What does transfer pricing involve?

Transfer pricing involves the process of determining the prices at which goods and services are exchanged between related entities within a corporate group, such as subsidiaries or divisions. It is critical in multinational corporations where transactions occur across different countries, as it affects the allocation of revenue and expenses, taxation, and financial reporting.

The focus on related entities differentiates transfer pricing from other pricing strategies, such as those that occur with external customers or competitors. These other pricing scenarios do not account for the complex relationships and agreements that can exist between affiliated companies. Additionally, transfer pricing strategies must adhere to regulations that ensure transactions are conducted at "arm's length," or the price that would be charged between unrelated parties, to prevent profit shifting and tax avoidance.

Understanding transfer pricing is essential for compliance with tax laws and accurately reflecting the financial performance of each entity within a corporate structure.