Lahdekorpi OY, a Finnish corporation, owns 100 percent of Three- O Company, a subsidiary incorporated in the United States. Required: Given the limited information provided, (a) determine the best transfer pricing method and (b) the appropriate transfer price $ in the following situation: Lahdekorpi manufacturers wooden puzzles at a cost of $2 each and sells them to Three- O Company for distribution in the United States. Other Finnish puzzle manufacturers sell their product to unrelated customers and normally earn a gross profit equal to 50 percent of the production cost.

Lahdekorpi OY, a Finnish corporation and Three-O Company, a subsidiary incorporated in the United States

Transfer Pricing:

a) The best transfer pricing method in this case is the cost plus method.  This gives the transfer price as Cost + 50%.

b) The appropriate transfer price should be $3 ($2 x 1.5).

Explanation:

Transfer pricing arises when controlled entities set prices for exchange of goods and services.  When Lahdekorpi OY, a Finnish corporation, sells wooden puzzles to Three-O Company, given their relationship, transfer pricing has arisen.  It is the assignment of cost for goods and services exchanged between related parties, like a parent and a subsidiary.

There are many Transfer Pricing methods which entities and the taxing authorities can use to determine the best transfer price.  According to the Organisation for Economic Co-operation and Development (OECD) Multinational Entities and tax authorities can use any of these five main transfer pricing methods:

a) Comparable uncontrolled price (CUP) method. The CUP method is grouped by the OECD as a traditional transaction method (as opposed to a transactional profit method)

b) Resale price method

c) Cost plus method

d) Transactional net margin method (TNMM)

e) Transactional profit split method.