Asian Accounting and Auditing Advancement, Volume 5, No 2 (2015) ISSN 2218-5666
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Senior Lecturer, Faculty of Business, ASA University Bangladesh, Dhaka, BANGLADESH
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Assistant Professor, Faculty of Business, ASA University Bangladesh, Dhaka, BANGLADESH
For many years transfer pricing has been considered as an adherence issue whereby MNCs are lawfully required to arrange, document and file with tax revenue authorities. Moreover, most researchers have written on economics, accounting, taxation and finance aspect of transfer pricing. But, later, transfer pricing has been recognized as a strategic tool that can facilitate MNCs to achieve competitive advantage. Furthermore, there are few literatures on transfer pricing and strategy. The research question of the study was to find out how MNCs operating in Bangladesh are applying transfer pricing as a strategic tool. The study adopted descriptive research design which enabled to describe characteristics connected with the subject population. It was found out that transfer pricing was practiced to achieve internal objectives such as motivating subsidiary managers, monitoring performance of foreign subsidiaries and as a way of achieving goal synchronization between subsidiary managers and parent companies. External objectives incorporated practice of transfer pricing as a means of reducing taxes and duties as a tool of controlling foreign exchange risks, as a cash management means and as a way of evasion of foreign government interfering. It was discovered that in contrast to a purely accounting, economics and tax driven systems, transfer pricing is viewed as a tool for advancing MNCs strategies in Bangladesh.
Findings pointed out that executives were not exclusively focused on compliance, accounting, economics and taxation issues as primary objectives of transfer pricing.
Keywords: Transfer Pricing, MNC, Taxation, Strategy, Competitive advantage, Bangladesh
I
NTRODUCTION
As the matter of profits, cash flows, economies of scale and competitive advantages most companies have preferred the way of globalization. Globalization is the procedure by which companies develop worldwide brands and products that they sell across the countries of the world, and in which they employ labor. At present no country can supply all of the resources required to fully develop its economic prospect and satisfy the need and want of its population. International trade has facilitated countries to gain from the benefits of specialization by exchanging its surplus products for surpluses produced by other countries. So, its inhabitants can prosper from lower prices and higher living standards
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Siddique and Ahmed: Congruence of Competitive Advantage and Transfer Pricing: A Study on Selected MNCs Operating in Bangladesh (119-126)
(Cole, 1996). In order to enjoy the advantages of international expansion MNCs are anticipated to come up with effective business strategies that make them able to fit in the situation whereby they are capable to face challenges offered by the global markets such as tax, costs and pricing conventions. They also can take the advantage of opportunities created by those markets consisting of un-met want and un-explored markets. MNCs may never succeed in global markets without a clear strategy. (Martinson, Englebrecht, &
Mitchell, C, 1999). A planned transfer pricing strategy will enable management to make decisions harmonious with the firms’ objectives. It will also help a company to achieve its corporate-wide goals (Martinson, Englebrecht and Mitchell, 1999). Transfer pricing is one of the most significant strategic tools involved in the management of multiple business units within the firm. According to (Czinkota and Ronkainen, 2007) an effective transfer pricing is a key element in the marketing mix since it involves pricing of sales to members of the corporate family as well as pricing within the individual markets in which the companies operate. Transfer pricing has been considered for many years as a compliance issue whereby tax revenue authorities have legally required taxpayers to set, prepare, and document transfer pricing documentation and submit to them (Muhoho, 2012). Determination of the right transfer price is influenced by many factors. In fact, one study (Burns, 2001) recognized ten factors. Among them were market conditions, economic conditions, and competition in the foreign market, exchange and price controls, and differences in income taxes in different countries. Transfer pricing is a tool which reduces global corporate tax and indirect business tax. So, by successfully applying transfer pricing the MNCs can increase their competitive superiority.
R ESEARCH Q UESTION
The specific purpose of this study is to find out the answer of the questions that as a strategic tool how MNCs operating in Bangladesh are applying transfer pricing and how it can contribute to achieve competitive advantage of those MNCs.
L
ITERATURE
R
EVIEW
Prior literature widely examines multinational tax planning. In this broad theme, whether companies avoid taxes by shifting income from high-tax to low-tax jurisdictions has also been revealed. Transfer price is often stated to be the way of achieving tax savings by income shifting, direct evidence on the role of transfer prices in tax reduction remains elusive. This study attempts to fill this void. Klassen, Lang, and Wolfson (1993) provide evidence of geographical income shifting in response to tax rate changes in the U.S., Canada, and Europe.
Examining 191 U.S. multinational corporations, they find that after 1985-86 reductions in the
U.K. and French income tax rates, along with a simultaneous increase in the Canadian tax rates, led U.S. multinationals to shift income from Canada to Europe. They find that income shifted to the U.S. from other jurisdictions due to tax rate reduction in the U.S. in 1987. Though they explore evidence consistent with income shifting from higher-tax jurisdictions to lowertax jurisdictions when the appropriate tax incentives appear, using their data sources they are unable to test directly whether transfer pricing itself, or some other instruments (e.g., financing arrangements), explicate their outcome. Using financial statement disclosures under SFAS 14 of intra-firm sales, Jacob (1996) finds that the magnitude of income shifting appears to be related to the volume of intra-firm international transfers and regional differences in tax rates.
His evidence supports Klassen et al. (1993) in that more intra-firm trade consistently lowers worldwide tax payments. However, more intra-firm trade lowers U.S. tax payments prior to the tax rate reduction in the U.S. in 1987, but raised U.S. tax payments after the rate reduction.
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Asian Accounting and Auditing Advancement, Volume 5, No 2 (2015) ISSN 2218-5666
Because his results are consistent with a decrease in the marginal cost of locating income in the
U.S. compared to other countries, Jacob (1996) infers that transfer prices are a likely mechanism for the income shifting found in Klassen et al. (1993).
Klassen and Laplante (2012a, b) explore income shifting more broadly and show that foreign profitability is negatively related to foreign tax rates, after controlling for total profitability.
They also show that this relation is related to firm and time-period characteristics, respectively. More closely related to transfer pricing, Mescall and Klassen (2014) find that stricter transfer pricing enforcement across countries adversely impacts cross-border merger and acquisition premia, which suggests that reducing the opportunities to select advantageous transfer prices for tax purposes diminishes firm value. Available archival data sources cannot directly identify transfer pricing as a mechanism for shifting income to reduce global tax burdens (Donohoe et al. 2012). Thus, the evidence in each of these studies is indirect and readers are left to infer the specific mechanism that leads to the observable outcome. More recently, researchers are beginning to use survey methods and sources. Graham et al. (2010,
2011) survey TEI executives regarding deliberations on earnings repatriation, tax planning, and location of foreign operations and its effect on tax expense. They find that financial reporting costs are a major consideration in these decisions. Overall, the goals, approaches, and motivations behind these surveys are broadly to avoid tax and ultimately reduce cost of products. And they employ non-archival methods to obtain direct evidence from inside corporate tax departments. This study will contribute to the economics and accounting literature by conducting a survey study focused on directly identifying corporate tax considerations surrounding transfer prices from competitive advantage. In doing so, This study has uncovered differing strategies that firms apply to their transfer pricing activities and measure the observable tax outcomes that flow from these strategies.
T
HEORETICAL
F
RAMEWORK
Transfer pricing refers to the pricing of goods and services within a multi-divisional organization, particularly in regard to cross-border transactions. For example, goods from the production division may be sold to the marketing division, or goods from a parent company may be sold to a foreign subsidiary, with the choice of the transfer price affecting the division of the total profit among the parts of the company. There are various theories on economics, accounting, taxation and finance aspect of transfer pricing. They include:
Economic Theory
Under economic theory, the company is considered as a mini-economy in which scarce resources require to be allocated. Just as in the general economy, prices are a mechanism to allocate these scarce resources. The purpose of the economic theory based approaches is to find the transfer price that will lead the divisions, both buying and selling, to choose production levels which maximize total company profits (Eccles, 1985). Persons within the organization are viewed as rational utility maximizers (Simon, 1978). Therefore, they hypothetically will not exhibit dysfunctional behaviors that would lead to a misallocation of the scarce resources. The literature in the economic theory based approach to transfer pricing is built upon the Hirshleifer (1956) model. This was the first formal treatment of the transfer pricing issue from the economics viewpoint (Eccles, 1985; Grabski, 1985). This model assumed two profit centers: one was a manufacturing division and the other a distribution division. The manufacturing division had no external market for its product, whereas the distribution division had a competitive external market.
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Siddique and Ahmed: Congruence of Competitive Advantage and Transfer Pricing: A Study on Selected MNCs Operating in Bangladesh (119-126)
Mathematical Programming Theory
As in the economic theory approach, the objective of the mathematical programming approaches was to determine the transfer price which yielded the best results for the firm as a whole. However, the mathematical programming approach utilized opportunity cost as the basic concept for determining transfer prices, rather than marginal cost as employed by the economic approach. The procedures of this approach introduced a pricing mechanism which determined the allocation of resources when constraints on capacity exist or when multiple buying divisions exist (Eccles, 1985). Most of the linear programming approaches to transfer pricing solved for profit maximization as the primary constraint. Conversely,
Harris, Kriebel and Raviv (1982) viewed cost minimization as the vehicle to profit maximization. By using cost minimization under varying levels of information, the authors proposed a scheme that would penalize divisions for being in efficient. This scheme created a situation in which transfer prices increase as divisions become more efficient forcing the divisions to cut costs to maximize profits.
Accounting Theory
The transfer pricing approaches based on accounting theory had the same objective as the economic theory and mathematical programming approaches: they sought to find the transfer price that would motivate divisional managers to make decisions that benefited the firm as a whole. The primary focus of this stream of literature was whether market price or some form of standard variable cost should be used (Eccles, 1985). The first effort to apply
Hirshleifer’s (1956) theory to accounting was made by Solomons (1965). He prescribed five different transfer prices applicable to five different environmental conditions (external markets and extent of internal transfers). The first of these prescriptions was that market price was applicable when the external market was highly competitive. Kaplan (1982) later agreed. The next four were for situations when the external market was not highly competitive. They were for varying forms of cost, dependent upon how important the transfer price issue was to the organization. It was assumed that most of the producing departments’ goods were transferred to other departments. Kaplan (1982) would have categorized this department as a cost center.
Organizational Behavior Theory
Grabski (1985) noted how unusual it was that only a small amount of research focusing on organizational behavior theory and transfer prices had been published by the mid-eighties.
He stated that it was probably because the transfer pricing technique was needed before the impact of the method on an individual and an organization can be addressed.
Unfortunately, it appeared that this viewpoint was quite prevalent because very little research had been done in this area.
Therefore, the technical transfer pricing schemes could not work unless they fit the organization, and are accepted by the managers as fair and neutral. Also, for these models to work, divisional profits must be seen as an appropriate evaluator for performance.
Strategic Management Theory
The strategic management theory of transfer pricing is based on some models. These are-
Model of negotiation to solve problems, The choice model, The dynamic model of change
The hierarchy model. Through application of these models MNCs try to achieve competitive advantage.
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Asian Accounting and Auditing Advancement, Volume 5, No 2 (2015) ISSN 2218-5666
M
ETHODOLOGY
This study adopted a descriptive research design. A descriptive research design is best for this study as it describes characteristics associated with the subject population. Descriptive design allows one to establish relationships between variables (Cooper and Schindler, 2003).
It also allows collection of a large quantity of in-depth data about the population being studied. Since the focus of the study is on MNCs operating in Bangladesh, the population of interest comprised all MNCs operating in Bangladesh in the various sectors of the economy such as FMCGs, agriculture, manufacturing, construction, tourism, financial services amongst others both large and medium enterprises. As sample eight companies was selected randomly namely Unilever, Bata, Glaxosmithkline(GSK), Samsung, Nestle, Toyota,
Coca Cola, Exxon Mobil. This study relied on both primary and secondary data. Primary data were collected by use of a self made questionnaire. The target respondents for the questionnaire were Senior Managers and Managers working in the respective MNCs since they had a better understanding of the corporate strategy and implementation of transfer pricing as a strategic tool. The main source of secondary data that were information on the websites and annual reports of the sample MNCs. This helped in understanding MNCs mission, vision and strategy. Other secondary data sources were Transfer Pricing policies of
MNCS, Articles, and Journals on transfer pricing which were principally used to understand the MNCs being subject of this study. The collected data was cleaned, edited and entered into a computerized system to enable carrying out of descriptive statistical analysis of the data. The data was coded and presented in a thematic manner. Thereafter, the data was analyzed using descriptive statistics and in particular, used the mean as a measure of central tendency. The data was then tabulated and the most appropriate tables chosen to present the findings.
F
INDINGS
The findings of the study present an analysis of the information obtained with a view to fulfill the research question as outlined in the study. 40 questionnaires were distributed to the respondents of which 28 were completed. Thus the response rate was 70%. From the analysis it was established that the most common application include minimizing overall tax liability of MNC with a 57.14% frequency or popularity. Other common applications included minimizing tax duties on imports and exports, market penetration strategy, minimizing foreign exchange losses, motivating subsidiaries managers, performance and measurement of subsidiaries and avoiding exchange control restrictions with 50.00%,
42.86%, 39.29%, 38.22%, and 32.14% respectively. The least common applications included risk analysis and bench marking tool with 10.71% and 7.14% respectively. In addition, a few respondents also indicated that transfer pricing may be used to support subsidiaries for example providing stock and raw materials at a favorable price. The results are indicated on the following Table
Ranking
1
Business objectives
Minimizing tax liability of MNC
Total respondents
56
Frequency Frequency as percentage
32 57.14%
2
3
Minimizing tax duties on imports and exports
Market penetration
Strategy
56
56
28
24
50.00%
42.86%
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Siddique and Ahmed: Congruence of Competitive Advantage and Transfer Pricing: A Study on Selected MNCs Operating in Bangladesh (119-126)
4
5
6
7
8
9
10
Minimizing foreign exchange losses
Motivating subsidiary
Managers
Performance and measurements of subsidiaries
Avoiding exchange control restrictions
Acquiring cheap source of capital
Functional and risk analysis tool
Benchmarking tool
56
56
56
56
56
56
56
22
20
18
18
10
6
4
39.29%
38.22%
32.14%
32.14%
17.86%
10.71%
7.14%
The respondents were asked to state whether transfer prices affect sales level and profit achieved by the company. It was found that, 35% strongly agreed, 27% agreed, 18% remained neutral, 13% disagreed and 7% strongly disagreed. Majority of the respondents were certain that transfer prices affect sales level as well as profitability.
As to whether transfer pricing is used as a measure of performance. 26% of the respondents strongly agreed, 24% agreed, 32% remained neutral, 12% disagreed and 6% strongly disagreed.
Majority of the respondents were not aware that transfer pricing is used as a measure of performance for departmental heads. To find out whether the respondents understood that transfer pricing set by the company affect the level of other intercompany transactions with related non-resident companies, it was found that, 28% strongly agreed, 23% agreed, 30% remained neutral, 13% disagreed and 6% strongly disagreed. Majority of the respondents understands that transfer pricing affects level of intercompany transactions with related nonresident companies. 51% of the respondents agreed that apart from buying and selling transactions between resident corporate with nonresident related corporate, other transactions affected by transfer pricing include: provision of marketing and logistics support, sale and lease of tangible and intangible assets, borrowing of money to capitalize the business among others.
C
ONCLUSION
Transfer pricing has been viewed for many years as a compliance issue whereby MNCs are legally required to prepare, document and file with tax revenue authorities. Additionally, most authors have written on economics, accounting, taxation and finance aspect of transfer pricing. In contrast to a purely finance, economic and tax-driven mechanism, transfer pricing can be considered as a tool for advancing MNCs strategy in Kenya. Results indicate that executives are not solely focused on finance, economics and taxation issues as the primary objective of transfer pricing. MNCs in Bangladesh employ transfer pricing to assist in achieving corporate strategy and other corporate objectives as well. In general, executives perceive that transfer pricing does influence measures of corporate performance. This is supported by the finding that transfer pricing also contributes toward achieving objectives.
Among the business strategies that MNCs seek to achieve through transfer pricing include market penetration strategies including increasing turnover and market share, tax minimization strategies, cost of capital as well as cash flow strategies. The study further revealed that such strategies are achieved by adjusting the transfer price between related parties which is possible due to common control between related parties.
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Asian Accounting and Auditing Advancement, Volume 5, No 2 (2015) ISSN 2218-5666
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