Things to Know about Transfer Pricing
Transfer Pricing Regulations seek to regulate the inter group transactions in multi national group companies.Transfer Pricing Regulations were introduced via Finance Act 2001 and these provisions are enumerated under sections 92 to 92F.This article will explain meaning , need , related concepts and provisions at a glance.
What is Transfer Pricing ?
Transfer Pricing basically means pricing practices which are undertaken by multi group companies to account for or for costing the transactions taking place within the group of companies.So it is quite clear that transfer pricing can be adhered to by foreign as well as domestic companies also.
An example will clear the concept
Company X is a subsidiary of company Y. Company Y purchases the raw material from company X , so this transaction will have a different pricing structure than other transaction which are applicable for the external suppliers.In such a case , the transaction pricing will be known as transfer pricing transaction.
Need for Transfer pricing
As explained before , the group companies which have inter group transactions, may try to take undue advantage of the transfer pricing mechanism.If we refer to above example, we can explain better.
Company Y ,being holding company , can influence the major decision making including purchase and sales transactions.So, in absence of transfer pricing regulations , company Y may coerce company Y to increase the price of raw material as compared to market price. This will bring down the profits eligible for tax ,of company Y.This will ultimately result in tax evasion.
Hence , for tackling such situations ,the Income Tax India has come up with the legal framework ,which will regulate such inter group transactions.
- Associated Enterprise
This term is defined as a business entity
- Which participates directly or indirectly in management or control or capital of another enterprise or,
- In respect of which , one or more persons , who participate directly or indirectly in its management or control or capital , are the same person/s involved in management or control or capital of another enterprise.
- Arm’s Length Price
This is the price which is applied or should be applied in case of a transaction which takes place between persons other than Associate Enterprises , in uncontrolled conditions.
Ideally ,this should be the price which is generally charged in case of customers or by suppliers , during normal course of business.
- Permanent Establishment (PE)
It refers to permanent or fixed place of business through which the business is carried on partly or wholly.PE could be a branch or head office etc. Only condition should be that such PE shall have the ongoing business activity in the name of the business entity.
Computation of Arms Length Price
Transfer Pricing provisions seek to tax the transactions between Associated Enterprises (AE) , when there is PE for at least one of such enterprises.Such transaction should be at Arm’s Length Price which is calculated as per one of the methods specified below.
- Comparable Uncontrolled Price Method (CUP)
Wherein pricing for unrelated party transaction is adjusted for the specific differences for the related party transactions.
- Resale Priec Method
Here final sales price
dealt by Associated enterprise is adjusted for average industry GP margin and other functional differences, to arrive at Arm’s Length Price.
- Cost plus Method
Direct expenses and indirect expenses with respect to unrelated transaction is adjusted for Industry GP margin to find out Arm’s length price.
- Profit Split method
Here profits of the entity are apportioned directly which belongs to each individual entity .Then residual unallocated profits are apportioned on the basis of contribution ratio of these entities.
- Transactional Net Margin Method
Average Net profit margin of industry comparables is adjusted for the differences pertaining to transaction between Associated Enterprises.The ultimate net profit margin as calculated under this method would be applied to determine Arm’s Length Price.
Advance Pricing Agreement (APA)
- This is an agreement entered into by tax payer and the CBDT or Taxation Authorities , with respect to international transactions (between AE )for a fixed time period in future.
- Such an agreement is valid for 5 years
- Such APA is binding only on the such concerned person and the Commissioner , and only on the transaction for which it is entered into.
- The Roll back provision is introduced with respect to APA , wherein methodology for detremination of ALP as determined by APA , would be applied for trnsactons entered before the date of agreement.
Safe Harbor Rules
CBDT is empowered to frame the rules and regulations with respect to Safe harbor.These rules are applicable for the circumstances where the board will accept the transfer price as declared by the assessee.Please refer to Safe Harbor Rules on Income Tax website for updated list.
Transfer Pricing is a vst subject which cant be summed up in one article , as there are many aspects to it.However this article has tried to focus on most important topics so as to enable the readers to understand the basics of the Tranfer Pricing.