Prime Co: Transfer Pricing Case

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Strategies considered

There were several strategies, which Prime Co could have undertaken in its efforts to globalize. However, in this scenario, the entity’s target market was Japan which has a frail judicial system. This write-up seeks to analyze the strategies that were open to Prime Co. First, Prime Co might have opted to export readymade components hence, incurring shipment cost of the components. Additionally, Prime Co would be required to escalate its scale of operations to meet the foreign demand. The increased production would culminate in additional recruitment of employees enabling surplus production. The exports would comply with Japanese’ taxation regimes hence, escalating the prices of the components. Secondly, the entity would have contracted another organization to undertake the manufacturing. This would have lifted the manufacturing responsibility from Prime Co (Bloom & Myring, 2007). Furthermore, this entity would not have any challenges that emanate from hiring employees in foreign nations. A contract manufacturer may pose certain challenges to Prime Co despite relieving the manufacturing burden. The contract manufacturer could intentionally sabotage the operations of Prime Co by failing to meet set timelines or quality. Additionally, this may lead to the leakage of Prime Co’s secrets. Evidently, the entity operates in an ever-evolving industry. Hence, it is imperative for Prime Co to maintain secrecy since revealing its innovations would culminate in counterfeiting. Working with a contractor will imply that the entity has to provide information on the products to facilitate production. Such a deal results in the contracting firm paying exorbitantly since the contracted firm may doctor its cost analysis pertaining to production. Finally, the entity opted to internationalize through a fully owned subsidiary. This strategy will have multiple benefits to the entity since it will establish an entity whose basic role is to serve the new market. If the ownership of Sub co were partly by the holding firm Prime Co, there would be chances of corporate espionage. However, Sub co is a fully owned subsidiary. The founding of this entity creates management challenges since the two entities will require consolidation during the reporting of the financial status (Bloom & Myring, 2007).

Factors that James and Gold should consider

The two employees should first realize that during the preparation of statements both entities will appear as one. This is because the subsidiary is a constituent of the holding entity. Therefore, despite charging high or reduced transfer prices that will not reflect actual income to the entity since it is a single entity on consolidation. Overall, the sole objective of transfer pricing is to enable the preparation of records. However, it does not denote actual income to the entity. James and Gold should also consider the disparity between the legal structures of the two nations. The disparity between the legal frameworks in Japan and America will pose challenges during reporting of the transactions that transpire in the entities. Finally, James and Gold should consider a method of valuation that will maximize the profitability of both entities (Bloom & Myring, 2007).

Methods of transfer pricing

The 25% rule

Practitioners in this field consider the above value as what the owner of any patent should receive as proceeds, a value that courts worldwide have acknowledged as being reasonable. Additionally, revenue authorities have also accepted such a valuation (Inland Revenue, 2010).

Residual profit split

This methodology applies to the recipients of the intellectual property. The revenue authorities incline towards a fair division of the proceeds emanating from the utilization of any intellectual property (Hejazi, 2007).

The realization that the transfer prices do not reflect actual income to the entity will result in reasonable and objective pricing. However, it is imperative for the holding entity to reflect the patent as an asset in its statement. Additionally, it will be crucial to examine the Japanese regulations on royalties since they will provide guidance on the valuation of such complex items. If the legislation fails to stipulate the methodology of valuation of royalties, then James and Gold can adopt a reasonable value (Feinschreiber, 2002).

Effect of taxation law on Prime Co’s transfer pricing

Any rational organization seeks to optimize its proceeds. Similarly, it will also seek to reduce its tax burden. Consequently, Prime Co will adopt a transfer pricing that will reduce its tax burden and optimize its proceeds. Incidentally, Prime Co will seek to capitalize on the lower corporation taxation in the US (Bloom & Myring, 2007). Therefore, Prime Co will charge an exorbitant transfer price. As such, the subsidiary will have minimal taxable revenues. Conversely, the holding entity will have more proceeds taxable at a lower percentage. Overall, the taxation guidelines of Japan will determine the transfer price charged. According to the two laws, the charge on Sub co will be an expense thus diminishing the entity’s income. Conversely, the charge on Prime Co will be an income consequently, increasing revenues (King, 1994).

Advanced pricing agreement (APA)

When disparities exist in taxation legislation, turmoil may emerge on which law is applicable. The turmoil results since entities do not know what legislation to fulfill. In this scenario, the laws are similar. Nonetheless, there are disparities in the finer details of the relevant legislation. The entity may seek to resolve the disparity in taxation by appealing to the two taxation authorities to consider an agreement on a single transfer price. Enacting an APA is tricky since each nation seeks to ensure compliance with its regulations. If the authorities decide on a single transfer price, then this is an APA. This would simplify reporting in both the subsidiary and the holding entity. Prime Co and Sub co may seek to enact such a pact. However, the success of such a pact relies on the willingness of the tax authorities to compromise their regulations. Thus, allowing the attainment of a consensus on the transfer charge. Finally, an APA would reduce taxation hitches experienced by both entities. Enactment would depend on the taxation authorities’ willingness to engage with the relevant entities. Nonetheless, such a deal is possible between the two entities (Professional accountant, 2007).

Ethical issues

The above scenario generates certain ethical issues. First, any entity ought to pay tax. Therefore, both entities should charge apposite transfer figures enabling calculation of taxation. It is crucial that an entity compensates its workforce appropriately since they undertake the daily operations of the entity. Thus, compensating employees appropriately culminates in adherence to ethics. The effort by Prime Co to charge exorbitant transfer prices is unethical. It diminishes the tax payable to the Japanese authorities that have guaranteed an apt business surrounding. Therefore, Prime Co should charge a reasonable transfer price. Such a transfer price ought to guarantee that the American and Japanese’ authorities receive reasonable taxes (Bloom & Myring, 2007).


Bloom, R., & Myring, M. (2007). International transfer pricing and intellectual property: The prime Co case, Issues in Accounting Education, 22 (4), 769-774.

Feinschreiber, R. (2002). Transfer pricing handbook: transfer pricing international: a country-by… Canada: Wiley publication.

Hejazi, J. (2007). Transfer pricing – Royalties. Web.

Inland Revenue. (2010). Royalties. Web.

King, E. (1994). Transfer pricing and corporate taxation: problems, practical implications. Massachusetts, MA: Springer.

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