1Tax HavenLet me give you a background about what is transfer pricing. We heard of this term so many times and many of us have absolutely had no idea about what is it.

According to Wikipedia, transfer pricing is the setting of the price for goods and services sold between controlled (or related) legal entities within an enterprise. For example, if a subsidiary company sells goods to a parent company, the cost of those goods paid by the parent to the subsidiary is the transfer price. Legal entities considered under the control of a single corporation include branches and companies that are wholly or majority owned ultimately by the parent corporation. Certain jurisdictions consider entities to be under common control if they share family members on their boards of directors. Transfer pricing can be used as a profit allocation method to attribute a multinational corporation's net profit (or loss) before tax to countries where it does business. Transfer pricing results in the setting of prices among divisions within an enterprise.

In principle, a transfer price should match either what the seller would charge an independent, arm's length customer, or what the buyer would pay an independent, arm's length supplier. While unrealistic transfer prices do not affect the overall enterprise directly, they become a concern for government taxing authorities when transfer pricing is used to lower profits in a division of an enterprise located in a country that levies high-income taxes and raises profits in a country that is a tax haven that levies no (or low) income taxes.

Let me give you an example, US-based subsidiary of Starbuck buys something from a UK-based subsidiary of Starbuck. Transfer pricing isn't illegal. What is illegal is transfer mispricing, when the goods are priced way out of market price to benefit from the tax differentiate between these 2 countries.

Reinvoicing is another example of transfer pricing. Reinvoicing usually involves 3 entities. Let's us have Entity A as the producer of the goods with its jurisdiction of incorporation as China. Entity B as the middleman with its jurisdiction of incorporation as Belize and Entity C as the retailer with its jurisdiction of incorporation as Denmark. Entity A sells its finished goods to Entity B at a break-even price. In that case, low or no profit is made and in that aspect, the tax liability of this China company is low. The Entity B sells the same goods to Entity C at an extremely high price. Maybe somewhere near the selling price of Entity C to the end user. In that case, the transaction between Entity B and Entity C serves 2 objectives. The first objective is to make sure Entity C has no tax or low tax burden as it is another barely breakeven case. As for the second objective, it is to accumulate all the wealth in Entity B. Perfect scenario, isn't it? To make things more colorful, Entity B just need to open an offshore bank account with credit card and internet banking facilities.