Transfer pricing : definition

Introduction

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If you're a company that operates internationally via subsidiaries or branches, you've probably heard of transfer pricing.

This term, which is perceived as technical, is a key element in the exchanges carried out between the different companies of the same multinational group.

Let me explain what transfer pricing is and what's at stake for your company.

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What is transfer pricing ?

Let's take the example of a French company (the group's parent company) having a subsidiary in China and another in the United States. These entities exchange goods, services and intangible assets:
- The subsidiary in China manufactures spare parts which are sold to the group's parent company in France.
- The French company assembles these parts to make finished products, which are then sold to its US subsidiary.
- The US subsidiary sells these products on its market.
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The transfer price is the price charged by one group company to another group company for these transactions.

In our example, this could be :
- the price of spare parts sold by the Chinese subsidiary to the French company
- the price of products sold by the French company to the US subsidiary
- the cost of administrative services (HR, IT, accounting, etc.) provided by the French company (the group's parent company) to its subsidiaries
- patent and trademark royalties invoiced by the French company (which owns the intellectual property owner).

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Three components to define a transfer price

• Group companies must carry out transactions with each other
  

These transactions include exchanges of goods, services, intangible assets and financial transactions (excluding dividends).

• Group companies must be located in different countries
  

Only “cross-border” transactions, i.e. those between a company located in France and another based in another country (within or outside the European Union) fall within the scope of transfer pricing.

Thus, domestic transactions between group companies located in France are not covered by transfer pricing.

• Group companies must have a dependency relationship
  

Transactions must be carried out between companies belonging to the same group. There must be a relationship of dependency between the companies, which are called “related entities”.

In most cases, it is a legal (or capitalistic) dependency, which occurs when a company directly or indirectly holds more than 50% of the share capital or voting rights of another company (the threshold applicable in France).

It can also be a de facto (or economic) dependence, when a company has the capacity to impose its economic conditions on another company in the group. This is the case, for example, of a company that manufactures exclusively for another company.

It is important to note that when a transaction takes place between a French company and a foreign company located in a country benefiting from an advantageous tax regime or in a Non-Cooperative State or Territory (ETNC), the relationship of dependency is presumed.

In short, transfer pricing applies to transactions between a parent company and its subsidiaries (or branches), or between sister companies. On the other hand, transfer pricing does not apply to transactions with independent companies, which are assumed to be carried out at market prices.

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The arm's length principle

The fact that these transactions are carried out within the same group, and not with third parties, raises the following question: at what price should these transactions be carried out?

To prevent abuse, tax authorities require that t comply with the arm's length principle. This means that the prices applied between entities in the same group must be similar to those that independent companies would have charged under comparable conditions.

Why is this rule important? Because a multinational group could, in theory, manipulate transfer prices to pay less tax, for example :

• by invoicing at a very low price a group entity located in a high-tax country, in order to reduce taxable profits
  
• artificially increasing the taxable profits of a group entity located in a low-tax country.
  

Let's continue with our example: if the parent company in France charges its US subsidiary a price that is too low for the products it manufactures, it reduces its taxable profits in France (a high-tax country) and increases the taxable profits of the US subsidiary (a country where taxes may be lower).

The main aim of transfer pricing is therefore to determine a fair and equitable price for these transactions, in order to guarantee an appropriate distribution of taxable profits between countries, and to prevent tax avoidance practices.

Indeed, tax authorities keep a close eye on these practices, as they can lead to the erosion of tax bases in high-tax countries.

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The challenges of transfer pricing

Transfer pricing is not just a technical issue. They touch on fiscal, strategic and even reputational aspects.

• Tax issues: limiting the risk of reassessment
  

If transfer prices do not comply with the arm's length principle, the tax authorities may adjust taxable profits. These adjustments are often significant, and penalties may also be applied.

In addition, these adjustments can lead to double taxation within the group. In effect, they modify the distribution of profits that have already been taxed between the various group entities.

• Reputation: protecting the company's image
  

In a context where corporate tax practices are often scrutinized by the media and NGOs, transfer pricing is a sensitive subject. Accusations of tax evasion or artificial transfer of profits abroad can damage a company's reputation. These negative impacts can result in :

- a deterioration in relations with investors

- a loss of confidence on the part of customers and partners.

- a deterioration in the social climate within the company.

• Strategic issues: optimizing group tax management
  

Properly managed, transfer pricing is more than just a constraint: it can become a strategic tool for :

- optimize financial flows: for example, by better controlling margins and costs between group entities

- Facilitate international tax planning: by taking into account differences in tax rates between the different countries in which the group operates.

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Conclusion

Transfer pricing is not just an issue for large multinationals. Even small and medium-sized enterprises (SMEs) carrying out transactions with one or more foreign subsidiaries (or branches) need to pay close attention.

For tax authorities, transfer pricing plays an essential role in ensuring fair and equitable taxation of international group transactions.

For companies, they represent a tool for tax and financial management. When controlled, they limit the risk of tax reassessments, while optimizing tax management within the group.

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If you have any questions or would like to find out more about this subject, please do not hesitate to contact me.