What is Transfer Pricing and why is it a hot economic issue?

We have added to our YouTube channel a short explainer video that looks at transfer pricing. Transfer pricing is controversial because it can be used by transnational corporations to manipulate taxable income and avoid paying taxes. Understanding this issue is important for students taking macroeconomics exams especially when studying globalisation and fiscal policy.

Transfer pricing refers to the practice of determining the price at which goods or services are bought and sold between related companies, such as subsidiaries of the same multinational corporation operating in different countries. The objective of transfer pricing is to allocate the profits earned by the multinational corporation among its different subsidiaries, based on the value they contribute to the overall business.

Transfer pricing has become a hot economic issue because it can be used by multinational corporations to shift profits to lower-tax jurisdictions, thereby reducing their overall tax liabilities. This has led to concerns among tax authorities that they may be losing out on significant tax revenues, and among the public that multinational corporations are not paying their fair share of taxes.

Furthermore, transfer pricing can also be used to distort trade patterns and investment decisions, as companies may be incentivized to locate their operations in countries with lower tax rates rather than where it makes the most economic sense. This can have negative implications for the overall efficiency and competitiveness of the global economy.

To address these concerns, tax authorities around the world have been increasing their scrutiny of transfer pricing practices, and have been developing regulations and guidelines to ensure that multinational corporations are not engaging in tax avoidance or other harmful practices.