Reading your tax column ["Multinational firms and transfer pricing" by Anna Frimmelová, Vol. 4 No. 28, Nov. 23 to 29], it appeared to me that multinationals have always tried to exploit differences in the tax rates of the countries in which they do business, and that Slovakia was a victim of such a behavior. Thus, Slovakia had the right to defend itself by high penalties [regarding 'transfer pricing', or the money that branches of a firm doing business in different countries charge themselves for goods and services].
There is, however, another side: Once a firm starts to become active in several countries it becomes multinational. Producing abroad can be advantageous for many reasons: the market for the product might be there, inputs might be more available or cheaper, exports might grow in one specific country, and last not least, it creates employment.
This is the context of the transfer pricing issue. Imagine a multinational producing parts in England and Italy for assembly in Germany and eventual export to Switzerland. How should the correct price of the product be calculated? In which of the four countries' currency should it be listed? Should it be changed in case of currency fluctuations? What is the market price of the piece produced in Italy, where a market for it might not exist?
Whatever prices are eventually agreed on, the important thing is that they are accepted by the tax authorities in the each of the countries involved. Otherwise, if sales are increased in one country and cost of sales in another, the company's taxable income rises in both countries leading to the possibility of double taxation.
Treaties for avoidance of double taxation can help. They establish rules for transfer prices to be accepted in both countries. Thus, the firm can be sure that it is not overtaxed.
In many countries, income tax has to be paid on a consolidated basis. That means that multinationals are not as affected by variations in tax rates between countries. And indeed, if we look at the criteria by which investors decide to enter a market, taxation is only one of fifteen important variables. Economic and political stability are others.
Many countries try to attract production facilities of multinationals by offering grants, low taxation and so on. Slovakia until now has not followed this policy, but it would be a pity if rigid taxation policy regarding transfer prices discouraged foreign investors from coming to a country which has so many other advantages.
14. Dec 1998 at 0:00