Transfer Pricing

Recent growth in international trade and global commerce is increasingly relevant to college students who desire to obtain maximum value from their course work in economics and accounting. Transfer pricing, as a topic spanning those two disciplines, describes a set of strategies through which firms attempt to send a portion of their profits offshore in order to minimize their income tax liabilities. Because those transactions occur between two firms related through common ownership, transfer pricing historically downplayed the influence of markets in price determination processes. More recently, however, tax regulations and authorities from around the globe are calling for broader perspectives in order to avoid corporate income tax evasion. Effective involvement in those processes requires a solid understanding of the essential differences and similarities between economics and accounting. The tax laws in many countries define five methods for determining and communicating a firm's transfer price to taxing authorities. Those methods generally involve primary comparisons between two unrelated firms and a secondary comparison of those results to related firms, which is the essence of the so-called arm length standard. The purpose of this essay is to illuminate standards, methods, and concepts that are relevant to transfer pricing and to demonstrate the importance and value of integrating economics and accounting perspectives. Individuals who gain a better understanding of transfer pricing may find themselves in high demand.

In an era expecting growth in international trade and relations, college students will find additional value from courses in economics and accounting. Professionals at facilitating decision making and planning, economists and accountants are becoming integral partners in helping multinational corporations in demonstrating regulatory compliance and developing pricing strategies. Transfer pricing is an interdisciplinary topic that challenges governmental tax authorities, corporate accountants, and market analysts equally. On the one hand, there is a need to describe how the prices of goods and services reflect cost functions, consumer demand, and market conditions. On the other hand, there lies a need to determine prices that maximize profits while using specific methods for minimizing tax burdens.

Transfer pricing, as a topic that traditionally downplays the forces of markets and consumer demand, represents a vast opportunity for closing a lingering gap between theory and practice. It also presents a dynamic tension between a group of professionals who seek to minimize corporate income tax burdens and another group whose aim is to prevent tax evasion. In their works related to taxation, accountants are encountering unprecedented challenges to apply sound economic analysis in their tax reduction methodologies and post-tax profit maximization efforts. Transfer pricing practices require interactions between the regulated and regulators. Furthermore, governmental tax authorities around the world are adjusting corporate tax returns and prompting timely explanations. In response, accounting service firms are helping their corporate clients by preparing reports that justify, document, and communicate how they determine prices for transactions between firms (which have relationships through common ownership) that operate in multiple countries.

Involvement in those processes requires a solid understanding of the essential differences and similarities between economics and accounting. Acknowledging the reality that persons learned and trained in one discipline often find it difficult to comprehend other disciplines, this essay tends to emphasize the economics perspective because of its reference in tax regulations that govern the treatment of international transactions. Consequently, several of the largest accounting firms in the world recognize those limitations and are adding economists to their staff. If recent job postings for transfer pricing specialists are any gauge, it appears that the demand for economists is much higher now than it was before the $3.4 billion settlement in September, 2006 between GlaxoSmithKline (GSK) and the Internal Revenue Service. Whether they agree or disagree on this verdict, many professionals are aware of the important and interrelated roles of maintaining data accuracy and assuring assumption reliability. In the pages ahead, the reader will find an exposition of varied aspects with regard to transfer pricing and the apparent need to depart from past inward- or domestic-focused practices.

Firm Profitability & Tax Regulations

In terms of long-standing traditions, a major task of corporate tax departments and accounting staff is to influence firm profitability. Taking a narrow view of that work, accounting is a profession that prepares governmental and financial reports, analyzes costs and revenues, and calculates post-profit tax liabilities. In short, income tax minimization represents a final step toward profit maximization. Therefore, it is reasonable for accountants to invest their time, talent, and energy adding legitimacy to their efforts to minimize the tax burdens of their employers and their clients. Likewise, it is reasonable for government revenue agents to scrutinize that work guarding against potential cases of tax evasion and/or system abuse.

Many tend to view economics in terms of its focus on pre-tax profit maximization conditions. Casting aside any debate regarding views on the inclusion of taxes as an economic cost, economists and some tax authorities expect to observe high levels of profits in industries and markets characterized by new entry, product innovation, and price leadership strategies. Any attempts by corporate tax departments and their accounting staff to understate those profits by transferring them via questionable, inappropriate, and/or undocumented methods of pricing will certainly raise suspicions and garner attention from taxing authorities especially those who understand the broader perspective. As something to which we return later in this essay, it is important for students, practitioners, and clients to focus their attention on a few concepts central to economics including, but not limited to, opportunity costs, economic profits, and market structures.

A cursory review of regulations on transfer pricing makes it apparent that tax accountants, their clients, and other parties stand to benefit from learning more about the price determination processes whether those analyses include or exclude market orientations. Because the regulations contain numerous references to marketplace dimensions, the apparent gap between accounting and economics is quite perplexing given the fact that most students in business programs receive ample exposure to those disciplines early in their studies. Perhaps those studies need to place greater emphasis on transfer pricing mechanisms and on international tax regulations. With some digression at this juncture, that need is real especially in light of the fact that China and other developing nations will become major economic forces in the future.

Transfer Pricing

Returning attention to the central topic here, the field of transfer pricing seems to remain in its infancy although publications on the topic first appeared in academic journals several decades ago. Without tracing the historical roots and development of transfer pricing in this essay, readers can begin to gain a deeper appreciation of this time-honored and current topic by pondering the content and relevance of a clear and concise definition. Using the words from Pearce (1992), transfer pricing is: "The system of setting prices for transactions among subsidiaries of a multinational corporation, where the prices are not subject to market determination. The prices are often deliberately chosen to minimize tax or tariff burdens on the corporation on a world scale, e.g. costs may be overstated in subsidiaries in a country with a high profits tax so that profits can be shifted to a subsidiary in lower tax country" (p. 433).

Readers of this essay will find departure from that fine definition with respect to its dismissal of market influences on transfer price. Furthermore, the applicable regulations call for its inclusion in transfer price determinations and analyses. Moreover, a portion of this essay devotes itself to the division between market and non-market influences.

Applications

In the context of international trade and global commerce, tax strategy is largely a function of the geographic locations of the seller and the buyer which also happen to be affiliates by virtue of common ownership. Furthermore, firms that charge their subsidiaries a high (low) price suggests they are booking a higher (lower) taxable income on the sales end of a transaction and a lower (higher) taxable income on the purchase end of a transaction. Those bookings are controlled transactions because one party is under the control of the other party. More precisely, the seller is often the parent firm and the buyer its subsidiary. Moreover, the price of an item in a transaction between two related firms, in contrast to two unrelated firms, may reflect professional creativity more so than market forces.

According to Amram, "transfer pricing is merely an art describing the internal accounting costs assigned to an exchange of goods, services, or intangibles between commonly controlled foreign and domestic entities." Consider the following hypothetical case presented by Amram. Let's say that domestic parent company USCO, which is located in United States, owns foreign subsidiary CaymanCo, which is located in the Cayman Islands. The former entity produces laptop computers at a cost of $50.00 per unit and sells them to the latter entity for $100.00 per unit. CaymanCo incurs an additional $400.00 in costs per computer bringing the total unit cost to $500.00. CaymanCo distributes those laptops to third-parties elsewhere around the globe who pay $1,000.00 for each new laptop. In sum, CaymanCo realizes a taxable income of $500.00 for each computer it sold and USCO realizes $50.00. The hypothetical corporate income tax rate, furthermore, in the US is 35 percent whereas it is zero in the Cayman Islands. In accordance with Generally Accepted Accounting Principles, USCO and CaymanCo prepare and file consolidated financial statements for a governing agency. In addition, they prepare and file an annual report with their shareholders. On the one hand, the actual post-tax profit on each computer amounts to $482.50. This is the result of subtracting USCO's income tax of $17.50, which is thirty-five percent of the initial $50.00 transfer pricing profit, from CaymanCo's $500.00 profit per computer. On the other hand, the potential post-tax profit on each computer sold amounts to $500.00 per computer, which would produce $175.00 (35 percent of $500.00) per computer in tax revenue for the United States given the absence of a transfer pricing arrangement.

At issue is whether the shifting of income offshore is legitimate or artificial in nature. In order to ensure legitimacy, the Organization for Economic Cooperation and Development (OECD) in conjunction with various professions established a set of methods for determining transfer prices. The specific choice of methods for pricing international transactions will likely affect the allocation of total profit among units within a multinational company. Application of a single method or an inappropriate method without ample justification may give the appearance of being tax evasive whether accidental or otherwise. The challenge is to devise, use, and document the most appropriate methods of transfer pricing thereby proactively avoiding an unfortunate appearance and the associative complexities of reactively untangling an adjustment by a district director at the Internal Revenue Service or another tax authority elsewhere.

Those price determination methods will receive some coverage later in this essay. Meanwhile, this essay directs the attention of readers to a set of economic concepts most applicable to transfer pricing and price determination processes. In doing so, the next section begins without references to market forces and it then concludes with some direct references.

Price & Profit Determinations with Limited Reference to Markets

Opportunity Cost

Undergraduate business students discover some key differences between accounting profit and normal or economic profit and between accounting costs and economic costs. In general, accountants tend to ignore or downplay the opportunity cost approach advanced in economics. Opportunity cost, by definition, it is the value assigned to the foregone next best alternative. Consider, for example, students cannot attend class and, at the same time, do whatever they would do if absent from class. The opportunity cost of their attendance is the value they receive from the alternative decision, which is the absence. Students will receive compensation, which may take the form of a higher course grade or a grade point average, in return for sacrificing their want to be absent. Likewise, business owners expect incentives to remain in their existing line of business. Consequently, the profits they expect to earn are taken as normal and they are inclusions in the cost of doing business.

Other Key Costs

Shifting gears away from the profit concept for the moment, students in economics courses learn that firms incur a variety of costs with the production of goods and services. Let us consider some key cost definitions and prepare to apply them in a variety of ways. Total cost is the sum of fixed costs and variable costs. Fixed costs are those that exist even without any production. Furthermore, they are constant as they do not vary with the scale of production. Variable costs are those that vary with production.

Valuable Graphs

The allocation of those costs across larger scales of production results in a variety of cost curve shapes or functions. Graphs depicting these functions show cost on the vertical axis and quantity on the horizontal axis. Readers need to keep in mind that average total cost and average variable cost form important U-shaped curves. Their calculations involve divisions by the production quantity coordinate. The lowest points on those curves are also significant because it is where the marginal cost curve, which is J-shaped, intersects them. Marginal cost is the change in total costs that arise from producing one additional unit.

Break-even Point

Next consider one of two key graphical references, which is the break-even point. It occurs where the marginal cost curve intersects the average total cost curve and at the latter's lowest point. The break-even point also marks the location at which those costs are equal and where price needs to be in order for the firm to earn a normal profit. The break-even term is misleading as it seems to indicate an absence of an accounting profit. As mentioned earlier, profits become part of the cost of operations if the owner is remaining consistent with the notion of opportunity cost. Therefore, in order to remain in business, a firm owner or an entrepreneur will pursue the rate of profit considered normal for the market in which he or she conducts business operations.

Shut-down Point

The second key reference is the shut-down point. It occurs where the marginal cost curve intersects the average variable cost curve and at the latter's lowest point. The shut-down point also marks the location at which those costs are equal and where price needs to be in order for the firm to remain in business as an ongoing economically viable enterprise. For obvious reasons, as the name implies, a transfer price below the shut-down point is likely to grab the attention of tax authorities. It could signify the selling party's attempt to minimize its profit, conversely maximizing its loss, in transferring an item that is artificially under-priced to the related offshore party. As was the case presented by Amram, the offshore party is then in a position to earn maximum profit by purchasing the item from its parent at an extraordinarily low price and then selling it at the market price.

Price Determination

With this initial reference to market price, we are moving closer to the discussion on how the market influences price determination processes. Though transfer pricing involves a special case in which a firm is selling some of its product to itself or a subsidiary readers should take note of this initial reference to markets. Nevertheless, some product sales occur in the open market regardless of whether transfer pricing is present or absent. In the usual case, a market delineates the acceptable or competitive levels for prices and profits. In order to realize normal profit, a firm really needs to sell its items or services at a price that equals or exceeds the break-even point. For the sake of simplicity and brevity here, profit maximization under the economic perspective refers to the situation that occurs before the application of income taxes; one could argue that taxes are also a normal part of doing business and are therefore included as costs and by virtue of a net normal profit.

As an early introduction to the next section, readers need to keep in mind that firms produce and sell items and they receive a price for each one sold. Total revenue is the mathematical product of price times the quantity sold at each price. Marginal revenue is the change in total revenue that arises from selling one additional unit. To reach the normal profit-maximizing output requires a level of production where marginal costs are equal to marginal revenue. Before we depart this section, a discussion of the rules of production is in order. Adherence to these rules allows a firm to continue its operation as a viable entity. First, firms must produce at the profit maximizing output which is where marginal revenue equals marginal cost. Second, firms need to receive a price that is equal to or greater than average variable cost. Why? Their sales must cover, at the least, average variable costs and contribute something toward average fixed costs. In the context of transfer pricing, this is about as far as an economic analysis can go by excluding specific references to market forces. To recap, most firms face pricing and operating constraints by virtue of their cost functions and profit expectations. As readers are beginning to see, the relationship between market prices and producer costs is critical because it influences whether the production of an item will occur at all and in an efficient and profitable manner. Even with a limited reference to market conditions, business owners expect to earn profits and their firms will incur a variety of costs in their production of goods and services. The next section addresses some market influences that are relevant to transfer pricing, in part, due to necessities for an analysis of markets in accordance with Section 482 of the Internal Revenue Code.

Economic & Market Factors: Possible Relevance to Transfer Pricing Methods & Cases

Tax laws in many of the countries with membership in the OECD define five methods for gauging and auditing a firm's transfer price. The United States is a member and its tax codes for transfer pricing draw from those of the OECD with the additional stipulation that method choice and supporting documentation need to accompany the tax return at time of its filing. Accordingly, in its absence, district directors at the Internal Revenue Service have explicit authority for adjusting the contents of a corporate tax return and for imposing hefty penalties when they encounter questionable applications of the proscribed transfer pricing methods. The guidelines, as expressed in Section 482 of the US Internal Revenue Code, bring market forces into the regulatory fold. It is clear that government revenue agents expect corporate taxpayers and tax return accountants to use an economic perspective in supporting their transfer pricing methods. This section outlines some additional economic concepts relevant to price determination by directing the reader to a complex array of market characteristics.

Though this essay attempts to simplify the economic perspective, some methods are better and more appropriate for corporate income tax estimation purposes than others. At the least, Section 482 requires tax filers to be in a position to explain the rationale for method selection and to describe the market influences on price determination. Furthermore, that position comes with the abilities to articulate the best model and to define and present it in a clear, concise, and compelling manner. To do otherwise means elevating the likelihood of receiving unwanted and/or unfavorable adjustments to tax returns and experiencing unfortunate determinations by a district director. As part of the process, the guidelines encourage tax filers to conduct economic analyses, to provide accurate documentation, and to offer reliable comparisons.

Using whatever amount of time it takes, analysts need to demonstrate reliability in commercial practices, economic principles, or statistical analyses. The guidelines also make it clear that comparability flows from extensive evaluation processes. In essence, a requirement exists for an evaluation of all factors likely to affect prices or profits in arm's length transactions. Moreover, full compliance requires familiarity with an array of economic concepts.

Toward that end, readers of this essay will find brief descriptions of concepts that can help them demonstrate compliance and prepare documentation. From an economics perspective, market price determination involves interactions between demand and supply. More precisely, prices reflect changes in demand and/or supply. Table 1 lists the factors that influence demand and supply.

Demand Supply Consumer income Prices of alternative outputs Population or number of buyers Number of sellers Consumer tastes and preferences Technology Prices of related goods Resource prices Expected prices Expected price

Those influences exist regardless of the ability of an individual firm or a group of firms to form and implement price determination strategies. A great deal of information will become available from the following overview of the structure, the conduct, and the performance of markets.

Market Structure

Pursuant to the structure-conduct-performance approach to market evaluation, Table 2 lists provides some key elements for drawing contrasts between a competitive and a noncompetitive market. Key descriptors of market structure include the number of sellers and buyers, the ease at which firms can enter or exit a market, and the level of profit. Imperfect competition produces lower quantities and higher prices than perfect competition. When those prices are higher than the break-even point, firms earn profits greater than the normal level.

Market structure reflects a firm's ability to make the price or to take the price. In microeconomic context, market structures form a continuum portraying the presence or the absence of competition in a market. The opposite ends of that continuum contain perfect competition and imperfect competition. Firms operating in noncompetitive market structures produce less and employ fewer workers than do firms operating in competitive markets. In addition, higher prices result from placement of the profit-maximizing output at a lower level of production in contrast to its placement in competitive markets. It is also important to note that average total costs are higher at lower levels of output and are greater than a competitive market level.

Competition Type Structure Conduct Performance Perfect / High Low concentration Independent Allocative efficiency Easy entry or exit Price = MC Normal profit level Standardized products Low innovation level Imperfect / Low High concentration Maximum profits Allocative inefficiency Entry barriers Economic profit level Differentiated products High innovation level

An economic profit occurs when prices are higher than average total cost, which typically invites new firm entry into the market. Economic profits will diminish with entries of new suppliers into the market and the resultant increases in quantity supplied. In turn, an increase in supply will propel prices downward toward the point at which an economic profit evaporates and normal profits resume. Entry into the market may be virtually impossible due to legal constraints such as licenses and patents. Economic profit is sustainable, however, when there are barriers to entry.

The amount of advertising can create differences whether real or perceived in product lines, which by definition is product differentiation. Brand name recognitions and customer loyalties present difficulties for firms contemplating entrance. Economic profit, entry barriers, and product differentiation are likely to result in a concentration of market power among a few firms. As a feature common to non-competitive market structures, there are at least two techniques applicable to measurements of market power.

Measures of market power include the concentration ratio and the Herfindahl Index (HI). Calculating the concentration ratio for the four largest firms (the CR4) involves dividing the dollar amount of their sales by the total dollar amount of market sales. For example, the CR4 in the soft drink market could be somewhere around a 95, after multiplying the result by 100, meaning that the four largest firms account for 95 percent of product sales within a given market. For a monopolist, the CR1 would be 100 percent, which is the maximum value of a concentration ratio. Calculating the HI involves squaring the market share of each firm in the market and then adding them together; it would be the highest at 100 squared, or 10,000, in the case of a monopolist.

Concentration ratios and the HI as well as levels of profit, price, and output are especially useful in examining industry proposals for merger. A vertical merger occurs when a firm buys one or more of its suppliers; for example, a soft drink manufacturer buys an aluminum can producer. It is important to remember that firms currently engaged in transfer pricing are likely to be the result of an earlier vertical merger. A horizontal merger occurs when a firm buys a competitor; for example, a restaurant owner buys another restaurant. A conglomerate merger occurs when a firm buys a firm in a separate but related industry; for example, a soft drink manufacturer buys a fast food restaurant.

Market Conduct

Firm conduct within a market economy reflects various strategies. In addition to those centering on price determination, there are firm strategies that involve product line content, research and development activities, and legalistic arrangements. In combination, all these strategies portray their market conduct. The most prevalent behavioral conduct of firms is in the form of their perpetual search for prices. The nature of those search processes may be interactive, collusive, or reactive at any given point in time. Additional objectives may include setting a high price, maximizing a market share, and/or earning a profit. All this involves varying degrees of cooperation including methods that resemble an informal follow-the-leader strategy or those that amount to a formal agreement to fix prices at a specific amount.

Market Performance

Market conduct and market structure jointly determine market performance, which is the last of three dimensions presented in this essay for evaluating economic markets. Evaluation of market performance may include a focus on the statistical association between profit levels and market concentration ratios. Through that examination, analysts should expect to find a strong, positive correlation between the two. In contrast to imperfect market conditions, analysts may also find that performance in competitive markets exhibits greater amounts of production at lower average cost in concert with higher outputs, employments, and household incomes. Current and future market analysts should take note that it is possible to gather data on these consequences from external sources such as local, state, or federal government agencies and industrial trade associations.

As this section concludes, a number of factors exist that could raise suspicions about tax evasion. For example, features commonly associated with markets in which profits exceed the normal level include the presence of intangible assets such as patents and other intellectual property, barriers to entry, and non-price competition. In essence, the main challenge to the tax departments and staff of multinational corporations is to maximize profit and to minimize taxes by determining transfer prices in accordance with the appropriate methods. The next section provides a brief summary of those methods.

Tax Determination Methods: An Integration of Economic Perspectives & Accounting Practices

The appropriate methods for determining transfer prices generally involve a primary comparison between two unrelated firms and then a secondary comparison of those results with the relationship between two related firms. This is the essence of the arm's length standard usage as a guideline for determining the taxable income of firms with common ownership. Application of the standard is demonstrable under specific conditions. First, there is an expectation of comparing the income generated from the transactions of a firm having a parent (a subsidiary) with those from a firm without a parent firm. The purpose of that comparative analysis is to establish a hypothetical tax liability reference point for transactions similar in content and circumstances similar in nature given the explicit absence of parent-subsidiary relationship. Second, there is an expectation of applying several alternative methods of comparison from which a set of consistent results will emerge. In other words, the purpose is to identify the most appropriate method by minimizing the variance in tax liabilities. That emergent set will contain the best or most reliable method of transfer pricing. A description of the alternative, allowable methods appear in the next section.

On page 20 or so of the 90-page document is the definition of transactions covered by the regulations. With their origins in OECD's initiatives, the transactions governed by Section 482 of the United States Internal Revenue Code include sales; assignments; leases; licenses; loans; advances; contributions; transfers of interests in or rights in properties whether tangible, intangible, real, or personal or in money; and whether any of the aforementioned are documented or conducted on the behalf of another taxpayer. In brief, some contend that it covers virtually any interaction that occurs between or among individuals and/or organizations. Other methods involving financial and accounting ratios and concepts are available within the document as well, which receive cursory treatment here for the sake of brevity. An extraction and synthesis of the basic set of five transfer pricing methods found in Section 482 are as follows:

• The Comparable Uncontrolled Price method reveals a price that is determined by market forces. It attempts to find prices in the transactions of firms controlled by a parent firm and those without a parent firm (uncontrolled) whether the properties in exchange are tangible or intangible. In brief, it compares actual transfer prices.

• The Cost Plus method employs a mark-up according to normal rate of profit. The base could include actual, standard, variable and/or marginal costs. It requires decisions regarding treatments of fixed costs and research and development costs. In brief, it compares cost mark-ups in upstream transactions, which are usually those that occur in a parent firm.

• The Resale Price method reveals a price in cases where there is no additional value added to the tangible product by the reseller. It attempts to draw comparisons on price between controlled and uncontrolled transactions. In brief, it compares mark-ups of price over cost in downstream transactions, which are those that usually occur in a subsidiary.

• The Comparable Profits method is most applicable when an agreement exists between countries. That agreement governs the applicability of domestic and/or foreign tax rules to various transactions. In special form, an Advance Pricing Agreement establishes future prices as agreed between the taxpayer and the taxing authority and they diminish the risk of double-taxation. In brief, it compares a variety of financial and accounting ratios.

• The Profit Split method, the most recent addition to the set, is applicable when services are highly integrated and difficult to separate. An expectation is that the distributions of profit will track closely with an entity's contribution to total revenues. In brief, it is most applicable in the absence of unrelated firms for use as comparables. Elaborations of these five methods are available from a number of sources including the US Internal Revenue Service and accounting service entities. A few of the big-four accounting firms hold documentation with which to learn about and monitor updates in tax laws of most countries around the globe.

Conclusion

In conclusion, the purpose of this essay is to introduce readers and undergraduate students to the topic of transfer pricing and to demonstrate the importance and value of integrating economics and accounting perspectives. As international trade and global commerce continues to bring developing countries into the array, job opportunities for those with a firm understanding of economics will find themselves in high demand.

Terms & Concepts

Barriers to Entry: Legal, marketing, and scale factors that prevent or inhibit potentially rival competitors from supplying a good or service to a market.

Break-even Point: The point in a graph of cost functions at which average total cost and marginal cost curves intersect.

Concentration Ratio: A metric that estimates the concentration of market power among a small number of firms.

Controlled Transactions: Transactions between two or more related firms controlled through common ownership.

Economic Profit: Realized when market price exceeds average total cost; invites rival firm entry into a market in the absence of barriers.

Fixed Costs: Costs for any level of production or output that remain constant.

Herfindahl Index: Results when multiplying by 100 the total sum of the market shares held by individual firms in a market; at a maximum of 10,000 in the case of monopolist.

Market Conduct: The behavior of firms in setting prices and pursuing non-price competition.

Market Performance: Measured in terms of allocative efficiency.

Market Structure: The degree of competition that exists among firms within a market.

Merger: Occurs when firm ownership expands combining firms that may be competitors, suppliers, or buyers of an item within a given market or different industries.

Marginal Cost: The contribution to total cost from the production of one additional item.

Marginal Revenue: The contribution to total revenue from the sale of one additional item.

Multinational Company: A company that operates in more than one nation; frequently in the form of a parent-subsidiary relationship.

Normal Profit: The amount of profit considered normal for retaining an entrepreneur in the existing line of business; occurs where price equals average total costs at the profit-maximizing output.

Opportunity Cost: The value of the best, yet foregone alternative because of making a decision due to scarcity.

Rules of Production: Two rules determine the economic viability of a firm: First, a profit-maximizing output level occurs marginal revenue is equal to marginal cost; second, price for output must be equal to or greater than average variable cost.

Shut-down Point: The point in a graph of cost functions at which average variable cost and marginal cost curves intersect.

Total Revenue: The proceeds from the sale of an item; the mathematical product of quantity of item sold times the price of item.

Variable Costs: Costs for production or output that vary according to activity level.

Bibliography

Amram, O. (n.d.). When worlds collide: Transfer pricing tax strategies and securities laws. Retrieved December 5, 2007, from http://www.kentlaw.edu/perritt/courses/seminar/oren-amram-Tax%20Paper-26apr07-final.htm

Dogan, Z., Deran, A., & Köksal, A. (2013). Factors influencing the selection of methods and determination of transfer pricing in multinational companies: A case study of United Kingdom. International Journal of Economics & Financial Issues (IJEFI), 3(3), 734-742. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=90539908&site=ehost-live

Dürr, O.M., & Gox, R.F. (2013). Specific investment and negotiated transfer pricing in an international transfer pricing model. Schmalenbach Business Review (SBR), 65(1), 27-50. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=85818615 &site=ehost-live

Pearce, D.W. (Ed.). (1992). The MIT dictionary of modern economics. Cambridge, MA: MIT Press.

Internal Revenue Code Section 482. Retrieved December 5, 2007, from http://www.ustransferpricing.com/26CFR%5F1%5F482%5Fcomplete.pdf

Martini, J., Niemann, R., & Simons, D. (2012). Transfer pricing or formula apportionment? tax-induced distortions of multinationals' investment and production decisions. Contemporary Accounting Research, 29(4), 1060-1086. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=84385460&site=ehost-live

Suggested Reading

Andreoli, B., & Hryck, D. (2006). IRS takes aim at service issues in transfer pricing. Financial Executive, 22(9), 47-49. Retrieved November 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=22990283&site=ehost-live

Gold, L. (2007). International tax: Translation needed: Transfer pricing and FIN 48. Accounting Today, 21 (20), 1, 8. Retrieved December 5, 2007, from http://www.webcpa.com/article.cfm?articleid=25793&pg=ros

O'Brien, J. (2007). Transfer pricing. International Tax Journal, 33(5), 21-73. Retrieved November 30, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26475017&site=ehost-live