Question

what is transfer pricing and explain with example the technique of transfer pricing ignou 2019-20 solved answer​

Answer 1

Transfer pricing is the setting of the price for goods/services that are sold between related/controlled legal entities within an organisation. For example, if a subsidiary firm sells goods to its parent firm, the cost of those goods paid by the parent firm to the subsidiary firm is the transfer price.

Explanation:

• Transfer pricing is an accounting practice which denotes the price that one division in an organisation charges another division for services/goods offered.
• Transfer pricing facilitates in the setting up of prices for the goods/services exchanged between an affiliate, commonly controlled firms, or a subsidiary which are part of the same larger organisation.
• Transfer pricing leads to tax savings for organisations, although tax authorities can contest their claims

For example,

• Let us assume that  a vehicle manufacturer has 2 divisions: Division X, that make software and Division Y that manufactures cars. Division A sells the software to other automobile manufacturers  and also to its parent company. Division Y pays Division X for the software usually at the prevailing market price which Division X charges other automobile manufacturers.
• Assume Division X decides to charge lesser price to Division Y  instead of prevailing the market price. Because of this, Division X's sales/revenues will be lower owing to the lower pricing. Whereas, Division Y's costs of goods sold (COGS) are lower, thereby increasing the profits of division Y. As such Division X's sales/revenues are lower by the same amount as Division Y's COGS, hence there is no financial impact on the overall organisation.
• However, if Division X is in a higher tax nation than Division Y. The overall company can save on taxes by making Division X less profitable and Division Y more profitable. When Division X charges lower prices and pass the savings to Division Y, increasing its profits by way of lower COGS, Division Y would be taxed at a lower rate. In other words, Division A's decision not to charge the prevailing market pricing to Division B allows the overall organisation to evade taxes.
• In short, by charging above/below the market price, firms use transfer pricing to transfer costs and profits to other divisions internally to lower their tax burden. However, tax authorities have stringent rules concerning transfer pricing to prevent firms from adopting it to avoid taxes.

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