In vertically integrated multinational companies, transfer pricing is used for two purposes: compliance with countries’ tax rules and internal management and control. To comply with tax regulations, the price for transfer of goods and services between a multinational’s affiliates in two tax jurisdictions must meet the arm’s-length standard; for internal purposes, the managerial transfer price aligns the incentives of managers in different divisions to jointly maximize the multinational’s overall profits.

While the tax transfer price may coincide with the managerial transfer price, often this is not the case. When there is a difference between the two transfer prices, the multinational must determine how to balance the objectives of tax compliance and incentive alignment, and explain this difference to the relevant taxing authorities because it could be misunderstood and misinterpreted as evidence of conflict with nefarious motivations.

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