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Transfer Pricing
Kim: “I ... don’t understand why it would make sense to pay $450/ton for pulp [to buy internally from Northwestern’s U.S. pulp mills] when I can get it for $330/ton from Chile.”
Ewing: “I understand your motivation for wanting to source the pulp from Chile, but it is important [to buy inside] for the corporation to act as an integrated team.”
Barrett and Slape (2000: 597)
Executive summary
The quote above is an excerpt from a phone conversation between Bill Ewing, the Vice President of Northwestern Paper Company 1, and Arthur Kim, the Director of Northwestern’s South Korean subsidiary. This conversation rises questions on the advantages and disadvantages of utilizing internal transfer prices. Such as: given that some subsidiaries are located in lower tax jurisdictions, would it not be logical to set lower internal transfer prices to those subsidiaries? Would it not be logical to allow the Korean subsidiary to purchase from outside suppliers given that internal transfer prices are much higher than market prices in Chile? Allowing subsidiaries to outsource externally would lead to the bankruptcy of the US subsidiaries, which would not have enough demand for their products? What are the advantages and disadvantages of a reward system based on the allocation of internal consumption? Is the allocation process “fair” to each subsidiary? Is it “fair” to the company as a whole? Questions and doubts on transfer pricing probably haunt not only Mr. Ewing and the Northwestern Paper Company, but more generally all the managers who need to set internal prices for intra-firm flows of goods and services.

Intra-firm trade accounts for about 55% of the international trade between the EU and Japan, 40% of the trade between the EU and the US, and 80% of the trade between Japan and the US (Stewart, 1993). Furthermore, transfer pricing is also a concern for

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