What is Transfer Pricing?

Transfer pricing is the rates or prices that are used when selling goods or services between company divisions and departments, or between a parent company and a subsidiary. The pricing that is set for the exchange may be the original purchase price of the goods in question or a rate that is reduced due to internal depreciation. When used properly, it can help to more efficiently manage profit and loss ratios within the company. Generally, transfer pricing is considered to be a relatively simple method of moving goods and services among the overall corporate family.

In situations where the transportation of goods is involved in the transaction, the rates may include both a fixed price per unit transferred, plus additional charges to cover the cost of shipping. This model is especially helpful when the transfer takes place between a parent company and a subsidiary. The larger entity can arrange the shipping through a discounted shipping plan that the smaller entity may not be able to access. The end result is that the pricing makes it possible to move the goods with the smallest amount of expense to the company as a whole.

In addition, transfer pricing is a great way to move goods from one company division or department to another without generating a lot of postings on the accounts receivable and accounts payable books. The value of the goods is simply moved from one division to the other, a process that greatly simplifies the process. Normally, there is a simple form that accompanies the physical transfer of the goods, and it is used by both the sender and the recipient to make appropriate posts in company accounting records. This process eliminates the necessity for invoices, tariffs, internal bills of lading, and other documents that would normally apply to a new purchase using an outside vendor.

While the main purpose of transfer pricing is to enhance the overall value of the corporate family of companies, there are instances when this type of transaction can be abused. This is especially true when transfers to international locations are conducted. Today, many countries have regulations to help prevent the use of this pricing method as a means of evading taxes or similar unethical and illegal activities.