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Potential for maximization of income through use of transfer pricing

(a) Marketable Transfer Pricing Procedure
(i) When division are not captives of internal divisions and the divisions are free to do business both internally and externally and when there are reasonably competitive external markets for the transferred products, then the most suitable transfer price would be, the market price, as it generally leads to optimal decisions.
(ii) In case, the external market for the transferred good is not reasonable competitive, following two situations may arise in this case.
(a) If there is idle capacity: Under this situation opportunity cost will be zero hence minimum transfer price should be equal to the additional outlay costs incurred upto the point of transfer (sometimes approximated by variable costs).
(b) If there is no idle capacity: Under this situation opportunity cost should be added to outlay costs for determining minimum transfer price.

(b) The potential for maximization of income by a multinational through the use of transfer pricing mechanism is based on the successful implementation of the following steps:

(i) Transfer pricing may be set relatively higher for affiliates in relatively high-tax countries that purchase inputs from affiliates located in relatively low-tax countries.
(ii) Transfer prices to affiliates in countries which are subject to import duties for goods or services purchase may be set low so as to avoid host country taxes.
(iii) Transfer prices to an affiliate in a country that is encountering relatively high inflation may be set relatively high to avoid some of the adverse effects of local currency devaluation that are related to the high inflation.
(iv) Transfer prices may be set high for goods and services purchased by an affiliate operating in a country that has imposed restriction on the repatriation of income to foreign companies.
(v) Transfer prices may be set low for an affiliate that is trying to establish a competitive advantage over a local company either to break into a market or to establish a higher share of the company’s business.
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