Transfer pricing refers to the terms and conditions surrounding transactions within a multi-national company. It concerns the prices charged between associated enterprises established in different countries for their inter-company transactions, i.e. transfer of goods and services. Since the prices are set by non independent associates within the multi-national, it may be the prices do not reflect an independent market price. This is a major concern for tax authorities who worry that multi-national entities may set transfer prices on cross-border transactions to reduce taxable profits in their jurisdiction. This has led to the rise of transfer pricing regulations and enforcement, making transfer pricing a major tax compliance issue.
According to international standards individual group members of a multi-national enterprise must be taxed on the basis that they act at arm's length in their dealings with each other. This arm's length principle is found in article 9 of the OECD Model Tax Convention:
"[When] conditions are made or imposed between ... two [associated] enterprises in their commercial or financial relations which differ from those which would be made between independent enterprises, then any profits which would, but for those conditions, have accrued to one of the enterprises, but, by reason of those conditions, have not so accrued, may be included in the profits of that enterprise and taxed accordingly."
In The Company Tax Study (SEC(2001) 1681 ), the Commission identified the increasing importance of transfer pricing tax problems as an Internal Market issue: although all Member States apply and recognise the merits of the OECD "Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations", the different interpretations given to these Guidelines often give rise to cross border disputes which are detrimental to the smooth functioning of the Internal Market and which create additional costs both for business and national tax administrations.
On the following web pages you will find further information on the tax problems involved and solutions proposed: