TRANSFER PRICING - NEGOTIATED BASIS

by Kent Edward Baxter        1 December 1999

The purpose of negotiated transfer prices are their use in situations where market prices are prone to sudden changes. The final negotiated transfer price results from bargaining between the buying and selling parties. Bargaining usually involves standards and conditions being set by both parties. For example, the purchasing party may make a condition that the cost of a unit of raw material must be a certain amount. 

                In the realm of negotiations, subunits or divisions of a company have the freedom to negotiate a transfer price between themselves, and then to make a decision as whether to make transactions internally, or make deals with outside parties. During negotiations, the subunits can use information on costs and market prices, yet no requirement is given that the chosen transfer price be directly or uniquely related to market price or cost data. 

                Firms with interrelated activities in different countries must satisfy tax authorities that they are not evading taxes through the use of transfer prices. To do this, they must review all regulations and laws regarding taxation and transfer pricing rules and practices.

                 Implications of taxation can and often do arise from transfer pricing. From country to country, rates and factors such as income taxes, payroll taxes, regulations, duties, tariffs, sales (consumption) taxes, value added taxes, environmental and social taxes, plus regulations and levies may vary to different degrees. 

                Negotiations must be privy to all foreign investment-related information, as there may be certain benefits - for example, certain countries may have some have tax incentives, providing transfer price regulations are followed. 

                If one company is dealing with another in a similar line of operations, negotiations must be conducted carefully (with all factors being taken into consideration) so that violations of anti-trust laws and competition acts will be avoided. This isn't likely to be a problem with most foreign dealings, mainly domestic companies. GM and Toyota are unlikely to be penalized for joint ventures, not unlike if GM and Ford were to take part in a similar project.

 Foreign negotiations should take into consideration the following questions: 

- Are there, or will there be any tariffs of duties on the potential goods to be traded?

- What are government regulations and controls for multinational corporations placed by foreign governments?

                 Example: Canada's FIRA (Foreign Investment Review Agency) was a body

- Are there limits on foreign investment in certain sectors of the economy?

                Example: foreign investment in the privately-owned Australian media is restricted to 25%

- Has the currency been suitably stable?

- Are there requirement s for governments to make the final decision, based on satisfactory criteria?

                 Although there is [generally] no requirement that the negotiated transfer price resemble or come close to market prices, there is the possibility that a government within the jurisdiction of one of the parties may intervene, and set a pricing standard. Canada has introduced such a matter. An initiative that went into effect on 1 January 1998 specified that 'all transactions between taxpayers and related entities located outside Canada must take place at fair market value.'

                 When dealing in foreign markets, corporations need to take into consideration the issue of how competitive the market in question is from region to region within a country, such as in the case of provinces (or states), and territories. The revenue, finance and taxation departments of these entities may provide certain transfer pricing arrangements, as well as analytical perspectives and guidance from the profession. In addition, the company may have economists specializing in specific international markets. 

                Related to the above factor, there may be additional taxation and regulations if the country where an investment is to take place is a federation, such as Canada or Australia, where provinces (or states) may have different corporate guidelines. 

                If dealing with a foreign country, currency fluctuations must be taken into consideration if the country in question had had currency problems - purchasing power may be affected, more so the balance of trade. A devalued foreign currency may have a positive benefit for the foreign-based purchasing party as more goods could be acquired at a lower cost, although not necessarily for the domestic (selling) party. 

                Divisions within a company with the autonomy to negotiate freely (or any deal maker, for that matter) should negotiate with the bottom line being whatever is in the best interest for that entity, what is best for that division, not just the entire company, since the financial well-being could differ greatly. 

                As an important note for negotiations, feedback should be collected from both parties and their entities, as some elements specified may effect them. The more information that each side is privy to as a whole, the greater chance there is for success.

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