Transfer pricing, tax considerations, and performance evaluation : interactions in a divisionalised multinational business

Abstract

Purpose: The main purpose of this study is to analyse the interactions between transfer pricing, tax considerations, and performance evaluation in a divisionalised multinational entity. This study evaluates the transfer pricing mechanisms currently used by the case company. This will in turn aid in exploring how these mechanisms are impacted by the global tax and transfer pricing requirements. This research also assesses how the transfer pricing system used, can affect the performance evaluation done by top management. Design: The objectives of this study were achieved through a case study approach comprising of four semi-structured interviews with high-level officials within the divisionalised multinational entity being analysed. Findings: Being a group of companies located in different jurisdictions, engaged in several related party transactions, the case company uses a hybrid transfer pricing system. This system, while adhering to the fundamental arm’s length principle, looks towards preserving divisional independence and autonomy, whilst also balancing it with the overriding fear of attracting a tax investigation. This implies that the global tax and transfer pricing requirements impact the transfer pricing mechanisms adopted. To reduce the effect of profits that cannot be fully controlled by the divisional managers and hence maximise fairness in performance evaluation of subsidiaries, the case company analyses both financial and non-financial performance measures. This shows that the performance evaluation implemented is highly influenced by the transfer pricing decisions, which in turn are highly influenced by tax considerations. Conclusions: This study clearly shows that it is quite challenging for a multinational entity to find a balance between achieving the transfer pricing objectives, adhering to the requirements imposed by authorities, whilst also motivating their employees through a fair performance evaluation system. It is of utmost importance that, irrespective of what transfer pricing and performance evaluation model the company opts for, these are revised periodically to reflect the constant environmental changes faced by the group. Failing to do so might mean inability to achieve the desired success in the competitive global market. Value: The company under review and other multinational entities operating in the same sector and facing similar circumstances can use the findings of this study as a reference in their decision-making around transfer pricing and performance evaluation mechanisms. This research aims to highlight other methods of such mechanisms that can be more beneficial than the ones currently in place at the case company. The recommendations included in this study can be implemented by the company under review, as well as by similar companies to improve their systems, while still ensuring that all requirements imposed by authorities around the globe are properly adhered to.