Transfer pricing with third party consequences

Transfer prices are used not only for internal record keeping and performance evaluation purposes.

There are several settings where transfer prices have direct cash consequences for a company. The most widely cited case is in interstate and international transactions where transfer prices may affect tax liabilities, royalties or other payments due to different government jurisdiction. Since tax rates differ across states, or jurisdictions, companies have an incentive to establish a transfer price which will increase the income in the lower tax jurisdiction and decrease income in the higher tax jurisdiction.