A substantial portion of global trade contains transactions between related enterprises in the groups of Multinational Enterprises (MNEs). The transactions between these related or associated enterprises may occur under conditions different from those taking place between independent enterprises. Transfer pricing is a term used for the pricing of such cross-border, inter-group transactions of goods, intangibles, or services including financial services. Transfer pricing is a practice performed which represents the price that one department in a company charges another department for goods and services provided.
The tax administration has introduced several initiatives in the recent past for reducing transfer pricing in India, and some of the initiatives include introducing an advance pricing agreement APS scheme. It consists of safe harbor provisions which utilize the map provision and bilateral tracks treatise to resolve the TB disputes.
Key Objectives of Transfer Pricing
• Generating separate profit for individual divisions, enabling the performance evaluation of each of them individually.
• Transfer prices affect both the reported profits of every centre and the allocation of a company’s resources.
Transactions subject to Transfer Pricing
Some of the typical transactions which are governed by the transfer pricing rules include:
- Sale for the finished goods
- Purchasing raw material
- Purchasing fixed assets
- Sale or purchase of machinery
- Sale or purchase of Intangibles.
- IT Enabled Services
- Support services
- Software Development services
- Transfer Pricing Methodologies
The OECD guidelines (The Organisation for Economic Co-operation and Development) address the transfer pricing in India, which can be used for surveying the arm’s-length price of the controlled transactions. Here, arms-length price means the price applied when unrelated parties enter into the same transactions in an uncontrollable situation.
The general condition of the economic transfer price service is that the minimum cost must be more than or equal to the selling division’s marginal cost.
Transfer Pricing Methodologies
These are the three most commonly used transfer pricing methodologies:
1. Comparable Uncontrolled Price (CUP) Method: Under this method, a price charged in an uncontrolled transaction between some good firms are recognised and calculated with a verified entity price to decide the arm’s length price.
Adjustments are required for some differences in:
• Quantity discount – If some companies offer the same discount, the price will be lower by INR 500/MT.
• Freight & Insurance – In this case, the cost must be reduced by the original purchase price.
• Credit period – Here credit offered by some company, the price charged by them would be more after factoring such cost. Hence, 1.25% pm is added to the purchase price.
This method is quite reliable, and it is a direct way of applying the arm’s-length principle and determining the prices for related party transactions.
2. Resale Price Method or Resale Minus Method – In this method, the prices at which the given enterprise sells its product to a third party are considered. This price is called the resale price. The gross margin determined by comparing gross margin in the uncontrolled transaction is then reduced from the given sale. After this, the cost associated with the purchase of such a product is deducted. The remaining cost is the arm’s-length price between the associated enterprises.
3. Cost Plus Method – With this method, we can pay attention to the suppliers’ costs or services in the controlled type of transactions. While viewing the costs, a mark-up should be added. This mark-up reflects the profit for the given enterprise based on risks and the functioning of the performance. It helps determine the arm’s-length price. Generally, this method’s mark-up is evaluated after direct and indirect cost related production or supply is done.
With the speed at which globalization is affecting the business world and how the countries are competing with each other for investments in foreign countries, it is safe to conclude that the world of transfer pricing will get interesting by the day. It is also visible that the regulators are also evolving, as there is a clear picture of intent to simplify the processes. However, only time will tell if we can keep pace with the business world’s dynamic changes.