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Transfer Pricing

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Introduction to Transfer Pricing

Transactions between two companies of the same group separately will not be subject to the same market forces affecting work between the two independent companies. For example, the price at which a good or service is transferred from a subsidiary to a controlling entity will be inconsistent and determined by management. However, the price of the goods or services transferred between the two private companies will be determined by the market, depending on the competition. A lower or excessive balance of activity that occurs between two businesses of the same group could result in a loss of revenue for the State. Therefore, the concept of transfer price has been used to ensure that all commercial activities between the various MNCs are carried out at an arm-length price.

Transfer Pricing Objectives

The key objectives after having a transfer price are:

Generating different benefits for each phase and allowing performance evaluation for each phase separately.

Transfer prices will not only affect the reported profit of the entire institution but will also affect the provision of company services (Expenses incurred by one institution will be considered as utilities).

Importance of Transfer Price

For accounting and reporting, multinational corporations (MNCs) have several options while defining how to distribute profits and costs to foreign companies located in various countries. Sometimes a subsidiary company may be categorized or classified as a private entity. In these cases, price transfers help to distribute revenue and expenditure to such subsidiaries in an efficient manner.

The profits of the underlying company depend on the prices at which the transaction takes place within the company. These days’ transactions between companies are subject to further government scrutiny. Here, when transfer rates are applied, they can affect shareholder wealth as this affects the company's tax revenue and its after-tax income, free cash flow.

A business with cross-border operational activities must understand the concept of transfer price, especially in terms of legal compliance requirements, and eliminate the risk of non-compliance.

Ways to Transfer Pricing

The Organization for Economic Co-operation and Development (OECD) guidelines discuss transaction pricing mechanisms that may be used to assess the long-term price of weapons for controlled operations.

Here, the length of the arm length refers to the amount used or proposed, or charged when unrelated persons engage in the same activities in an uncontrolled manner. The following are the three most commonly used transfer price methods.

Cost Plus Method

Comparable Uncontrolled Price method

Resale Price method

For understanding, related entities refer to a business that directly or indirectly participates in the management or finance, or control of another business.

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FAQs on Transfer Pricing

Associated Enterprise is any company that participates directly or indirectly or through one or more consultants in the management or control, or other company in terms of the Act. If a company has a voting share of 26% or more in another business, it will be considered a Joint Company. Therefore, the term refers to entities that are under common ownership, management, or control.

If there is an international transaction between two related businesses, the transfer price rules apply. Functions covered under the transfer price policy include the purchase, sale, or lease of tangible or intangible assets, the provision of services, loans or mortgages, a cost-sharing system, or any other transaction, which contributes to profit, income, or loss of enterprise goods.
If such a transaction occurs between affiliated businesses, the revenue from the transaction should be calculated by taking into account the length of the arm.

Arm’s length price is the price at which private parties charge under uncontrollable conditions. An uncontrolled condition is a transaction that takes place between two independent entities under the free market power. Therefore, international transactions between two related businesses should take place at arm-length prices.

The following are some of the accepted ways to calculate the arm length:
  • Comparable Price Comparison method
  • Resale Price Method
  • Cost Plus Method
  • How to split profit method
  • Transaction Net Margin method
  • Alternatives as determined by CBDT

Every business that enters into international trade and related business is required to maintain and maintain documents and information related to employment. In addition, businesses that enter into international service during the past year are required to obtain a report from the trustees and submit it together with the income tax return.

Any person who has been involved in international trade for the past year will submit a report to Form 3CEB using a Chartered Accountant, certified by him or her, on or before the date determined by the official, providing all the required information.

Profitability is a form of income, there is no escaping the application of transfer rules to determine capital gains, so that a clear consideration can be drawn if such a legal transfer value exceeds the value of the transaction.

Importing raw materials, semi-finished goods for integration and most importantly, intellectual property such as knowledge and technology are areas that tend to transfer prices. Such goods or services may be exported to companies affiliated to India at a higher or lower price than those charged by unrelated persons in order to protect the profits of international taxes.
In the age of high technology, Indian companies tend to rely on technology and knowledge from their partners in a foreign joint venture: so strict rules are very important.

The consequences of disobeying Indian transfer rules are as follows
  • Case of under-reporting or non-reporting of income: Amount equal to 50% of the amount of tax payable for misreported income Amount equal to 200% of the amount of tax payable on under reporting income where the reported low income is the result of any inaccurate reporting

The entity is required to comply with the transfer price rules in which: The taxpayer has enter into international trade or a particular domestic business (within India) by associated business outside of India, (international service) or within India (of a particular domestic transaction).