Transfer pricing is a concept used in accounting and taxation that involves assigning a price for the transfer of goods or services between related business entities within the same corporate group. This practice has become increasingly popular over recent years due to governments wanting to ensure that large multinational companies are paying the appropriate amounts of taxes. Transfer pricing is often utilized to reduce overall tax burden and allow the parent company to manipulate their financial statements to show a favorable image to stakeholders.

The pricing of goods or services between divisions of the same company is not likely to be at the same rate that would exist in the open market, nor is it likely to adhere to the same terms and conditions. Instead, the transaction price typically reflects the purpose and structure of the company, often distinguishing between divisions that serve different markets, as well as different subsidiaries in various locations. Companies strive to maximize their profits and reduce their taxes by establishing an agreed-upon transfer price for each transaction.

The IRS states that the transfer price for such transactions must be at least equal to the amount it would have been had the company conducted the transaction outside of the organization. This helps ensure that multinational companies are not simply placing profits in lower-tax countries, which could result in them paying significantly less in taxes than they otherwise would have.

Some companies use complex transfer pricing schemes to reduce their taxable income. This often involves setting up cost sharing arrangements between related subsidiaries in different countries. The purpose of these arrangements is to transfer profits out of higher-taxed countries to lower-taxed countries, U.S. companies are also able to use certain laws such as the Foreign Investment in Real Property Tax Act to further reduce their income tax liability.

While this type of arrangement is legal, it is heavily scrutinized by governments, who often pass laws designed to limit transfer pricing schemes. In the United States, for instance, any transfer pricing dealings must follow the principles of the "arm's length" rule, which prevents companies from offering pricing or terms to a related party that are not similar to the ones accessible in the open market.

In short, transfer pricing is a technique utilized by companies to attempt to reduce their tax burden by taking advantage of transfer pricing differences between different countries. This can be accomplished through a variety of methods, such as cost sharing arrangements and the Foreign Investment in Real Property Tax Act. Ultimately, governments must ensure that businesses are paying the appropriate amounts of taxes through rigorous regulation and scrutiny of international transfer pricing schemes.