Transfer Pricing Guidelines for an Optimum Transfer Pricing Mechanism:

If market prices are used as a base for evolving transfer prices through
negotiations, long run competitive market prices should be used. When a
competitive market exists for an intermediate product, the market price should be
used as the transfer price. When cost based transfer prices are used standard costs,
and not actual costs, per unit of output should be used. If divisional managers are
allowed to buy / sell a small quantity (5-10 per cent) outside the company, it gives
them an awareness of the supply and demand conditions of the market, which
facilitates negotiation of transfer prices by them.
Managers at different levels in a firm attempt to achieve different objectives
through their transfer pricing policies.
Corporate managers want transfer prices to: Encourage division managers to make
decisions that maximize the long-run profitability of the overall firm
Provide information so that managers can make good short term decisions (such as
bids for orders) and long term decisions (such as adding or deleting product lines)
Division Managers want Transfer Prices to: Represent fairly the financial
performance of their division Reflect the impact of good decisions with in their
division
Financial Staffs want Transfer Prices that: Are simple and credible, so that they
will be used and useful by managers Are easy to use and easy to explain

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1. Transfer Pricing International Marketing Overview

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2. Transfer Pricing is Big News! <ul><li>Current surveys would indicate that transfer pricing is one of
the most important international tax issue facing multinational enterprises (MNEs)
</li></ul><ul><li>MNE s managers indicate that audit s by tax authorities are becoming a rule, rather
than an exception. </li></ul><ul><li>In the last two years more fiscal government authorities have
taken action on transfer pricing. </li></ul>
3. What is Transfer Pricing? <ul><li>Transfer pricing is a term used to describe aspects of
intercompany pricing arrangements between related business entities and commonly applies to
intercompany transfers tangible property, intangible property services and finance transfers.
</li></ul><ul><li>Intercompany transactions across borders are growing rapidly and becoming more
complex. </li></ul>
4. Objectives of Transfer Pricing <ul><li>Competitiveness in the international marketplace
</li></ul><ul><li>Reduction of taxes and tariffs </li></ul><ul><li>Management of cash flows
</li></ul><ul><li>Minimization of foreign exchange risks </li></ul><ul><li>Avoidance of conflicts with
home and host governments over tax issues and repatriation of profits </li></ul><ul><li>Internal
concerns - goal congruence or subsidiary manager motivation </li></ul>
5. Transfer Pricing <ul><li>The price that is assumed to have been charged by one part of the
company for products and services it provides to another part of the company, In order to calculate
each divisions product and loss separately. </li></ul>The Parent Corporation Subsidiary B Latin
America Subsidiary A North America Subsidiary C Africa $$$ $$$
6. Transfer Pricing Methods <ul><li>Market-based transfer price: In the presence of competitive and
stable external markets for the transferred product, many firms use the external market price as the
transfer price. </li></ul><ul><li>Cost-based transfer price: The transfer price is based on the
production cost of the upstream division. A cost-based transfer price requires that the following criteria
be specified: </li></ul><ul><ul><li>Actual cost or budgeted (standard) cost.
</li></ul></ul><ul><ul><li>Full cost or variable cost. </li></ul></ul><ul><ul><li>The amount of markup, if any, to allow the upstream division to earn a profit on the transferred product.
</li></ul></ul><ul><li>Negotiated transfer price: Senior management does not specify the transfer
price. Rather, divisional managers negotiate a mutually-agreeable price. </li></ul>
7. Figure 1.0 Hiding Profits with Transfer Pricing GREAT BRITAIN JAMAICA UNITED STATES An item
costs $100 to produce. It is sold to a Jamaican subsidiary for $100. Tax rate: 52% Tax paid: $0 The
Jamaican subsidiary resells the item for $200 to a U.S subsidiary. Tax rate: 5% Tax paid: $5 The
American subsidiary sells the item at a cost for $200. No profits earned. No tax paid. Tax rate: 34% Tax
paid: $0
8. Benefits of Transfer Pricing 2. Reducing income taxes in high-tax countries by overpricing goods
transferred to units in such countries; profits are eliminated and shifted to low-tax countries 1. Lowering
duty costs by shipping goods into high-tariff countries at minimal transfer prices so that duty base and
duty are low 3. Facilitating dividend repatriation when dividend repatriation is curtailed by government
policy by inflating prices of goods transferred
9. Challenges of Transfer Pricing <ul><li>Internal and external problems for the multinational
corporation </li></ul><ul><ul><li>Performance Measurement </li></ul></ul><ul><ul><ul><li>The
clouding effect of manipulating intra corporate prices on a subsidiarys apparent and actual profit
performance </li></ul></ul></ul><ul><ul><ul><li>Difficulty in maintaining relationships with
subsidiaries that are negatively impacted by transfer pricing. </li></ul></ul></ul><ul><ul><li>Taxation
</li></ul></ul><ul><ul><ul><li>Tax and regulatory jurisdictions contribute to and compound transfer
pricing problems. Pricing that is justified and reasonable in the home country may not be perceived as
such in the host country. </li></ul></ul></ul>

10.Transfer Pricing Mechanism in Banks

11. there has been a marked shift in the measures used for evaluating the bank
branches. From deposit mobilization criterion the emphasis is now being
turned on to the profits made by the bank branches. When the concept of
profit centers is being applied the significance of the methodology involved
in ascertaining the profits gains prominence for the management control
system. Transfer price, in the context of banking sector, is the interest
charged by the surplus funds branch to the deficit funds branch on the
transferred funds. Though branches are identified to be of deposit intensive,
advances intensive and ancillary business intensive for administrative
convenience there are other material factors like the location, size, and the
nature of clientele that impinges on the performance of the branches. Profit
is the most commonly acceptable measure for evaluation of Branch
performance. To what extent profit is a good indicator of viability of the
branches depends upon how independent the branches are in the commercial
sense. As the branches of a Bank, in reality, are not truly and entirely
independent commercial units, it is difficult to determine the real
profitability of such branches with the help of existing systems that are less
transparent, less accurate and having weak linkage with the overall costing
and pricing structure of business/products. In the light of the above, the
present study probes into various modalities of Transfer Pricing Systems and
suggests a suitable mechanism so as to reflect the true profitability,
productivity and efficiency of the Branches.
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13.The bank branches are identified into two:

14. 1. Deposit oriented Majority of bank branches comes under this category.
Though 80% of branches are acting as deposit-pooling centers all branches
are not uniform in terms of deposit mix. It is a fact that the deposit mix is
favorable (low cost deposits) with respect to Metro/Urban branches where as
depositors of Rural and Semi-urban branches tend to keep their deposits in
Term deposits. This has effect on branch profitability.
15.2. Advance oriented Though the branches are independent units in terms of
accepting deposits and lending funds, the CD ratio is below 25% in many of
the bank branches. It speaks that the lending activity is considered as
centralized activity and the lending of top 10% branches constitutes 80% of
lending. However, all lending branches are not uniform in terms of yield on
advances since it depends on sectoral deployment and quality of lending.
Obviously, the yield on advances at Metro/Urban branches is higher when
compared to rural and Semi-Urban branches.
16.The direct and indirect costs of production incurred by the enterprise in
respect of property transferred or services provided to an associated
enterprise, are determined. The amount of a normal gross profit mark-up to
such costs (computed according to the same accounting norms) arising from
the transfer or provision of the same or similar property or services by the
enterprise, or by an unrelated enterprise, in a comparable uncontrolled
transaction, or a number of such transactions, is determined. The normal
gross profit mark-up referred to in sub-clause (ii) is adjusted to take into
account the functional and other differences, if any, between the
international transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which could
materially affect such profit mark-up in the open market; The costs
referred to in sub-clause (i) are increased by the adjusted profit mark-up

arrived at under sub-clause (iii) The sum so arrived at is taken to be an arm's

length price in relation to the supply of the property or provision of services
by the enterprise.
17.
18.b) Resale price method (RPM): The price at which property purchased or
services obtained by the enterprise from an associated enterprise is resold or
are provided to an unrelated enterprise is identified; Such resale price is
reduced by the amount of a normal gross profit margin accruing to the
enterprise or to an unrelated enterprise from the purchase and resale of the
same or similar property or from obtaining and providing the same or similar
services, in a comparable uncontrolled transaction, or a number of such
transactions;
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22.The price so arrived at is further reduced by the expenses incurred by the
enterprise in connection with the purchase of property or obtaining of
services; The price so arrived at is adjusted to take into account the
functional accounting and other differences, if any, including the differences
in practices, between international
23.transaction and the comparable uncontrolled transactions, or between the
enterprises entering into such transactions, which could materially affect the
amount of gross profit margin in the open market; The adjusted price
arrived at under sub-clause (iv) is taken to be an arm's length price in respect
of the purchase of the property or obtaining of the services by the enterprise
from the associated enterprise.
24. c) Cost plus method (CPM):
25.
26.d) Profit split method (PSM): The Indian Regulations define PSM, which
may be applicable mainly in international transactions involving transfer of
unique intangibles or in multiple international transactions which are so
interrelated that they cannot be evaluated separately for the purpose of
determining the arm's length price of any one transaction, as follows: The
combined net profit of the associated enterprises arising from the
international transaction, in which they are engaged, is determined; The
relative contribution made by each of the associated enterprises to the
earning of such combined net profit, is then evaluated on the basis of the
functions performed, assets employed or to be employed and risks assumed
by each enterprise and on the basis of reliable external market data which
indicates how such contribution would be evaluated by unrelated enterprises
performing comparable functions in similar circumstances;
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28.The combined net profit is then split amongst the enterprises in proportion
to their relative contributions, as evaluated under sub-clause (ii); The profit
thus apportioned to the assessee is taken into account to arrive at an arm's
length price in relation to the international transaction:
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30.Provided that the combined net profit referred to in sub-clause (i) may, in the
first instance, be partially allocated to each enterprise so as to provide it with
a basic return appropriate for the type of international transaction in which it
is engaged, with reference to market returns achieved for similar types of
transactions by independent enterprises, and thereafter, the residual net profit
remaining after such allocation may be split amongst the enterprises in
proportion to their relative contribution in the manner specified under subclauses (ii) and (iii), and in such a case the aggregate of the net profit
allocated to the enterprise in the first instance together with the residual net
profit apportioned to that enterprise on the basis of its relative contribution
shall be taken to be the net profit arising to that enterprise from the
international transaction. This method evaluates whether the allocation of
the combined profit or loss attributable to one or more controlled
transactions in arms length. This method is applied where each party to the
transaction has significant intangible assets or operations are integrated and
cannot be separately evaluated.
31.
32.e) Transactional net margin method (TNM): The net profit margin
realised by the enterprise from an international transaction entered into with
an associated enterprise is computed in relation to costs incurred or sales
affected or assets employed or to be employed by the enterprise or having
regard to any other relevant base; The net profit margin realised by the
enterprise or by an unrelated enterprise from a comparable uncontrolled

transaction or a number of such transactions is computed having regard to

the same base;
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36.The net profit margin referred to in sub-clause (ii) arising in comparable
uncontrolled transactions is adjusted to take into account the differences, if
any, between the international transaction and the comparable uncontrolled
transactions, or between the enterprises entering into such transactions,
which could materially affect the amount of net profit margin in the open
market; The net profit margin realised by the enterprise and referred to in
sub-clause (i) is established to be the same as the net profit margin referred
to in sub-clause (iii); The net profit margin thus established is then taken into
account to arrive at an arm's length price in relation to the international
transaction.
37.
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39.The transactional net margin method (TNMM) assesses the arms length
character of transfer prices in a controlled transaction by testing the profit
results of one participant in the transaction. f) Such other method as may be
prescribed by the Board.
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41.The taxpayer can select the most appropriate method to be applied to any
given transaction, but such selection has to be made taking into account the
factors prescribed in the Rules. With a view to allow a degree of flexibility
in adopting an arms length price the provison to sub-section (2) of
section 92C provides that where the most appropriate method results in more
than one price, a price which differs from the arithmetical mean by an
amount not exceeding five percent of such mean may be taken to be the
arms length price, at the option of the assessee.