Transfer Pricing

What Is Transfer Pricing?

Transfer pricing accounts for the prices

As per the Section 92E of the Income Tax Act, transfer pricing is the actual price charged in a transaction between related entities which are part of the same Multi National Enterprises (MNE) group. The tax rates vary from country to country. So, there is incentive for the MNE group to set transfer prices for transactions between its group members such that tax liability for the group as a whole is minimised.

How Does Transfer Pricing Work?

Transfer pricing is mainly used by multinational corporations to set prices for goods, services, or intellectual property that are exchanged between their subsidiaries. The main goal is to set prices to ensure that profits are tax-free and that companies do not have to bear the burden of paying unnecessary taxes. Transfer pricing also allows companies to remain compliant during a tax audit.

Benefits & Importance of Transfer Pricing

Tax benefits: Transfer pricing offers multiple tax benefits to companies. This keeps the company's finances in order at all times.

Lower tax rates: Transfer prices ensure profits for products and services with a lower tax rate.

Avoid high tariffs: You will be able to move resources from one country to another conveniently and avoid high tariffs on the same.

Avoid tax liabilities: With transfer pricing, you can avoid tax liability and carry out transactions hassle-free.

Transfer Pricing Methodologies

• Comparable Uncontrolled Price (CUP) Method:

The CUP method is employed to contrast the prices charged for comparable items or services in regulated and uncontrolled transactions.

• Cost Plus Method:

To calculate the transfer pricing in international business using the cost plus method, the cost of the goods and services is increased by a specific profit margin.

• Resale Price Method:

The Resale Price Method involves marking up the resale price of the good or service to calculate the transfer price.

• Transactional Net Margin Method (TNMM):

TNMM can be used to compare the net profit margin earned by a related entity in a controlled transaction with the net profit margin earned by comparable independent entities in similar transactions.

Safe Harbour Guidelines

As described by the Indian Income Tax Law (ITL), a safe harbour refers to a situation under which the tax authorities will accept the transfer price declared by the taxpayer.Safe harbour guidelines refer to the rules that provide taxpayers with certainty in setting transfer prices. These rules help relieve taxpayers from various obligations under the general transfer pricing rules.

Domestic And International Transfer Pricing

Domestic transfer pricing involves setting prices for goods and products for transactions between entities in the same country, while international transfer pricing extends this concept to transactions held between entities in different countries. Domestic transfer pricing allows you to remain compliant with domestic tax laws, while international transfer pricing helps navigate the complexities of international tax regulations.

Penalties For Non-Compliance

Non-compliance with transfer pricing guidelines can cause you to pay heavy penalties. The penalties are laid down under Section 270A of the Income Tax Act. Some of the penalties have been listed below:

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TDS on purchase of goods above 50 Lakhs: Implications Section 194Q of Income Tax Act

Landmark Judgments — Related To Transfer Pricing

In the Supreme Court case of Morgan Stanley (2023), a judgment was passed stating that transfer pricing is applicable to all transactions between related companies, regardless of whether they are intra-group or inter-group transactions.

Purpose of Transfer Pricing

The main purpose of transfer pricing is to allow companies to generate profits for all their departments. It also allows the business owners to save themselves from tax liabilities and allocate resources to the required sections of the company. Transfer pricing also plays a big role in allowing companies to save themselves from paying heavy taxes on their profits.

Need Of Transfer Pricing In Modern Businesses

Transfer pricing allows modern companies to conduct global operations smoothly and effectively. It allows for a fair allocation of profits between the different segments of the company. Transfer pricing also promotes financial transparency and tax compliance. It allows businesses to strategically allocate funds to different operations and maintain global supply chains. Transfer pricing also plays a major role in company incorporation.

Transfer Pricing Examples

Now, here is a transfer pricing example to explain the process:

A parent company sells a particular service to its subsidiary at a price far below the market value of the service. This allows the subsidiary to report lower profits and pay less taxes. This allows the company to run smoothly even while adhering to the country's various tax laws.

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Transfer Pricing Documentation

• Master File

The Master File gives a general picture of the group's international business operations, including its organisational structure, intangible assets, financing actions, and transfer pricing rules.

• Local File

A local subsidiary's intercompany transactions are thoroughly described in the Local File. It contains details about the type and extent of the transactions, the transfer pricing methodology employed, etc.

• Country-by-Country Report

The Country-by-Country Report offers a high-level overview of the income, taxes, and economic activity of a multinational group on a global scale.

• Transfer Pricing Study - Preparation of Transfer Pricing Documentation:

To comply with the requirements of Section 92E of Income Tax Act, 1962, businesses must put together proof that their dealings with connected entities are similar to that of dealing between independent parties through benchmarking studies.

The Transfer Pricing Study is a thorough examination of a multinational group's transfer pricing practices and cross-company dealings.

Transfer Pricing Compliance

• Determination of Arm's Length Price:

To determine whether a transaction between related businesses was priced at an arm's length price, it is necessary to examine the pricing of that transaction.

• Filing of Transfer Pricing Documentation:

Businesses are required to submit their transfer pricing documentation to tax authorities in several nations. It's possible to do this yearly or as part of a tax audit.

• Representation before Tax Authorities:

It can be required to represent a corporation before tax authorities if a tax audit shows problems with its transfer pricing.

Transfer Pricing Dispute Resolution

• Advance Pricing Agreement (APA):

An APA is a formal agreement that specifies the correct transfer pricing technique to be used with respect to a specific set of transactions. It is made between a taxpayer and one or more tax authorities.

• Mutual Agreement Procedure (MAP):

In tax treaties between nations, the MAP is a procedure for resolving disputes. The MAP allows taxpayers to ask that negotiations be held between the tax authorities of the nations concerned in a transfer pricing issue.

• Transfer Pricing Litigation:

On occasion, APAs or the MAP are unable to resolve transfer pricing disputes, necessitating litigation. Taxpayers who are involved in transfer pricing litigation can challenge the tax authority's determination of the transfer price in a court or tribunal.