Transfer pricing equity: fairness in regards to transfer pricing. I.e. paying tax on revenue where it is earned.
Taxation.
Governments need to make money in order to run a country, which is the reason for the existence of taxes. They also, however, must create an attractive environment in which companies can operate, which usually means favourable taxing policies. This paradoxical imperative has the potential to cause many headaches, one of which is double taxation. If a government employs both the worldwide and territorial taxation principles, a firm can sometimes pay tax twice on the same item. For example, if a firm in country A manufactures and sells a product in country B, it can pay tax both in country A (under the worldwide principle) and in country B (under the territorial principle). Suffice to say that this is a situation which many firms try to avoid.
One way to deal with this problem is through double taxation treaties. That is, in the example above, the governments of country A and country B agree that the profit earned by the firm in question will be taxed only once. Who will get the tax revenue, or how it will be divided up, depends on the treaty and the countries involved.
Such treaties do not exist everywhere. Many companies will manipulate their transfer prices in order to reduce profits in high tax countries and increase them in low (or zero) tax countries. Consider the following example:.
Japan has a tax rate of 50%, whereas Mexico has a tax rate of 25%. The firm XYZ Ltd. sells its goods in Japan, and manufactures them in Mexico. Goods going from Mexico to Japan are sold at an inflated transfer price (i.e. above market value) in order to shift funds to Mexico. The subsidiary in Japan then sells the goods and makes a profit. It might then purchase another batch of goods from the Mexican subsidiary, again at an inflated transfer price, which effectively moves all of its newly acquired profit away from Japan (50% tax) to Mexico (25% tax).
