Transfer pricing is the price one subunit of a company charges for the services it provides another subunit of the same company

At Ford, for example, automotive components, vehicles, and assembly services are bought and sold internally across divisions. The intellectual property patents of many pharmaceutical companies, such as Merck, are usually held by foreign subsidiaries, making the transfer price to these subsidiaries a critical factor in how much income is recognized in various tax jurisdictions.

Firms use transfer prices (1) to focus managers’ attention on the performance of their own subunits and (2) to plan and coordinate the actions of different subunits to maximize the company’s income as a whole. Transfer prices can lead to disagreements, however, because managers of different subunits often have very different preferences about how transfer prices should be set. For example, some managers prefer the prices be based on market prices. Others prefer the prices be based on costs alone. Controversies also arise when multinational corporations seek to reduce their overall income tax burden by charging high transfer prices to units located in countries with high tax rates. Many jurisdictions, including the European Union, attempt to restrict this practice, as the following article shows.

A sign at the entrance reads “Apple Campus One Infinite Loop.”

Ken Wolter/Shutterstock

Apple Forced To Pay Ireland €14.3 Billion In Tax Settlement^*

For many years, companies have used controversial transfer-pricing techniques to shift their profits from higher-tax countries to lower-tax jurisdictions. In 2016, the European Union (EU) ordered Apple to pay €13.1 billion in back taxes plus €1.2 billion in interest to Ireland for unpaid taxes on €111 billion of profits from 2004 to 2014. This was the largest corporate tax fine ever.

The EU concluded that Apple booked almost all the profit generated from its sales of iPhones and other products across Europe between 1991 and 2015 to a “head office,” Apple Sales International, in Ireland that only existed on paper. From there, Apple Inc., the corporate parent, levied a heavy charge on those profits to account for the subsidiary’s use of its intellectual property, which reduced the tax owed Ireland to extremely low levels. The EU found that the deal allowed Apple to pay a maximum annual tax rate of just 1%. Often, it paid far less. In 2014, for example, the company paid a mere 0.005% of its profits in tax.

For its part, Apple rejected the EU ruling and filed an appeal. Tim Cook, Apple’s chief executive officer (CEO), said the EU was rewriting Apple’s history in Ireland and disrupting the international tax system. He said Apple chose the Irish city of Cork as its European base in the 1980s, and it had expanded to almost 6,000 workers in Ireland. The appeal is still under review.

Though not all companies face multinational tax concerns, transfer-pricing issues are common to many companies. In these companies, transfer pricing is part of the larger management control system. This chapter discusses the links among a firm’s strategy, organizational structure, management control systems, and accounting information. We’ll examine the benefits and costs of centralized and decentralized organizational structures and look at the pricing of products or services transferred between subunits of the same company. We emphasize how accounting data, such as costs, budgets, and prices, help in planning and coordinating actions of subunits.