer prices for transfers between a U.S. parent firm and a foreign
subsidiary or division can be market-based or cost-plus-based. In the latter case, the markup over
cost must approximate the margin on similar, unrelated transactions.
We note here that in addition to income tax considerations, the transfer price in an international
setting has a cash-flow effect through its impact on the level of import duties and tariffs. These items
are imposed by a country on goods being imported into that country. The amount imposed is typically
levied on the basis of the reported value of the imports. As in the income-tax case, the laws across
countries differ with respect to the ability of a company to manage its import duty and tariff expense
via the transfer pricing mechanism.
Finally, students should be made aware that many of the same issues that arise in an international
setting (regarding the effect of alternative transfer prices on cash flows) are relevant in the U.S. as
well, specifically, for interstate transfers of goods and services.
19-91
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-92
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-54 Transfer Pricing, International Considerations; Strategy (60 Minutes)
1. Transfer prices represent the amount that one division (subunit) of an organization charges another
division (subunit) of the organization for services and products transferred internally.
Transfer prices serve the following roles:
a) They provide price data (i.e., inputs) for evaluating the financial performance of profit centers
and investment centers. In the absence of such price information regarding internal exchanges,
motivate producing divisions to produce efficiently; it should motivate the buying division to
acquire and use internally purchased goods and services efficiently.
2. It is the existence of differential income tax rates across countries that provides managers with some
opportunities to increase after-tax cash flows through setting of the transfer price. In general,
countries (or states), then the opportunities for tax planning are eliminated.
19-93
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-94
Chapter 19 – Strategic Performance Measurement—Investment Centers
19-54 (Continued-1)
Laws limiting the kind of tax-planning opportunities alluded to above in differ across countries. The
laws in some countries prohibit such practice altogether, while other countries provide at least some
possibility for reducing income taxes through transfer pricing decision.
division can also be market-based or cost-plus-based. In the latter case, the markup over cost must
approximate the margin on similar, unrelated transactions.
We note here that in addition to income tax considerations, the transfer price in an international
setting has a cash-flow effect through its impact on the level of import duties and tariffs. These items
The following sites provide students with information regarding differential income-tax rates for
countries across the world: http://www.worldwide-tax.com/; http://www.dits.deloitte.com/;
http://www.cbo.gov/ftpdocs/69xx/doc6902/11-28-CorporateTax.pdf ; and,
http://www.pwc.com/extweb/pwcpublications.nsf/docid/9B2B76032544964C8525717E00606CBD.
As alluded to above, students should be made aware that many of the same issues that arise in an
international setting (regarding the effect of alternative transfer prices on cash flows) are relevant in
the U.S. as well, specifically, for interstate transfers of goods and services. This issue arises, once
again, because of the differential income-tax rates across states.
19-95
19-54 (Continued-2)
3. Profit and Income Tax Expense: Transfer Price Alternative #1
Italian Irish U.S. Parent
Subsidiary Subsidiary Company Combined
Revenue/Unit = $1,200 $1,600 $2,000 $2,000
Cost/Unit:
Incremental Cost = $1,000 $100 $100 $1,200
Transfer Price = $0 $1,200 $1,600
4. Profit and Income Tax Expense: Transfer Price Alternative #2
Italian Irish
U.S.
Parent
Subsidiar
y
Subsidiar
y Company
Combine
d
Revenue/Unit = $1,100 $1,800 $2,000 $2,000
19-96