INTRODUCTION:

The concept of "Transfer pricing" refers to a figure which attempts to establish mechanisms to control that prices in commercial transactions among related parties are equal to those prices that would be given between non related firms or parts. It is used when individual entities of a larger multi-entity firm are treated as independent entities. The main purposes of this figure are to allow each country to collect all the taxes they have the right to and for multinational companies, to develop different tools in order to help them managing the problems of being regulated under several and different fiscal jurisdiction. The first purpose means a problem due to firms can achieve tax benefits using different techniques of transfer pricing to manipulate the prices under which companies change goods, services and property (in a way that increases their cost or deductions and decreases their taxable revenues). Hence, to avoid this mechanism is the main goal of tax authorities in this issue. Over 60 governments have adopted transfer pricing rules, that are based on the arms length principle which establish transfer prices based on analysis of pricing in comparable transactions among unrelated parties dealing at arms length. Within these regulations we can find different techniques of transfer pricing, being the most used: 1. 2. 3. 4. 5. 6. 7. Market based Cost based Negotiated, Resale price Cost plus Profitability based methods Comparable uncontrolled price

Also previous agreement between taxpayers and government can be accepted (specially reducing the double taxation).Within these regulations we can also find different methods of transfer pricing depending on which goods, services or use of property are transferred, for the difference of the nature of the transaction. The issue of this essay is nowadays a topic of high relevance as it is said by the International Tax Review: "Transfer pricing continues to dominate the agenda of international tax debate. As many countries continue to refine their transfer pricing rules, for directors of multinational corporations, the compliance burden is becoming heavier and more complex. Some initiatives, like the single documentation package from the Pacific Association of Tax Administrators, seek to reduce the burden but even this initiative has its critics. " (International Tax Review, Transfer Pricing 5th Edition, 2002, pp.181.).

TRANSFER PRICING METHODS:

According to Putra (2009, p.2), "The transfer pricing method used must be the one most beneficial to the company", but it can happen that the interest of the managers may conflict

with the interest of the company as a whole, where managers have to act to ensure the interest of both parties. To select a reasonable transfer pricing method, managers have to compare and analyze those characteristics of comparable enterprises or the comparable transactions that could affect the application of the arms length principle, with intention of determining any needed adjustments and the degree of comparability. According to the OECD guidelines, a comparable analysis has to consider these factors: 1- Characteristics of services or transferred assets . E.g. physical characteristics, quantity, and quality of those assets that are tangible. 2- Risks assumed and functions performed by parties to the transaction, including functions such as. E.g. production, financial market and distributing risk, research and development ("R&D"), etc. 3- Contractual terms. E.g. terms and scope of the well known after-sale services. 4- Economic environment. E.g. market scale, the geographical region or industry overview. 5- Business strategy. E.g. risk avoidance and market penetration strategies , etc. In connection with the main methods for establishing transfer prices, we can say that there are three general ones (there are others which are collected by the OECD guidelines that will be explained later): 1-Market-based Transfer Prices: According to Putra (2009, p.2), the market price is considered the best transfer pricing when the middle-market (is a market in which engages an alien force of supply and demand, as the government) is perfectly competitive, i. e. there is a homogeneous product with equivalent price of buying and selling and no individual buyer or seller can affect that prices through their own acts. In general, internal transfers are made when the product of the selling center is equal (in quality, delivery, credit terms...) to that of outsiders in quality and price. Often a lower price may be justified due to the existence of less selling and administrative expenses, larger purchases and the guarantee that has the buyer of a good quality and delivery. Some disadvantages are that in some cases, prices obtained cannot be reliable caused by distress prices for excess inventory or defective goods, or also it can be due to an outside bidder who has consistently lost to internal transfers may possibly make a deliberately low bid (therefore, it is desirable for the buying center to maintain contact with more than one supplier). Finally, another disadvantage is that prices for some products can fluctuate widely and quickly.

However, many intermediate products do not have readily-available market prices, or there may not even be a market for an intermediate product .Then, obviously a market price cannot be used. 2-Cost-based Transfer Prices: In accordance with Lalith Abeysingue R. (2010), this method is used in practice, because these conditions are common: -Does not exists any external market to transfer the intermediate product. -Alternatively, can happen that if exist this market it is not a arms length market because is affected by although exists an external market it is imperfect due to the market price is affected by some factors as that there is only a limited external demand. In any case, there is not be a suitable market price in which to base the transfer price. The use of standard costs is therefore recommended due to costs vary with volume and with others seasonal factors and because they are used as a basis for the price; this leads to any inefficiency in the producing department is passed on the receiving department as an increased transfer price. -Transfer prices based on full cost. Full costs include fixed overheads absorbed and is simultaneous to profit margin in the transfer price. In this method, the cost of the product incurred by the supplying center are charged to the receiving center. Probably, the transfer price does not provide fair charge or revenue by a reasonable cost, being their profit performance distorted. Caused by this unfairness, the autonomy of each of the divisional managers is threatened, and if they do not agree what is a fair division of the external profit, the decision is imposed form above. It incentive to sell more goods externally and transfer less to other centers of the firm. (This can or cannot be in the best interest of the company as a whole). -Transfer prices based on Variable cost. A variable cost approach leads charging the variable cost that has been incurred by the supplying center to the receiving center. The variable-cost-based transfer price has an advantage over the full cost method due to in the short term it can lead to ensure the best utilization of the overall company`s resources. This is because fixed costs do not change and any use of facilities, without incidence of additional fixed costs, will increase the company`s overall profits.

3- Negotiated Transfer Prices: "Negotiated transfer pricing has the advantage of emulating a free market in which divisional managers buy and sell from each other in a manner that simulates arms-length transactions" (D. Caplan, 2008). Nonetheless, there is no reason to admit that the outcome of these transfer pricing negotiations is going to serve for the best interests of the shareholder or the company. The transfer Price concept depends on if manager gets the best deal for his center, instead of whether the transfer leads in a production which maximizes the profit. Furthermore, if managers of both centers do not achieve a deal on price, even though when the transfer is in the best interests of the company, senior management could impose a transfer price, defeating the motivation for using a negotiated transfer price in the first place. *External Reporting: For external reporting under Generally Accepted Accounting Principles, the effect is reversed and intercompany profits are eliminated when the financial results of the centers are consolidated, without taking into account what kind of transfer price is used for calculating divisional profits. It is obvious that intercompany transfers are not arms-length transactions, hence, a firm may not generate profits or increase the reported cost of its inventory through the transference of products from one division to another.

OECD Transfer Pricing Methods:

The OECD (Organisation for Economic Co-operation and Development), which is an international economic organisation formed by the 39 high-income economies whose goal is to stimulate economic progress and world trade, has published guidelines based on the arm's length principle, which are followed by many of its member countries , as it is said by Ernst & Young (2008, p.89): "The purpose of the OCDE guidelines is to alleviate double taxation issues by establishing the arms length principle as well as a hierarchy of transfer pricing methodologies for establishing or testing the application of the arms-length standard on intercompany pricing. While many tax regimes are aligned with the OECD Guidelines, local characteristics of compliance are not universal". The United States and Canadian (countries members) guidelines are similar in many aspects to the OECD rules, with some points of material difference. Just a few countries, such as Brazil and Kazakhstan, follow different rules.

The OECD Guidelines subdivide these methods into traditional transaction-based pricing methods and profit-based pricing method. This table shows the main differences among both:

-Deloitte Touche Tohmatsu CPA Ltd, (2010)-

As we can see in the table above the OECD guidelines divide transfer pricing methods between: - Traditional transaction based pricing methods, which are the most direct way of determining if commercial and financial relations among associated enterprises are normal (being these methods preferred in theory). - and Profit based method, such as an inability to obtain reliable and sufficient comparable data. These methods are in practise the most use due to the operational complexities.

*Dual Transfer Pricing: Some firms choose the dual transfer pricing through the use of two methods of transfer pricing by separately to set the price of each transfer from one center to another. The main motivation for using this method is to achieve a selling price higher to the purchase price, resulting in a corporate-level subsidy that promotes the divisions to engage in the transfer. In the purchasing center the function of the price is to make a decision to buy and therefore establish the output, and in the selling center, the price is an essential factor in evaluating their performance; while the first center its charged by the market price, the second is given credit for either standard variable or full cost plus a normal markup. The total income for the center will result bigger than for the whole company. These differences are going to be finally erased in the financial statements. *External Reporting: For external reporting under Generally Accepted Accounting Principles, the effect is reversed and intercompany profits are eliminated when the financial results of the centers are consolidated, without taking into account what kind of transfer price is used for calculating divisional profits. It is obvious that intercompany transfers are not arms-length transactions, hence, a firm may not generate profits or increase the reported cost of its inventory through the transference of products from one division to another.

-Developments in Transfer Pricing in a globalized world.

The concept of Transfer Pricing appeared and was developed during the 20th century, when multinational companies were born. Companies were developing strategies in order to maximize profit and minimize risk through the diversification of activities that were done in different departments, and inside this context, techniques were developed in order to manage transfer pricing between these departments. The first country in elaborating law against price manipulation was the United Kingdom in 1915, under the Finance Act 1915 which regulated the way in which profits were adjusted when a non-UK resident carried on business with, and controlled, a UK settled business. In USA the first antecedent that can be found takes us back to the Revenue Act of 1917 where transfer pricing problems emerged not between different countries but states of the Federal Union. Afterwards, in 1935 we can see the first attempt to define the Arms lenght principle under the Internal Revenue Code (IRC). At the same time, it can be seen as other countries like Argentina started to elaborate law about the very same issue. An example of this was the Argentina 11682 Law, 1932 which was the first intent to solve this problem in Latin America.
6

Other countries in this region did not elaborate anything about transfer pricing until the end of the 20th century, e.g., Mexico in 1992, Brazil in 1996 and Colombia in 1992. USA would be the first country in promulgate in 1968 a detailed regulation in which was developed the different methods to determinate the correct transfer pricing. Therefore, as we can see transfer pricing adjustments have been a feature of many tax systems since the 1930s. Both the OECD (of which the U.S. is member) and the US had some guidelines by 1979. The United States led the development of detailed, comprehensive transfer pricing guidelines with a White Paper in 1988 and proposals in 1990-1992, which finally became regulations in 1994. In 1995, the OECD issued the first draft of current guidelines, which it expanded in 1996. These two sets of guidelines are very similar and contain certain principles followed by many countries. The OECD guidelines have been formally adopted by many European Union countries with little or no modification. ACTUALITY: Currently the topic of transfer pricing is of high relevance, as it is displayed by International Tax Review, (2011, p.125): "Nowadays transfer pricing remains as a key tax challenge for the worlds leading companies. In a slowly recovering global economy and record deficits, governments are increasingly focused on raising revenues through taxation. As a result, more and more jurisdictions are rising up their enforcement efforts not only in developed nations but also in many emerging markets such as China, India, Russia and Brazil". Since 2007 to present China, France, Greece, Indonesia, Malaysia and Vietnam have included significantly improved transfer pricing requirements. Even jurisdictions traditionally viewed as tax-favorable, such as Hong Kong and Ireland, have injected a certain level of exigency for transfer pricing documentation. Comparing to before, tax authorities are armed with increasingly sophisticated and more general transfer pricing tools. During the last three years the IRS (tax authorities of EEUU), and also the OECD, the German administration and the Australian tax authorities has issued guidance of transfer pricing regulations on business restructurings. These regulatory developments are characterized by the next features: Greater sophistication and flexibility in the selection of transfer pricing methods, adopting realistic alternatives criterion into the selection of best method. The OECDs prohibition of inappropriate risk transfer (and profit), which covers the use of intercompany deals or low risk transfer pricing methods, such as cost-plus arrangements. A trend toward macro-level evaluations and analysing transfer pricing beyond to examine its effect on the profit or the full value chain.

As a result of all these changes in regulation, "companies are finding they must work harder to define and adopt a more proactive stance in defending their transfer pricing policies and practices" (Ernst & Young, 2010).

BIBLIOGRAPHY:
Deloitte Touche Tohmatsu CPA Ltd, (2010), China Transfer Pricing Guide 2012/2011, Section 1: Overview of Transfer Pricing Methodologies, pp.67-69. Dennis Caplan, (2008), Management Accounting: Concepts and Techniques, Part 5: Planning tools and performance measures for projects and divisions, Oregon State University. Ernst & Young (a), Global Transfer Pricing Survey 2007/2008, p. 3 Ernst & Young (b), Global Transfer Pricing Survey 2007/2008, p. 15-16 Ernst & Young (c), Global Transfer Pricing Survey 2007/2008, p. 17-18 Ernst & Young (d), Global Transfer Pricing Survey 2010, pp. 1-7 Ian Brimicombe, Head of Tax, AstraZeneca, (2010), Transfer pricing developments, Tax Journal. www.taxjournal.com International Tax Review (a), (2007), Transfer Pricing, 9th Edition, Vol. 2007, No. 35, pp. 181. International Tax Review (b), (2008), Asia Transfer Pricing, 4th Edition, No. 42, pp. 64-65. International Tax Review (c), (September 2011), Another world: Why the UN is adding another dimension to transfer pricing guidance, pp. 89. International Tax Review (d), (October 2011), Checking Out: Why the OECD list its two top transfer pricing officials, pp. 123-137. KPMG's Global Transfer Pricing Review, 2011 Edition, pp. 4-7. Lalith Abeysingue R. (2010), Cost-Based Approaches to Transfer Pricing, www.enzinearticles.com Putra, (2009), "Transfer Pricing for Profit Center", Accounting Financial and Tax, www.AccountingFinancial-Tax.com