Transfer Pricing

Team Members:

Juanita Kabse

Manisha Kunwar

Rajesh Mudaliyar

Pawan Pandey

Introduction:Determination of exchange price when

different business units within a firm exchange the products and services

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).

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”. 

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.

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.

Explanation of Transfer Pricing

Transfer Pricing Model In India

Every country is following its own TP model but most of the countries are following OECD model of convention on Transfer Pricing

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).

India is successful in implementing the Transfer Pricing laws in the country achieving its targets.

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.

India is rapidly growing using its own model of TP rules and also observing the OECD TP Guidelines.

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.

Some Transactions subject to ALP(Arm’s Length Price)

• 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.

• Purchase at little or no cost.• Payment for services never rendered.• Sales below MP/ Purchase above MP• Interest free borrowings

Transfer Price Regulation

International National (India)

o OECD formulated “Guidelines on

transfer pricing”. They serve as generally

accepted

o The Finance Act 2001 introduced the

detailed TPR w. e. f. April 1, 2001

o Practices by the tax authorities

o The Income Tax Act

Income Tax Act 1961Section 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 enter ing into international transaction

Section 92 F: Definitions of certain terms relevant to computation of arm’s length price, etc

Penal Provisions

o Non Maintenance of Records : 2% of the transaction value (u/s 271AA)

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)

Above penalty need not be levied if reasonable cause for failure is proved u/s 273B

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

271(1)(c)

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

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

• Negotiated Price Method

Why Did TEVA Introduce Transfer Pricing

Teva, a multinational pharmaceutical company, solved its transfer pricing problems by using activity-based costing

Teva reorganized its pharmaceutical operations into 1 operation division (with 4 manufacturing plants) and 3 marketing divisions

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

Marketing were evaluated on sales, not profit

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

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

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

Market Price MethodNo market existed for manufactured and packaged products that had not been distributed or marketed to customers

Negotiated price methodWould 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 (India/Europe)

WTP

A Client wished to establish a single global production facility in India

recommended transfer

pricing modifications to the

global Supply chain for

finished products, defensive

transfer pricing study &

European tax authorities

TP

provided transfer pricing

analysis and structuring

advice manufacturing

facility in India within

Special Economic Zone

The global nature of this transfer pricing project required us to develop

solutions for manufacturing, distribution and margin changes among three

separately-managed regions.