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
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.
- Comparable Price Comparison method
- Resale Price Method
- Cost Plus Method
- How to split profit method
- Transaction Net Margin method
- Alternatives as determined by CBDT
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.
- 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