Week 5 Transfer pricing

Transfer pricing is importance to international corporations because their operations extend to countries with diverse taxation regimes and regulatory capacities. The pursuit of profits, cash flows, marketing goals, economies of scale and competitive advantage through joint ventures, subsidiaries and affiliates necessitates estimations of costs to measure performance and taxable profits. In such an environment corporations need to develop processes for allocating  costs and overheads and design strategies for estimating transfer prices for goods and services. Since costs and overhead allocation mechanisms are highly subjective corporations enjoy considerable discretion in allocating them to paricular products and geographical jurisdictions. Such discretion can enable them to minimize taxes and swell profits by ensuring that, wherever possible, most profits are located in  low-tax or low risk jurisdictions. Transfer pricing can enable companies to avoid double taxation.

The offshore companies are typically remunerated using traditional transfer pricing approaches. In case of outsourced services predominantly the cost plus method is applied. However, in view of the substantial cost savings generated through offshoring of activities to low-cost economies and the increasing degree  of complexity of the off shored functions, the tax administrations, in particular of emerging markets such as China and India, have started adopting more aggressive positions with regards to the traditional cost plus mark-ups applied, hence requesting much higher profit margins for the offshore companies. The main concept behind the tax management use of a Tax-Haven by a company is to restructure the company's transactions so that the majority of the taxable profit arises in a very low tax regime. It should be note that the actual operations of the company normally still operate in the original country. A number of companies have inventively restructured them or outsourced their operations to make use of Tax loopholes. The most popular tax heavens are Dublin, Luxembourg, America British Virgin Isles, Cayman Islands, Hong Kong.

Take Jersey as an example, Jersey are tax advantage for customers in that order up to £18 in value are VAT free under the personal import rules. This means that by outsourcing the sale to Indigo Lighthouse, Amazon can enjoy a competitive advantage of 15% (UK VAT) on UK based high street retailers for the same product like HMV or Zavvi. Indigo Lighthouse also deals directly with the contact lens suppliers, including Busch & Lomb, Johnstone & Johnstone, Cooper Vision and Ciba Vision as well as a number of other businesses.