Question

A subsidiary SS in CLand sells lumber to Parents PP in BLand. The market price of lumber is B$100/m3. The full cost of lumber of SS is B$60/m3. Parents allow the normal markup 20% for subsidiaries. Corporate income tax (CIT) is 30% and 20% in CLand and BLand, respectively.
Required:
• If Parents wants to control for tax minimization, what is the transfer price? The market price or the 20% cost plus price?
• Is there any macro impact to CLand? What should authorities of CLand do to control over such transfer pricing implications?

Answer 1

1. If the parents want to control for tax minimization, the transfer price should be the market price of B$100/m³

^{When the parent company pays a higher price (market prive) for the lumber to its subsidiary, it can increase the purchase costs thereby resulting a savings in tax in their home country. Therefore, Parents PP should purchase lumber from their subsidiary at market price to control for tax minimization.}

^{2. The macro impact of CLand is that they get a higher revenue from taxes. When the subsidiary sells at a profit of B$40 (B$100 - B$60) to its parent, the state CLand is benefitted from more tax revenue to its account.}

^{The subsidiary in CLand will try to reduce the transfer price from market price to cost + 20% markup price in order to pay less taxes. The state CLand should ensure that the transfer price is fixed on an arms length basis between them.}