Tax treatment of transfer prices

In some businesses, production takes place at different levels and the manufacturing process goes through those different levels categorized as divisions such as first second and third. Each level incurs its own cost but that too, depends upon the interaction among the different divisions. The second division takes all its material from the first and transfers the improved ones to the third.

So how do they agree upon the costs and revenues incurred by each division? So we use transfer pricing strategy.

But the problem here arise is that transfer prices are subject to legal restrictions in form of fines, penalties or some other legal constraint. Assigning different custom values for tax purposes to a good is an issue here because custom authorities may not be able to accept the custom prices given by the company.

The IRS (Internal Revenue Service) may put restriction on how subsidiary liquidation costs, gains and losses from each division are recognized. Transfer pricing also affects the extent to which amount of corporate tax is paid. It may also lead to double taxation. Taxation pricing being a complicated task may induce a company to change its investment decisions confronting amount of corporate tax charged from them. Moreover, it may affect cash flow of the company and may drive down the performance of the company.

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