Transfer Pricing and International Corporate Deviance

Transfer Pricing and International Corporate Deviance

Workplace deviance isn’t limited to the harmful behaviors of employees within one location. There are cases of corporate deviance that extend across country borders. Consider transfer pricing, which is the price that one part of a company charges another part of the same company for a product or service. What happens with transfer pricing if various parts of a company are located in different countries, which happens as more and more companies extend their operations across the globe to become multinational businesses?
Tax rates on company profits differ—sometimes greatly—from country to country. Transfer pricing, when used to shift income from high-tax countries to low-tax countries, can be a deviant corporate policy if abused. One way to increase overall profit—that is, the combined profit of the multinational’s headquarters and its subsidiaries—is to take profits in the country with the lower taxes.
Take the case of a multinational firm whose headquarters sold toothbrushes to a subsidiary for $5,000—each. The subsidiary, with the higher tax of the two, claimed a loss (after all, it paid $5,000 per toothbrush). The multinational firm, with the lower tax of the two, took the profit and paid the tax on it. Because the two firms were part of the same organization, they combined the results of the transaction, and the company made a staggering profit.
Transfer pricing, according to a survey by the international auditing firm Ernst & Young, has become a heated issue among multinational companies. Why? The U.S. Multistate Tax Commission estimated that states were losing almost a third of their corporate tax income because of tax-sheltering practices by multinational companies—transfer pricing among them. The U.S. Internal Revenue Service is keeping a watchful eye on international transactions.

Source: Based on “Case of the U.S. $5000 Toothbrush,” Finance Week, April 27, 2005, pp. 45–46.