Transfer+pricing

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=An introduction to transfer pricing=

Transfer pricing occurs when two related companies, such as parent companies and subsidiaries, trade with each other. While the prices for various transactions normally is determined by the free market, related companies can distort the market price in order to reduce the tax bill. Transfer pricing may for example involve that companies organize their business transactions so that the largest possible share of profits are paid to tax havens with low or zero taxes.

Together with thin capitalization, transfer pricing is one the most significant ways to practice tax avoidance. As in the example above, transfer pricing usually involves the use of tax haven s.

The "Arm’s Length" principle
When two unrelated companies trade with each other, a price which is the product of negotiations on the free market will generally result. This is known as “Arms-length” trading. This market price is generally considered to be acceptable for tax purposes.

Despite that many companies use the arm’s length principle correctly, it also gives multinational companies a way to decide where to shift their profits. The arm’s length principle is difficult to implement and monitor, and therefore highlights the need for a unitary tax system.

Initiatives for controlling transfer pricing and other forms of tax avoidance
Several national and international authorities have established entities to tackle tax evasion and tax avoidance. Initiatives include frameworks and standards, as well as cooperation between the public sector, businesses and NGOs. The OECD has established a 'Harmful tax practices' unit, that follows and reports about activities, progress and potential threats within harmful taxation. The organization acts as a control mechanism in the fiscal landscape and helps governments promote economic growth and stability. Also the EU is committed to fighting against tax fraud and evasion. In 2012 the European Commission adopted an action plan setting out concrete measures to combat the phenomenon. Since taxation is often seen as the core of state sovereignity, states are reluctant to apply international regulations, although they are common in trade. G overnments of tax havens argue that rules on taxation violates their sovereignty. The fact that multinational companies collaborate with tax havens, gives added weight to these arguments.

From a business perspective, the Sarbanes -Oxley Act of 2002 brought about some changes. The framework states that tax services performed by the company's auditor must be approved by the audit committee. To preserve its independence, it is illegal for a company auditor to also provide consultation services. Companies use their accountants to develop tax policies because it causes knowledge spillover about the company's financial situation.