Within the past 5 to 10 years, transfer pricing has become a significant issue to the broader business audience. The popular press often portrays transfer pricing as a practice whereby multinational firms distort profit flows and corporate tax payments. In response to these fears, governments around the world follow the lead of the United States in making transfer pricing audits a strategic priority. Under a high level of scrutiny, establishing appropriate transfer pricing policies is a difficult task. What Is Transfer Pricing? The price that is assumed to have been charged by one part of a company for products and services it provides to another part of the same company, in order to calculate each division's profit and loss separately.
Transfer pricing refers to the price charged for goods and services sold within a
company. Transfer pricing is common among multinational corporations or corporations with multiple subsidiaries. Transfer pricing, or intra company pricing, is the pricing of goods (and sometimes services) to a firm's own subsidiaries and affiliates. Transfer pricing can occur with both domestic and international members of the corporate family
Transfer pricing involves the assignment of costs to transactions for goods and services between related parties. Transfer pricing is typically used for purposes of financial reporting and reporting income to taxing authorities. Transfer pricing is used to set the internal price of goods and services that move between the divisions or business units of a corporation. Transfer pricing is used throughout the corporate world and impacts performance management, cost management and taxation.When multinational firms transfer product across international borders, transfer prices are relevant in the calculation of income taxes, and are sometimes relevant in connection with other international trade and regulatory issues. In today's international market, a large share of world trade consists of transfer of goods, intangibles and services within multinational enterprises (MNEs) - associated companies with bussiness establishments in 2 or more countries. To determine the international tax liability in each jurisdiction, the right
it is important that transfer pricing within a group should approximate those which would be negotiated between independent firms.transfer pricing principle has to be applied.To ensure that the tax base of a multinational enterprise is divided fairly. or to minimise tax.payments from one part of a multinational enterprise for goods or services provided by another . Transfer pricing .may diverge from market prices for reasons of marketing or financial policy.
LAW OF TRANSFER PRICING IN INDIA
. Unfortunately this genuine debate suddenly stopped: the diffusion of Zappa's theories partly explains this phenomenon. mainly theoretic discussion for attaching a value to goods exchanged amongst segments of the same company indicates an early recognition of the potential influence of organizational structure.HISORTY
Transfer pricing: early Italian contributions This paper aims at reviewing the early contributions made by Italian scholars to the field of transfer pricing. 1853) to the birth of Economia Aziendale (in the first half of the twentieth century). this study shows how Italian accountants were familiar with different methods of transfer pricing and elaborated certain original solutions. from the works of Francesco Villa (1840. The intensive. Although this topic has been traditionally overlooked in the Italian accounting literature. coordination and differentiation that may have laid the platform for a greater integration between financial and cost accounting.
The concept of control adopted in the legislation extends not only to control through holding shares or voting power or the power to appoint the management of an enterprise. fair and equitable profits and tax in India in the case of such multinational enterprises. Associated Enterprises ('AEs').1. 2. methods of determining the transfer price and the documentation procedures. and control over various components of the business activity performed by the taxpayer such as control over raw materials. if enterprise B is managed. then Enterprise B is said to be an AE of enterprise A. control or ownership in order to find out association (a) Direct Control (b) Through Intermediary For instance. control or capital(ownership) of one enterprise by another enterprise. It even applies to transactions involving a mere book entry having no apparent financial impact.How Identified? The basic criterion to determine an AE is the participation in management. 2. Accordingly. their was a need to introduce a uniform and internationally accepted mechanism of determining reasonable. Therefore. controlled or owned either directly or through an intermediary. if Mr A and Mr B control both Enterprise A and Enterprise B then both Enterprise A and Enterprise B AEs. SCOPE & APPLICABILITY Transfer Pricing Regulations ("TPR") are applicable to the all enterprises that enter into an 'International Transaction' with an 'Associated Enterprise'. 1961 which guides computation of the transfer price and suggests detailed documentation procedures. INTRODUCTION Increasing participation of multi-national groups in economic activities in India has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same group. The participation may be direct or indirect or through one or more intermediaries. 2001 introduced law of transfer pricing in India through sections 92A to 92F of the Indian Incometax Act. generally it applies to all cross border transactions entered into between associated enterprises. It appears that one may go to any layer of management. The aim is to arrive at the comparable price as available to any unrelated party in open market conditions and is known as the Arm's Length Price ('ALP').
. the Finance Act. Further. Hence. This article aims to provide a brief overview on the applicability of transfer pricing regulations in India. blood relationships. sales and intangibles.1. but also through debt.
For example. intangibles or service transactions within an organization or related parties. FUNCTION Transfer pricing serves an internal function.3. Transfer pricing is used to assign a cost to tangible goods. Transfer pricing's function is to establish agreed upon costs and revenues for the interaction that occurs within a company.
TRANSFER PRICING POLICIES
. Since the business entity that produces the fabric does not formally sell it to the organization that cuts and assembles the fabric. transfer pricing is used to assign a sales price. because when the divisions and business units of a corporation combine their financial statements the internal costs and revenues cancel each other out. a business that manufactures clothing may have one business entity that produces the fabric.
The disadvantage is that the transfer price may not be known until the product is eventually sold to the final customer. Transfer pricing policy dictates the approach taken by the two companies when determining the price for the product or service. Cost-plus Approach Companies who incorporate a transfer pricing policy using a cost-plus approach provide for shipping facilities to recoup the costs and an additional amount to contribute to that site's profits. When the company sells the final product to a customer. The advantage of this policy is that the contribution margin is shared equally among all facilities. it is encouraged to do so. Companies incorporate different transfer pricing policies to achieve different objectives. Each contributing facility determines the cost of the component and applies the same contribution margin percentage to that component. The shipping facility charges the receiving facility the same price it charges customers outside of the organization. Negotiated Transfer Price Using a negotiated transfer pricing policy gives each facility some latitude in determining the price to use for inter-company transfers. The advantage of this policy is that all transactions occur at the higher market price.Transfer pricing represents the price paid from one company to another for a product or service when both are owned and report to the same parent company. the company determines the contribution margin percentage of that product. Contribution Margin Approach Companies who encourage a contribution margin approach to their transfer pricing policy split the contribution margin of the final product with all contributing facilities. The disadvantage is that the shipping facility has no incentive to manage its costs. The receiving facility determines the highest price by researching what it can pay for a similar product outside
. If the receiving company is able to obtain the same product or service at a cheaper price outside of the organization. The shipping facility calculates its costs and adds a predetermined percentage to that cost. The disadvantage of this policy is that the company loses control over quality when purchasing from outside the company. allowing the company to maximize profits. The advantage of this policy is that the calculation is simple to do. The shipping facility determines the lowest price by calculating its product cost. External Market Price Some companies employ a transfer pricing policy that incorporates the external market price for all inter-company transactions. The cost plus the contribution margin equals the transfer price of the component.
of the company. The advantage of this policy is that both companies feel ownership over the pricing decision.
. The disadvantage is that the control lies with the two managers. not with the parent company. Managers from the two companies meet and negotiate a price in the middle.
The main objective is to take advantage of different tax rates between countries. However. Transfer pricing also is used to evaluate performance of divisions within a company.or undercharging for goods sold between branches at a price determined by the company. by overcharging. enforcement of this rule is complicated. By setting a price for goods in each stage of the production process. usually in different countries. It involves over. A way of measuring that is through transfer pricing. the company can reduce its global tax bill. Tax Savings Imagine a company with two branches. Arm's Length Standard The basic principle of this standard used by most developed countries is that for transactions between branches a company should use market prices. where they are finished and sold. especially when a company has branches in numerous countries. where one makes semi-finished goods in a lowtax country and exports them to a branch in a high-tax country. the transfer price can determine whether managers’ incentives align with the incentives of the overall company and its owners. 1. 3.OBJECTIVES OF TRANSFER PRICING
Companies with dispersed production facilities. By increasing the transfer price and declaring more of its profits in the low-tax country. When divisional managers have the authority to decide whether to buy or sell internally or on the external market.
. Boost Profits By undercharging for goods crossing national borders. use transfer pricing. 4. a company can extract more money from a country with tighter currency outflow restrictions. Conversely. a company can save money on customs duties paid by the branch in the importing country. a company can measure the profitability of each division and decide where to make organizational adjustments. Measure Performance Companies need to know how their individual divisions are performing. 2.
. marketing objectives pricing objectives cost competition
Effective transfer prices are ideally set equal to or lower than those charged by a provider from outside the organization.FACTORS AFFECTING TRANSFER POLICY
There are several factors that affect a company's transfer pricing policies: organization's goals.
Management by exception is possible. subcontracting closing down of a division make or buy decisions etc.
It optimises the allocation of company's financial resources based of the relations performance of various profit center which in turn are influenced by transfer pricing policies.
It helps in co-ordination of divisional objectives in achieving organisational goals. It fosters economic entity and free enterprise system.
Transfer price will act as a check on supplier's prices.divisional competitive spirit.advancement generates high productivity and encouragement to meet the competitive economy. It helps in self. It provides useful information to the top management in making policy decisions like expansion.
It will develop healthy inter.BENEFITS OF TRANSFER PRICING POLICY An ideal transfer pricing policy will benefits the organization in the following ways: Divisional performance evaluation is made easier.
Direct Cost Plus Additional Expenses It is also referred to as cost-plus investment.Arm's-Length Pricing. End-Market Prices. This method calculates transfer prices based on the price an end user would pay. 3. the transfer cost is calculated by dividing all fixed and variable expenses for the production period by the actual number of units produced. but includes a small discount meant to reflect the lack of sales effort and other promotional expenses. such as specialized equipment used for production. but also includes a portion of assets. This method entails computing the direct cost. The arm's-length price is the price at which the company would have sold the product to an unrelated party.METHODS
There are different methods of transfer pricing: 1.
. 4.Actual full cost In this method. 2.
reliability of data necessary for applying a particular method Degree of comparability Extent to which reliable adjustments can be made to account for differences Reliability and extent of assumptions required to be made in applying a method
.MOST APPROPRIATE METHOD
Factors prescribed for selecting most appropriate method: Nature of transaction Functions performed Availability.
most countries have stringent transfer pricing review processes. Nippon Roche. via transfer pricing. when products are produced in different countries or tax jurisdictions. Nippon Roche paid artificially inflated prices for medicines and raw materials for cancer drugs purchased from Roche Holding in order to reduce taxable income in Japan. Repercussions According to The Japan Times. Dishonest companies can use transfer pricing to hide subsidiary profits and taxable income. Legal/Regulatory Issues Transfer pricing makes it possible for an organization to manipulate tax and financial outcomes.
The extensive use of transfer pricing has management. For example. These guidelines allow a wide variety of methods to be used for setting transfer prices. did not report 14 billion yen in taxable income between 1992 and 1995.
. Most countries follow guidelines put forth by the Organisation for Economic Co-operation and Development (OECD). organizations may utilize transfer pricing to assign the greatest profit to tax jurisdictions with the lowest tax rates. Companies often manage transfer pricing in such a way that profits and taxable income are taken in the country with the lowest tax rate. Nippon Roche was ordered to pay 5. Prevention/Solution To prevent businesses from assigning all profit to the lowest tax rate jurisdictions. Switzerland-based Roche Holding.5 billion yen in penalty fines. Often.LEGAL AND GOVERNMENTAL POLICIES GOVERNING PROFIT AND TAXES. while the selling division will have inflated profits. The unreported income was transferred to the firm's parent company. and to avoid paying foreign taxes. When Japanese tax authorities discovered the discrepancy. Unusually high transfer pricing can cause a purchasing division's taxable income to be lower than it might ordinarily be. financial and tax implications for corporations. a Japanese-based pharmaceutical company. low transfer pricing can make a division's financial performance look better than it might be if it had to pay open market prices for its inputs. This is especially common when customs and income taxes are high.
The transfer pricing method chosen by the company may result in the company paying more taxes overall. specific transfer pricing methods can result in lower taxation rates overall.TAX IMPLICATIONS OF TRANSFER PRICING
Multinational corporations can face serious tax implications if transfer pricing is not executed properly. import tariffs are tax deductible in the United States. referred to as a transfer pricing method. If the host country offers lower tax rates. Government Preferences Transfer pricing methods impact whether the home or host government receives the lion's share of the tax revenue. or taxpayers may be required to conduct such testing themselves in advance or filing tax returns. Tariffs and Duty Taxes Goods transferred from one country to another can incur tariffs and duty taxes depending on the country of origin. Such testing requires a determination of how the testing must be conducted. However. Double Taxation Corporations will be taxed by both the host country and the home country for the revenue generated by the good sold. Such testing may occur only on examination of tax returns by the tax authority.
Testing of prices
Tax authorities generally examine prices actually charged between related parties to determine whether adjustments are appropriate. Such examination is by comparison (testing) of such prices to comparable prices charged among unrelated parties. Transfer pricing has tax implications that should be discussed with a tax adviser. Speak with your tax adviser to determine methods that are best for your company. Tariffs and duties are applied to goods sold within a company as well.
the industry in which the taxpayer operates. Over the past four years. The fact pattern of adjustments indicates that one in every four cases picked-up for audit. In the past couple of years. The list of prescribed documentation in India is an exhaustive one with details relating to the profile of the group.75 million) the case should be compulsorily audited. Losses incurred by routine distributors. Significant changes in the profitability of the taxpayer and its associated enterprises. etc. The Central Board of Taxes in India introduced a special cell of trained officers which is responsible for all transfer pricing audits. This process has led to a large number of cases having selected. Unjustifiably large payment of management charges not passing the ‘benefit test’. is adjusted. and Low mark-ups for services. The TPOs in this short time have clearly been successful in positioning India’s transfer pricing administration as an aggressive one. The Indian transfer pricing regulations mandate a taxpayer entering into international transactions with its overseas affiliates.DOCUMENTATION OF TRANSFER PRICING
The Indian Transfer Pricing Regulations came into force in 2001 with the transfer pricing audits effectively beginning from 2003. a description of the functional profile of the taxpayer. It is important that a taxpayer regularly monitors and regulates its transfer prices to survive a transfer pricing audit in India. The Indian process of selecting cases for a transfer pricing audit is procedural and apparently does not deal with the qualitative aspects of the case. to maintain specified transfer pricing documentation and information. vide an instruction. which does not leave the TPOs with adequate time to scrutinise the case.25 million (now stands revised at $3. the TPOs have made significant adjustments. notified that should the value of its transaction exceeds $1. there has been a significant increase in the number of transfer pricing audit officers (TPOs). The typical scenarios which would attract the attention of the TPOs for a transfer pricing audit would be: Consistent losses of the taxpayer attributable to inter-company transactions. The economic analysis is
. The documentation maintained by the taxpayer must also include a detailed economic analysis which would be the basis to conclude that the taxpayer’s transactions are at arm’s length. The Board of Taxes has.
It also becomes imperative for a taxpayer to regularly update the information and documentation so that the true and accurate business reality of the taxpayer is reflected in the documentation. the taxpayer must deploy the right resources for a transfer pricing audit. Further. the taxpayer must take a firm stance and must clearly put his case forward to the TPO.the critical part of a transfer pricing documentation which would be the basis of defending the transfer pricing policy of a taxpayer. It is also crucial for a taxpayer to not deviate from global policies for pricing of goods and services unless the pricing is not feasible from a business perspective. contract manufacturers. Further.
Establishing control of the audit process
The Indian transfer pricing audit process may become tedious and lengthy at times. Thus there is a need for highlighting the factual peculiarities of the taxpayer’s case and distinguishing oneself from others.g. all reasons for any deviations must be clearly documented and recorded as the same may support the taxpayer during the audit process. strategies and market positioning. the former can really take control of the audit process.
. A clear approach in a transfer pricing audit is very important because the Indian TPOs tend to categorise taxpayers under certain classifications (e. routine distributors. etc. When a taxpayer provides timely and appropriate responses to the TPO with a clear focus on (i) the business reality and (ii) the economic analysis. however it is crucial for the taxpayer to take control of the audit process. including their future business plans. IT service providers.). To take control of the situation. which can drive the audit in the right direction.
. we have to ensure that a simplistic approach to transfer pricing does not create the unintended consequence of taking away a level playing field in some industries. This may involve companies spending resources to establish a robust documentation process. It is.CONCLUSION
Transfer pricing is of relevance to international transactions where inappropriate transfers could result in the loss of tax revenue to one country or another. Any company will always have unique characteristics. Consequently. The implications of transfer pricing can have a substantial impact on the net profits of such companies. Given that it is going to take time for all parties to reach the necessary level of maturity in this area. which. therefore. and so on Almost all large Indian companies either have substantial multinational operations or are themselves associates of foreign multinationals or of their subsidiaries. worthwhile for audit committees to dedicate sufficient time to assess the transfer pricing mechanics of the companies they audit. persuading tax authorities to look at substance over form while assessing transfer pricing structures. the challenge is to ensure that in the interim. neither revenue nor companies are affected adversely. if ignored. could place it at a disadvantage compared with others.
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