How Does a Company Sell to Itself? At Whatever Price It Chooses

A large company operates through separate legal entities in each country, and those entities trade with each other constantly, moving components, finished goods, services, loans and the right to use patents and brands. Each of those transfers needs a price, because each entity files accounts and pays tax where it sits, and profit is revenue minus costs. The price charged is simultaneously revenue for the selling entity and a cost for the buying one, so raising it moves profit from the buyer's country to the seller's and lowering it moves profit the other way. Nothing leaves the group in either case.

The mechanisms are straightforward once the principle is clear:

• •Sell components to a high-tax subsidiary at a high price
• •Charge that subsidiary a large royalty for using the brand
• •Lend it money from a low-tax subsidiary and charge heavy interest
• •Bill it substantial management and service fees from head office
• •Hold the valuable intellectual property in a low-tax jurisdiction
• •Each leaves little taxable profit where the sales actually happen

The international standard requires that transactions between related parties be priced as if the parties were unrelated, which is the arm's length principle, and tax authorities may adjust a company's accounts where they are not. Applying it means finding what an independent party would have charged, which is straightforward for a commodity with a market price and extremely difficult for anything distinctive. There is no market price for the use of a unique brand, for a component made by nobody else, or for a group service with no external equivalent. Disputes therefore turn on comparability, on which accounting methods are appropriate, and on economic analysis that both sides commission.

Applying the standard requires a method, and the recognised ones are worth knowing because arguments are conducted in their terms. Comparing the price directly against comparable uncontrolled transactions is the most reliable and needs a genuine comparable, which frequently does not exist. Resale price and cost plus methods work backwards or forwards from an observed price by applying a margin drawn from independent companies doing similar work. The transactional net margin method compares overall profitability against a set of independent comparables and is the most widely used in practice. Profit split allocates combined profit between the parties by their relative contributions, which suits genuinely integrated operations.

Pressure on the system produced a substantial international response over the last decade. An international project agreed measures requiring large groups to report revenue, profit, tax and employees country by country to tax authorities, which makes mismatches between where profit is booked and where activity happens visible for the first time. Rules on intangibles now allocate returns towards where the people making decisions about them actually are, rather than where the paper ownership sits. A global minimum tax rate agreed by a large number of countries and applying from 2024 reduces the benefit of moving profit to very low tax jurisdictions, since the difference is topped up elsewhere.

Entities within one group trade constantly and every transfer needs a price, which is revenue to one side and a cost to the other, so the price chosen decides which country's tax base holds the profit. The rule requires pricing as between unrelated parties, which is hard to apply to unique brands and components with no market price. Country by country reporting and a global minimum rate have narrowed the gap.