Comparison of Transfer Pricing Methods

Companies use transfer prices for tax optimisation purposes and achieving business objectives. The purpose of proving transfer prices in transactions with related parties for the needs of the Tax Authority is to demonstrate that generated revenues actually correspond to expenses, so that the effect can be measured at each step of the process. Through calculations, she proved that the comparable uncontrolled price method is not always the most favourable method for calculating transfer prices for a company, and there is also a difference between the internal and external comparable price methods. The purpose of the diploma thesis was to determine through research how different methods for determining transfer prices affect taxation with corporate income tax and, above all, to prove that a method for determining transfer prices must be selected separately for each business transaction.

Problem

Companies use transfer prices for tax optimisation purposes and achieving business objectives. The purpose of proving transfer prices in transactions with related parties for the needs of the Tax Authority is to demonstrate that generated revenues actually correspond to expenses, so that the effect can be measured at each step of the process. Establishing an appropriate transfer pricing policy is also important because savings and profits depend on it.

Transfer prices thus affect the entire business chain: from research and development, production, marketing, to distribution and sales and after-sales activities.

Solution and Method

Through calculations, she proved that the comparable uncontrolled price method is not always the most favourable method for calculating transfer prices for a company, and there is also a difference between the internal and external comparable price methods. In the given examples, the external comparable price method is indeed the most favourable in most calculations, but in some cases other methods are more appropriate from the company's perspective. She also found that it is very important that calculations and documentation regarding transfer prices and the use of methods are prepared continuously as business transactions occur, because the conditions under which transactions took place can change significantly within one year, and ensuring documentation and verifying conditions 'retrospectively' is very difficult, sometimes even impossible.

Transfer or transfer prices have become one of the major problems in annual profit calculation or in preparing tax returns, especially for multinational companies, as different tax legislation applies in different countries. Transfer prices are not only a problem for international corporations, but also for Slovenian companies that are connected through capital, ownership or management. Thus, differences in profit taxation and in recognising tax reliefs lead to companies transferring their operations to countries where effective tax burden is lowest, as it is in companies' interest to pay as little tax as possible.

It is in the interest of states, however, to collect as much tax as possible, so they naturally intensively monitor companies in establishing transfer prices and determine their appropriateness from a tax perspective. The problem with verifying the establishment of transfer prices is that tax authorities see them only as a tool for tax avoidance and usually do not take into account that, in addition to the tax rate, a huge number of other factors influence the establishment of transfer prices and that companies establish transfer prices in order to follow the set business objectives of the company.

The objectives of companies, however, are to generate as much profit as possible, not to avoid paying taxes.

Results

The purpose of the diploma thesis was to determine through research how different methods for determining transfer prices affect taxation with corporate income tax and, above all, to prove that a method for determining transfer prices must be selected separately for each business transaction. The Rules on Transfer Pricing stipulate that the comparable uncontrolled price method is the preferred method that should be used in preference to other methods, but each company must decide, based on simulations and calculations for each business transaction separately, which method or combination of methods for calculating transfer prices it will use, as the level of taxation depends on this.

In the first part of the diploma thesis, she presented the definition of transfer prices and the legislation that defines this area. In the continuation, she defined in more detail the definitions of related parties, and then described the OECD guidelines and factors that influence the establishment of transfer prices. In the sixth chapter, she defined in more detail the theoretical requirements for establishing transfer prices according to recognised methods.

In the seventh chapter, she made a simulation of calculations for certain business transactions and calculation of transfer prices according to methods most commonly used in practice. With the presented calculations, it was therefore proven that the comparable uncontrolled price method is not always the most favourable method for calculating transfer prices for a company, and there is also a difference between the internal and external comparable price methods. In most calculations in the given example, the external comparable price method is indeed the most favourable, but in some cases other methods are more appropriate from the company's perspective.

However, all these calculations and the appropriateness or inappropriateness of the methods used must be proven with appropriate documentation. Because of this, it is very important that calculations and documentation regarding transfer prices and the use of methods are prepared continuously as business transactions occur, as the conditions under which transactions took place can change significantly within one year, and ensuring documentation and verifying conditions 'retrospectively' is very difficult, sometimes even impossible. Every company dealing with transfer pricing issues should have a system in place that would enable it to continuously ensure appropriate calculations, comparable market prices, records, etc.

It is also important that we devote exceptional attention and sufficient time to establishing transfer prices, as only in this way can we ensure optimal taxation for companies and provide the tax authority with assurance that transfer prices are established in accordance with market principles and the law. It is necessary to know the methodology and legislation very well in order to effectively calculate the most appropriate transfer prices and also defend them and prove why a particular method was used and not some other. This also shortens a possible tax inspection, as the required documentation is immediately available to the inspector, and we also avoid doubts and different interpretations of calculations.