Final answer:
Transfer pricing can be used to reduce the amount of withholding taxes paid to a government on dividends remitted to a foreign stockholder by manipulating the prices at which goods and services are transferred between different subsidiaries of a multinational corporation.
Step-by-step explanation:
Transfer pricing can be used to reduce the amount of withholding taxes paid to a government on dividends remitted to a foreign stockholder by manipulating the prices at which goods and services are transferred between different subsidiaries or divisions of a multinational corporation. By setting artificially low prices for goods or services sold to a subsidiary in a high-tax jurisdiction, the company can reduce its taxable profits in that jurisdiction and therefore reduce the amount of withholding taxes paid. The subsidiary in the low-tax jurisdiction can then sell the goods or services at a higher price, allowing it to generate higher profits and pay lower taxes.
For example, let's say a multinational company has a subsidiary in a high-tax jurisdiction (Country A) and a subsidiary in a low-tax jurisdiction (Country B). The company can artificially lower the price of goods or services sold by the subsidiary in Country A to the subsidiary in Country B. This reduces the taxable profits in Country A and therefore reduces the amount of withholding taxes paid on dividends remitted to the foreign stockholder. The subsidiary in Country B can then sell the goods or services at a higher price, generating higher profits and paying lower taxes.
It's important to note that while transfer pricing can be used to reduce withholding taxes, there are regulations in place to prevent abusive transfer pricing practices. Tax authorities have guidelines and rules to ensure that transfer prices are set at fair market value, and companies can face penalties if they engage in transfer pricing that is not in line with these guidelines.