When market prices cannot be used, versions of “cost-plus-a-profit” are often used as a fair substitute.
Variable-Cost Pricing In situations where idle capacity exists, variable cost would generally be the better basis for transfer pricing and would lead to the optimum decision for the firm as a whole.
An item is produced by Division A in a country with a 25% income tax rate.
It is transferred to Division B in a country with a 50% income tax rate.
An import duty equal to 20% of the price of the item is assessed.
Full unit cost is Rs100, and variable cost is Rs60 (either transfer price could be chosen).
Multinational Transfer Pricing Example Which transfer price should be chosen? Rs100 Why?
Multinational Transfer Pricing Example Income of A is Rs40 higher: 25% × 40 = (Rs10) higher taxes Income of B is Rs40 lower: 50% × 40 = Rs20 lower taxes Import duty paid by B: 20% × 40 = (Rs8) Net savings = Rs2