Transfer Pricing

Team Members:
 Introduction:
Determination of exchange price when different business
units within a firm exchange the products and services
Commercial transactions between the different parts of the
multinational groups may not be subject to the same market forces
shaping relations between the two independent firms. One party
transfers to another goods or services, for a price. That price is known
as “transfer price”. 

Definition:
As per section 92 (1) of the Income Tax Act, 1961 –
Income from an international transaction shall be
computed having regard to the Arm’s length Price
(correct market price).
Uses of Transfer Pricing:
When product is transferred between profit centers or investment centers
within a decentralized firm, transfer prices are necessary to calculate
divisional profits, which then affect divisional performance evaluation

The objective is to achieve goal congruence, in which divisional managers

will want to transfer product when doing so maximizes consolidated
corporate profits, and at lest one managers will refuse the transfer when
transferring product is not the profit-maximizing strategy for the company

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.
 Explanation of Transfer Pricing
Transfer pricing is the process of setting transfer prices between associated
enterprises or related parties where at least one of the related parties is a
non-resident. Transfer Price is the price at which an enterprise transfers
goods and services, intangible and intangible assets, services or lending/
borrowing money to associated enterprises. Transfer prices are generally
decided prior to entering the transaction and they are audited/ reviewed
by the auditor after the year finalization. 

Example: 
In the example, we see that ABC (India)
and ABC (UK) are related parties or
associated enterprises while XYZ is an
independent enterprise. It is expected that
the prices at which ABC (India) deals with
ABC (UK) are expected to be at par with
the price at which it deals with XYZ i.e.
the fact that ABC(India) and ABC(UK) are
related parties should not have any
influence on the price at which transfers
take place between them.
Transfer Pricing Model In India
India is rapidly growing using its own model of TP rules and also
observing the OECD TP Guidelines.
There are so many new concepts have come up in treating the
“ Reimbursements , Interest income, deemed international transactions
, sale of shares, loans received/ paid , corporate guarantees etc., at Arm’s
Length Standard.
In fact, OECD is also agreed that India is fast developing country on
transfer pricing and OECD itself learning the rules/concepts framed by
Indian Revenue Authorities.
India is successful in implementing the Transfer Pricing laws in the
country achieving its targets.
India is following its own model of Transfer Pricing under the Income-
tax Act and IT Rules and India is an observer of OECD Model of
convention on Transfer Pricing. India is a non-member in OECD
(Organization for Economic Cooperation and Development).
Every country is following its own TP model but most of the countries
are following OECD model of convention on Transfer Pricing
Some Transactions subject to
ALP(Arm’s Length Price)
• Purchase at little or no cost.
• Payment for services never rendered.
• Sales below MP/ Purchase above MP
• Interest free borrowings

• Exchanging property
• Selling of real estate at a price different from MP
• Use of trade names or patents at exorbitant rates
even after their expiry.
Transfer Price Regulation
International National (India)

o OECD formulated o The Finance Act 2001

“Guidelines on transfer introduced the detailed TPR
pricing”. They serve as w. e. f. April 1, 2001
generally accepted

o Practices by the tax o The Income Tax Act

authorities
Income Tax Act 1961
Section 92: 92.Computation of income from international transaction
having regard to arm’s length price.  (ALP)

Section 92 A: Meaning of associated enterprise

Section 92 B: Meaning of international transaction
Section 92 C: Computation of arm’s length price

Section 92 D: keeping of information and document by persons entering

into an international transaction

Section 92 E: Report from an accountant to be furnished by persons enter­ing

into international transaction

Section 92 F: Definitions of certain terms relevant to computation of arm’s

length price, etc
Penal Provisions
o Non submission of information/Records :
2% of the transaction value (u/s 271G)
o Non submission of Report u/s 92E :
Rs. 1 lakh (u/s 271BA)
o Non Maintenance of Records :
2% of the transaction value (u/s 271AA)

o Penalty 100% to 300% of the tax on disputed income

o Addition / Disallowance u/s 92C(4) is deemed to be income concealed u/s

271(1)(c)

Above penalty need not be levied if reasonable cause for

failure is proved u/s 273B
Methods of Transfer Pricing:
Comparable uncontrolled price method
 CUP method compares the price transferred in a controlled transaction to the
price charged in a comparable un-controlled transaction.
 CUP method is the most direct and reliable way to apply the arm’s length
principle.

Resale price method

 The resale price method begins with the price at which a product is resold
to an independent enterprise (IE)by an associate enterprise.
 X sold to AE at Rs. 1000 (profit: 300)
 AE sold to an IE at Rs. 2000 (profit of Rs. 500 for relevant IE)
 Arms length price = 2000 - 500 = 1500
Profit Split Method
 PSM is used when transactions are inter-related and is not possible to
evaluate separately.
 PSM first identifies the profit to be split for the AE. The profit so
determined is split between the AE on the basis of the functions
performed/assets/CE

Cost Plus Method

 In CP method, first the cost incurred is determined. An appropriate cost
plus mark-up is then added to the cost to arrive at an appropriate profit.
The resultant figure is the arm’s length price.
 Methods of Transfer Pricing:

• Variable Cost Method

Transfer price = variable cost of selling unit + markup

• Full Cost Method

Transfer price = Variable Cost + allocated fixed cost

• Market Price Method

Transfer price = current price for the selling unit’s in the market

• Negotiated Price Method

Why Did TEVA Introduce Transfer Pricing
 Marketing divisions are organized into the US marketing and the local market, and
the rest of the world Responsible for decisions about sales, product mix, pricing
and customer relationships

 Teva reorganized its pharmaceutical operations into 1 operation division (with 4

manufacturing plants) and 3 marketing divisions

 Teva, a multinational pharmaceutical company, solved its transfer pricing

problems by using activity-based costing

 Marketing were evaluated on sales, not profit

 Cost system emphasized variable costs: materials expenses and direct labor. All
other costs were considered fixed

 Manufacturing plants were measured how meeting expense budgets and delivered the
right orders on time

 Decided to introduce transfer pricing system that would enhance profit

consciousness and improve coordination between operations and marketing
Why Traditional Transfer Pricing Method not work
Variable Cost Method
 Covering only ingredients and packaging materials which was inadequate for their
purposes
 Marketing divisions would report extremely high profits because they were being
charged for materials only
 Operations divisions would get credit only for expenses of purchased materials
• No motivation to control labor or other fixed expenses
 Marginal cost transfer price would give the marketing divisions no incentive to shift
their source of supply
 Measuring profits as price less materials cost would continue to allow marketing and
sales decisions to be make without regard to their implications for production capacity
and long-run costs and overall company profitability

Full cost Method

Overhead did not capture the actual cost structure in Teva’s plant

Market Price Method

No market existed for manufactured and packaged products that had not been
distributed or marketed to customers

Negotiated price method

Would lead to endless arguments
Strategic Factors of Transfer Pricing
1. International Transfer Pricing Consideration
 Tax Rate- minimize taxes locally as well
internationally
 Exchange Rate
 Custom Charges
 Risk of expropriation
 Currency Restriction

2. Strategic relationship
 Assist bayside division to grow
 Gain entrance in the new country
 Supplier’s quality or name
Case Study 1: Transfer Pricing Restructuring
A Client wished to
(India/Europe)
establish a single global
production facility in
India

The global nature of this transfer

pricing project required us to develop
solutions for manufacturing,

TP
distribution and margin changes among
three separately-managed regions.

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