Transfer Pricing – Explained Simply

Get to Know the Basics

What is Transfer Pricing?

In the last decade, international trade registered an unprecedented growth. With the advent of globalization, cross-border transactions became more frequent and apparently, more complex giving rise to new tax concerns. One such concern that bugged tax authorities all over the world was transfer pricing.

A simple way to define it is – Transfer pricing is the practice of setting up prices for trading valuables between two entities across different tax jurisdictions. The valuables can be tangibles, intangibles, services and financial transactions and the entities can be company divisions and departments, or parent companies and its subsidiaries.

Ideally, the parent company is supposed to buy/sell from it’s cross-border subsidiary on the same rate as it would have bought from an independent entity/external entity. This is technically known as arm-length’s principle. Organization for Economic Co-operation and Development (OECD) endorses arm-length’s principle for transfer pricing. Tax authorities followed suite and enforced MNCs to comply with the arm length’s principle.

Transfer pricing without arm length’s principle is vulnerable to be misused by the companies to evade taxes by showing minimum profits in countries where taxes are high and maximum profits in countries where taxes are low.

Why is it Needed?

As per 2013 Global Transfer Pricing Survey conducted by Ernst & Young, there has been a substantial rise in the percentage of companies that identified ‘risk management’ as their highest priority for transfer pricing. Here are a few reasons, why transfer pricing really matters for the organizations worldwide.

  • To avoid facing probable tax blows from local tax authorities
  • To avoid incurring tax penalties and interests
  • To safeguard company’s reputation
  • To be compliant with transfer pricing guidelines
  • To proactively prepare and maintain the required documents
  • To avoid getting stung  by double taxation
  • To minimize risk, maximize savings and optimize profits

How it Works?

Transfer pricing is not a single term. Rather, it is a  multi-layered concept which include a suite of broad-spectrum services including:

  • Planning and Analysis – Developing a standard Transfer Pricing policy after making a thorough functional and economic analysis.
  • Documentation & Benchmarking
  • Dispute Management – Mitigating the risks involved in transfer pricing proactively and controlling the damage if any dispute/litigation arises.
  • Business Model Optimization (BMO) – Putting the demands of tax law in sync with the core objectives of a business entity.
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