Transfer Pricing: How Profit Chooses a Country
Transfer pricing gets a sinister reputation it only half deserves. Most of it is genuinely hard accounting done in good faith, because pricing an internal sale of something with no external market is a real problem, not merely an excuse. The abuse lives at the margins, in the intangibles nobody can benchmark. My rule when reading a structure: follow the intangible. Find where the patents and brands are owned, ask what that jurisdiction's rate is, and you will usually have located both the cleverness and the controversy in a single step.
Knowledge check
A group puts the legal ownership of its most valuable patents in a subsidiary in a low-tax country, then has its operating companies in high-tax markets pay that subsidiary large royalties to use the patents. Walk through why this shifts taxable profit even though no physical operations moved.
Show the answer
The royalties are a deductible cost for the operating companies, reducing the profit they report — and pay tax on — in their high-tax home markets. The same royalties are income for the patent-owning subsidiary, where they are taxed lightly or not at all. Because the ownership of the intangible was placed in the low-tax entity by contract, the profit associated with that intangible accrues there, regardless of where the patents were actually invented or used. Geography of activity and geography of profit come apart.