Transfer prices: What are they? How do they work?

Transfer prices 

Transfer prices, what are they? How do they work? The transfer prices could be defined as the legal capacity that a company has to transfer the profits of a parent company to a subsidiary company (CFC) located in a tax haven or in a jurisdiction with a lower tax.

High taxation countries are pursuing companies through CFC legislation (Controlled Foreign Corporation) to prevent these companies from evading taxes by diverting the profits to their subsidiary holding companies (CFCs). The typical procedure to save taxes is to avoid the payment of dividends to the shareholders and, consequently, since there are no distributed benefits, there are no taxes to declare. For a company to make a transfer price successfully it has to explore the types of agreements that exist between countries and know what is best for saving taxes, this type of agreements are known as "treaty shopping." The "treaty shopping" excludes tax havens to avoid double taxation, or even a third country, in this way preventing the company from paying taxes in its subsidiaries.

Another problem that high taxation countries are encountering is the artificial modification of the prices of goods with the objective of increasing the purchase price that the parent company has to pay and trying to make the benefit to be taxed by minimal. For years the multinationals have used their subsidiaries spread all over the world with the aim of not paying taxes or significantly reducing them. The objective is to create an internal market in which all the divisions of the multinational are present. The tax advisors consider all the divisions of a company as functionally interchangeable, in this way the purchases, the orders and the contracts are assigned to the division that most interests. The result is that expenses will be higher in divisions that support higher taxation and lower in jurisdictions where they have a lower or no corporation tax.

The OECD developed some recommendations to avoid the fictitious prices of services, that is, the distribution of benefits to avoid paying taxes. One of these recommendations is that the country reserves a right to establish the market price of a service or merchandise between two related companies. The objective is to prevent the parent company from selling to an offshore company a product or service below its market value and then selling it at a higher price to the parent company. The company must justify to the tax authorities the internal prices between the related companies. 

Transfer prices in the European Union

The European Union has created anti-transfer pricing laws following the OECD criteria but has realized that it has generated a lot of legal uncertainty among companies, as it cannot define the criteria for valuing these linked operations. CFC regulations in the European Union identify two types of companies: companies registered in a tax haven with 0% tax and companies registered in a jurisdiction with lower tax rates (12.5%) or similar to the parent company (27%). In order not to violate the CFC regulations, the taxes of a country where the benefits are transferred cannot be 75% lower than those established in the parent company. Tax havens have designed schemes to avoid the transfer-pricing rule that allows CFCs to be circumvented legally. For example, in Jersey it is the company that can choose the type of tax it has to pay. In this way, when presenting the audit to the fiscal authorities of a parent company, you can see the type of tax paid in a country that has not been considered a tax haven and as a result reduce your tax bill.

European Union transfer pricing