The role of exchange rates in transfer pricing: How to maximise profitability
Sophie Grosvenor September 18th 2023 - 3 minute read
Companies that operate on the global stage are often aware of currency risks when dealing with buyers, suppliers and customers overseas.
However, a critical aspect often escapes the spotlight – the profound impact of exchange rates on transfer pricing within international organisations.
In this article we look at some typical examples of transfer pricing to highlight why having a currency strategy is vital for maximising profits and minimising risk.
What is transfer pricing?
Transfer pricing is the practice of charging for goods and services across companies that have some connection. The firms may be part of the same larger group or network of subsidiaries, or they may be affiliated in some other way.
The practice can be complex, as companies need to consider how transfer pricing impacts all the parties involved while also navigating tax laws across multiple countries.
Currency volatility can complicate things further, but fortunately there are ways that businesses can protect transfer pricing transactions from shifting exchange rates.
Transfer pricing and foreign exchange
There are lots of different scenarios in which the currency market can impact transfer pricing strategies.
For example, a manufacturing company in the US may sell components to a UK subsidiary. The UK division pays in pounds, which the parent company needs to exchange into US dollars. The parent company needs to set fair transfer prices, while ensuring that currency volatility doesn’t negatively impact either division.
Likewise, an offshore IT service centre based in India might serve a company’s offices around the world. The company will need to account for currency volatility to make sure that branches based in different countries pay similar amounts, without the service centre being under- or overpaid.
Other instances might include an intercompany loan, royalty payments from subsidiaries for intellectual property, or cost-sharing agreements across different international divisions.
The impacts of currency volatility
As with any transactions involving multiple currencies, shifting exchange rates can have a significant impact on the value of a transfer.
For instance, if the GBP/USD exchange rate drops from $1.28 to $1.25, as can happen in a matter of weeks, a charge of $100,000 would cost £3,000 more. If a UK subsidiary was paying its US parent in British pounds, this £3,000 would need to be accounted for. Would the UK firm have to fork out the extra money? Or would the parent company take the hit?
Shifts in exchange rates can also wreak havoc on budgets. Even if a company is able to balance the changing costs of transfer pricing in a practical way, the potential for huge shifts month over month can make it hard for all parties involved to plan ahead.
Instead, companies can use a forward contract to fix an exchange rate for up to a year. Although they won’t benefit if the rate improves, they will be protected from any unfavourable shifts.
This means a stable, predictable cashflow, making it much easier to budget effectively. And, if the rate is fixed at a time of relative strength, it could help the business maximise profits.
Working with Currencies Direct
If you think your business would benefit from having an FX strategy, it’s best to work with a specialist broker.
Staying up to date with what’s happening in the currency markets is crucial to making good FX decisions, and working with a provider that can offer you regular updates and market insights helps you keep on top of recent trends with minimal effort.
Here at Currencies Direct, we pride ourselves on offering an unrivalled high-touch service tailored to our customers. We take the time to understand your business inside and out so that we can develop a comprehensive currency strategy based on your unique needs.
We’ll then help you execute the plan, providing performance evaluations and expert insights. This way, we can gauge how well the strategy is working and adjust the course in line with market developments and the changing needs of your business.
We also offer excellent exchange rates, a range of transfer tools, and streamlined payment processes, to drive cost efficiencies and protect your bottom line.
If you want to find out more about how we can help you, get in touch.