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On the Necessity of Using Average Cost as a Base for Transfer Price

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Listed:
  • Tomáš Buus
  • Jaroslav BRADA

Abstract

Both older and recent literature on transfer pricing is not unified about the opinion whether optimal transfer price should be equal to marginal cost of supplying company and set by centralized decision (of vertically integrated multibusiness enterprise headquarters) or whether it should be set by negotiation or even set on level of market (arms-length) price. Those, who argue for setting transfer price by negotiation or at the market price base their arguments on market imperfections like information asymmetry, motivation of managers, et cetera. This paper deals inter alia with problem of methodology transfer pricing mathematical modelling. We prove that optimal transfer price should be equal to average cost of the supplying division plus part (or whole) economic profit of the multibusiness enterprise, independent on the market conditions at the market of either intermediate or final product. Setting transfer price on the level of marginal cost is inefficient and would earlier or later lead to loss of multibusiness enterprise’s ability to compete its rivals. Applicability of results of our research on multinational enterprises gives us possibility to use it for further research on optimal design of transfer pricing rules setting and of multinationals’ taxation.

Suggested Citation

  • Tomáš Buus & Jaroslav BRADA, 2008. "On the Necessity of Using Average Cost as a Base for Transfer Price," European Financial and Accounting Journal, University of Economics, Prague, vol. 2008(3), pages 79-94.
  • Handle: RePEc:prg:jnlefa:v:2008:y:2008:i:3:id:85:p:79-94
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    References listed on IDEAS

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    1. Baumol, William J & Bradford, David F, 1970. "Optimal Departures from Marginal Cost Pricing," American Economic Review, American Economic Association, vol. 60(3), pages 265-283, June.
    2. Jack Hirshleifer, 1956. "On the Economics of Transfer Pricing," The Journal of Business, University of Chicago Press, vol. 29, pages 172-172.
    3. Lutter, Marcus & Scheffler, Eberhard & Schneider, Uwe, 1998. "Handbuch der Konzernfinanzierung," Publications of Darmstadt Technical University, Institute for Business Studies (BWL) 5677, Darmstadt Technical University, Department of Business Administration, Economics and Law, Institute for Business Studies (BWL).
    4. Filip Novotný, 2008. "Daňová optimalizace nadnárodních společností prostřednictvím vnitřních cen: přehled hlavních teoretických východisek a možných makroekonomických dopadů
      [Tax optimization of multinational firms thro
      ," Politická ekonomie, University of Economics, Prague, vol. 2008(1), pages 40-53.
    5. Bruce L. Miller & A. G. Buckman, 1987. "Cost Allocation and Opportunity Costs," Management Science, INFORMS, vol. 33(5), pages 626-639, May.
    6. repec:bla:joares:v:8:y:1970:i:1:p:99-112 is not listed on IDEAS
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    Citations

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    Cited by:

    1. Tomáš Buus & Jaroslav BRADA, 2010. "VAT and Tax Credits: A Way to Eliminate Tax-Evasive Use of Transfer Prices?," European Financial and Accounting Journal, University of Economics, Prague, vol. 2010(1), pages 28-50.
    2. Tomáš Buus, 2009. "The Costing Formula Suitable for Pricing (Transfer Pricing) Decisions and Maximization of Business Value," Český finanční a účetní časopis, University of Economics, Prague, vol. 2009(2), pages 33-45.
    3. Jaroslav BRADA & Tomáš Buus, 2009. "Detection of Possible Tax-Evasive Transfer Pricing in Multinational Enterprises," European Financial and Accounting Journal, University of Economics, Prague, vol. 2009(2), pages 65-78.
    4. Tomáš Buus & Jaroslav Brada, 2008. "On the Properties of Transfer Pricing Rules," Český finanční a účetní časopis, University of Economics, Prague, vol. 2008(3), pages 39-55.

    More about this item

    Keywords

    Multibusiness enterprise; OECD taxation guidelines; Transfer pricing; Vertical integration;

    JEL classification:

    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D29 - Microeconomics - - Production and Organizations - - - Other
    • G39 - Financial Economics - - Corporate Finance and Governance - - - Other

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