An analysis of transfer pricing theory and an investigation into the domestic transfer pricing practices of large listed South African industrial companies.

Abstract

An analysis of transfer pricing theory reveals that there are three main objectives of a transfer pricing system: the attainment of goal congruence, the facilitation of fair divisional performance evaluation and the promotion of divisional autonomy. A critical evaluation of suggested theoretically correct transfer pricing methods suggests that the simultaneous attainment of all three objectives is a difficult goal to be realised by a single transfer pricing method. The most appropriate method to suit a particular set of circumstances is contingent upon those circumstances. The transfer pricing objective considered most important in practice by large listed South African industrial companies is the facilitation of fair divisional performance evaluation. Objectives relating to simplicity and ease of application are also rated more highly than goal congruence. Both these findings are somewhat surprising based on the review of current literature. The domestic transfer pricing methods used by large listed South African industrial companies are fairly evenly split between cost and non-cost-oriented methods. The most frequently used primary transfer pricing method is market price. The use of mathematical programming and economic marginal cost prices is practically non-existent. These findings are consistent with the findings of some recent overseas studies. Policies relating to the selection of the transfer pricing method, the purchase of intermediate goods and services and the settlement of transfer pricing disputes reflects some head office management involvement in the transfer price decision process in most cases. Three organisational variables appear to have a significant association with a firm's choice of transfer pricing method. Firstly, companies with a low level of interdivisional trading use non-cost oriented transfer pricing methods whereas companies with a high level of interdivisional trading use cost-oriented methods. Secondly, transfer pricing methods selected as a result of some head office management involvement tend to be cost-oriented whereas methods selected by the divisions themselves tend to be non-cost-oriented. Thirdly, cost-oriented methods tend to be used in companies in which transfer pricing disputes are normally settled by some form of head office intervention and non-cost oriented methods are used in those companies in which disputes are normally settled by the divisions themselves.