Transfer pricing has to do with the allocation of income among parties controlled by the same persons (controlled parties) that engage in transactions with each other (controlled transactions). In the international context where controlled parties may operate in different countries with different tax burdens, the concern is that the controlled parties may shift income from a higher-taxed country from a lower-taxed country. Here’s a simple example:
Here ProdCo and WidgCo are controlled parties because they are both 100% owned by Owner. And they’re engaged in a controlled transaction, because ProdCo is purchasing Widgets from WidgCo, which ProdCo then incorporates into Product which it sells to consumers for $100 a pop. ProdCo is based out of Country A, which has a 20% income tax rate, while WidgCo is based out Country B with a 10% income tax rate.