Transfer pricing occurs where a multinational business operates in two separate countries with two separate companies and they do business together. The two companies sells goods, services, or provide finance to each other in a way that minimises the two companies overall tax liabilities.
Australia’s transfer pricing rules counter the underpayment of tax in Australia by demanding businesses price related party international dealings according to what is expected from independent parties in the same situation. Pricing not in accordance with Australia’s transfer pricing rules is referred to as ‘international profit shifting’. Transfer pricing is a hot political issue with several multination companies (Apple and Google for example), having billions of dollars of Australian revenue pa, but paying very low rates of tax in Australia.
As Australia has high tax rates (either 28.5% or 30% for companies) normally an overseas related company based in a low taxing country (say Singapore, Ireland, Netherland, etc.) will provide goods, services, or finance to the Australian company. The transactions are structured so that the Australian company’s profits are reduced so the Australian tax liability is reduced.
The foreign company’s income is then increased but this still creates tax savings as the foreign company income is either tax free or taxed at low rates.
Transfer pricing needs to be done on an arms-length basis and the ATO has rulings on the transfer pricing methods that multinational companies can use between their related companies. The arms-length principal uses the behaviour of independent parties as a guide or benchmark to determine how income and expenses are allocated in international dealings between related parties. As many factors may influence prices or margins the comparison with arms-length activity is not absolutely precise or certain.