Advanced Higher Business
Advanced Higher Business
Week 3
Transfer Pricing
Exploitation of local resources
Transfer Pricing
Exploitation of local resources
Ways in which MNCs exploit local resources
impact of exploitation on economies, organisations and stakeholders
Definition
Costs and benefits of using TP
Effects of TP on tax paid, profits, home countries and host countries
Transfer Pricing
Transfer of goods
Multinational Companies transfer goods, partly finished goods or supplies between their operations in one country to another.
To take full advantage of Economies of Scale, MNCs will have subsidiaries (branches) that specialise in different stage of production – therefore one subsidiary will transfer a partly finished good to another foreign subsidiary and so on until the final good is fully assembled
For example, BP Oil extract crude oil from the Gulf of Mexico and transfer it to the BP Refinery in Indiana who refine it into fuel
Transfer pricing
Transfer Pricing is a technique used by MNCs when declaring profit to reduce the amount of tax they have to pay.
A multinational will declare low profits in a country with high tax rates or high profits in a country with low tax
As the transfer of goods is internal, the price is set by the business themselves and is not influenced by external market forces. E.g. competition, economy, etc
Main aims of TP
Help achieve the company’s strategies/targets
Minimise overall tax liability
Profits and tax
The MNC will look to declare most of its profits in a country with low taxes
This means the business must shift profit around in order to reduce the amount of tax paid – it can do this by carefully setting transfer prices between subsidiaries
Transfer prices high and low
Setting a high TP when transferring to subsidiaries in high tax countries achieves the following:
Lowering the profit margin of the receiving subsidiary
Therefore lowering the profit margin overall
Therefore lowering the amount of tax that subsidiary has to pay
Setting a low TP when transferring to subsidiaries in low tax countries achieves the following:
Increasing the profit margin of the receiving subsidiary
Therefore increasing the profit margin
But, despite also increasing the tax, this is still less than the tax paid in the high tax country so overall tax payable is minimised
Impact of TP on MNC
Positive
Can reduce the amount of tax paid
Can increase profit margins – higher dividends for shareholders/used for finding expansion, etc
Can allow a legal agreement with host country to pay less tax in return for setting up operations in the country
Government protection from high tax bills
Can reduce the impact of exchange rate changes
Can be used to offset cost of import/export tariffs
Impact of TP on MNCs- negative
Potential damage to reputation if host country or consumers protest against it
- Could lead to boycotts – loss of sales & damages profits
- Lead to legal problems if host country pursue unpaid tax
Transfer prices have to be very carefully set to avoid investigation by tax offices
-Requires regular time-consuming internal audits
Masks actual regional performance
- Internal conflicts may occur between regional managers
Impact of TP on MNCs- positive
Can reduce the amount of tax paid
Can reduce the impact of exchange rate changes
Can allow a legal agreement with host country to pay less tax in return for setting up operations in the country
Can be used to offset cost of import/export tariffs
Impact of TP on MNCs- negative
Potential damage to reputation if host country or consumers protest against it (boycotts or legal problems)
Transfer prices have to be very carefully set to avoid investigation by tax offices
Impact of MNC on host countries- pos
Low tax countries can attract multinationals to operate in that country
Creates employment
Increases wealth
Boosts economy
Can allow maximum tax revenue to be collected by certain governments
Helps investment in state services and infrastructure
Impact of MNC on host countries- negative
Limits or reduces the amount of tax revenue taking in
Government spends less on country
Governments allowing excessive transfer pricing may look weak to voters
Impact of TP on host country positive
Low tax countries can attract multinationals to operate in that country
Can allow maximum tax revenue to be collected by certain governments
Impact of TP on host country negative
Limits or reduces the amount of tax revenue taking in
Governments allowing excessive transfer pricing may look weak to voters
Impact of TP on home country- positive
MNCs can reinvest more in growth, R&D or innovation due to having reduced tax liabilities, this will benefit the home countries economy
- Headquarters often still remain in the home counry meaning high demand for high skilled jobs- sustains employment rate
Impact of TP on home country- negative
Profits being declared in lower tax countries means home counry may collect less corporation tax- impacting funding of state services
Governments must invest in the monitoring of TP- increased costs,
Impact of TP on home country- positive
MNCs can reinvest more in growth, R&D or innovation due to having reduced tax liabilities
Headquarters often still remain in the home counry meaning high demand for highly skilled jobs
Impact of TP on home country- positive
home country may collect less corporation tax-
Governments must invest in the monitoring of TP
Explore the effects of Transfer Pricing on a multinational and its hosts countries (4) 2017 Q8a
Discuss the use of TP by a MNC (6) 2023 Q10a
Can reduce the amount of taxation paid by the organisation
Means there is more profit available for retaining
Leading to higher dividends for shareholders
Declaring profits in a country leads to taxation revenue
This can be used to improve state services
May improve organisations relationship with the government
The transfer price should be determined using an ‘arm-length’ principle to reduce the risk of tax offices investigating
- organisations should carry out regular internal audits to review their transfer price practices
Exploitation of local resources
MNCs can bring many benefits to host nations
Employment
Wealth
Technological advances
Infrastructure
However, they are often accused of exploiting the natural resources of a host country
Especially in developing nations such as various African countries
Examples of exploitation
Overconsumption of Natural Resources (Overharvesting)
Over-fishing
Excessive farming
Deep Fossil fuel drilling and mining (Fracking)
Overuse of water supply
Excessive logging (De-forestation)
Can result in:
Massive depletion of natural resources
Irreversible damage to farm land and natural habitats i.e. pollution, etc
Contributing to climate change
Endangerment of local species
Natural resource not being available to local population
Examples of exploitation
Financial
Repatriation (moving) of profits to home nation
Transfer pricing to lower tax obligations
Use of influence to lower costs – land, labour, production
Sale of natural resources to foreign nations
Can result in:
Local governments not collecting tax revenue
Use of sweatshops and/or extremely low wages and long hours
Host country not benefitting from its own resources
Damage to local competition and economy
Examples of exploitation
Legislation
Influencing government policies and taxes
Lower standard of Health & Safety
Lower standard of employee rights
Use of influence to threaten government
Can result in:
Government being forced to change policy or lower tax
Dangerous working practices
Poor standard of living
Unregulated pollution, greenhouse gases, destruction of land/sea
Q10b 2023
Impact of TP on MNCs- positive
Impact of TP on MNCs- negative
Impact of TP on host country positive
Impact of TP on host country negative
Impact of TP on home country- positive
Impact of TP on home country- positive