Companies involved in international trade usually exist in order to make a profit for their shareholders. Activities which generate revenue are carried out, costs of operations are subtracted from the revenue created, and the leftover amount is (hopefully, for the firm) a net profit. The objective is to maximise the efficiency of activities which generate revenue, and at the same time to minimise the costs of generating that revenue. One of the ways that this can be done is through transfer pricing. This is the price at which: .
"goods or services are exchanged between organisational units of the same company a transfer price is a substitute for a market price." .
(Gernon & Meek 2001, p170).
Transfer pricing is a tool that can be used to move money around the world in order to maximise profits and minimise tax. The details of how this is done will be briefly described later. .
What is best for the firm, in terms of profit maximisation, is not, however, best for a government which stands to loose tax revenue as a result. Companies, by reducing the tax they pay in a certain country, reduce the revenue of the government of that country - which means that there is less money to pay for social services and infrastructure such as welfare, hospitals, roads, defence, etc (Mahoney, Trigg, Griffin & Pustay 2001, p791). .
What this report does is probe how transfer pricing and the issue of equity affect companies, governments, and societies at large.
There are a few key terms and concepts which need defining in order to fully understand the issue of transfer pricing and equity. The definitions come from the work of Gernon and Meek (2001).
Territorial principle of taxation: income earned outside [a country's] domestic boundaries is not taxed.
Worldwide principle of taxation: the right to tax income earned outside [a country's] boundaries when earned by an entity based in [that] country.