Transfer pricing is the price charged by an enterprise for the transfer of physical goods or services to the associated enterprises (Clausing, 2003). Associated enterprises are the ones which directly or indirectly participates in the management and control of one another or when both are controlled by another entity. In the case of international transfer pricing, more than one tax jurisdictions are involved.

The issues in transfer pricing:

Additional cost that is associated with required manpower and time for the execution of transfer pricing system and for the designing of appropriate accounting system. Also, it is a very complicated

Transfer pricing matters because:

It has potential benefits of reduction in the tax obligation as the tax rate in parent country i.e. US is excessively higher than that of the countries where subsidiaries are intended to be established by the company.

Ethical consideration that may arise due to the use of TP:

Whether the company will pay less than their fair tax obligations or whether the society is harmed with corporation’s approach of reducing its tax liabilities. It is problematic because it is difficult to estimate pricing policy for the intangibles like services.

• License to the related enterprise will help the company to increase its market in the same country where transfer pricing can be adopted but the tax rate will remain same as the tax jurisdiction will not be changed.
• License to the unrelated party will have to be given on arm’s length price as they are not associated with each other. This might not help the company to achieve the maximum profitability and also the tax rate would not change due to the same tax jurisdiction.
• Establishing subsidiary in Australia will lead to royalty income from Australia and which will be taxed at tax rate of Australia. Setting up a subsidiary in Singapore will enable it to reap out maximum benefits of transfer pricing as subsidiaries are associated enterprises on which transfer pricing rules can be applied and also the tax rate is minimum in Singapore i.e. 17% so the tax obligation will be reduced.

Tax risk will be reduced as the Singapore tax rate is quite lower and therefore its tax obligations will be reduced.

Business risk: There will be no business risk as the business is not managed by the licensor.

Accounting risk: The accounting policies would remain as the same accounting treatment of transfer pricing is required to be given across the entire country. However, there is risk of manipulation of profits based on transfer prices of goods.

License to unrelated party:

Tax risk: Since the license is to be given to the entity of same country there would be imposition of higher tax rate as the tax rate in US is 35%.

Business risk: There would be risk of adverse impact on company’s original goodwill if license is given to unrelated party.

Accounting Risk: When transactions are recorded on arm’s length price basis there would be no risk of manipulation of records.

Establishing subsidiary in Singapore or Australia:

Business risk: The subsidiary will be the part of company itself and hence performance will impact the company’s performance.

Accounting Risk: With the change in countries, the accounting policies will be changed and there may arise conflicts of opinion to account for transfer pricing transactions.

Tax risks: The payment of tax at the higher rate as country is not changed in case if license is given to the company of same country.

Yes the corporation has a moral duty to pay its fair share of tax to the country in which it operates. Being a constituent of civilised society, tax payment of appropriate amount is to be made. It is an unethical practice to avoid taxes (McGee, 2010). But they are not obliged to pay tax more than the minimum legal amount.

References:

Clausing, K. A. (2003). Tax-motivated transfer pricing and US intrafirm trade prices. Journal of Public Economics, 87(9), 2207-2223.

McGee, R. W. (2010). Ethical issues in transfer pricing.