One of the main tax challenges for multinational corporations is transfer pricing. It covers every facet of the pricing agreements made between legal entities that make up a corporate group for the sale of goods and services.
History and reasons for its significance
Cross-border intra-company transactions have increased in frequency with the rise of globalisation. As a result, the Organisation for Economic Co-operation and Development (OECD) and the United Nations Tax Committee support the “arm’s length” principle, which states that a company should set transfer prices at the same level it would use if the other trading party were an outside company rather than a member of the same entity. Companies are warned against employing “creative” pricing strategies to evade paying taxes in the region with higher rates.
The “arm’s length” rule, which many nations have made a legal requirement, is challenging to uphold in practise. It causes conflict between tax authorities, who seek to increase their own revenues, and businesses, who want to minimise taxes and maximise earnings.
In other words, firms can utilise transfer pricing to transfer revenues and costs to other divisions internally to lower their tax burden by charging above or below the market price. To try to stop businesses from utilising transfer pricing to evade taxes, tax authorities have tight regulations about it.