Overview of Transfer Pricing
Objective: – To understand the basic concept of Transfer pricing, Transfer Pricing Audit and adjustment along with key term used in Transfer Pricing.
Transfer Pricing as describe in common parlance, where one business entity does business with other associate business entity. The sheer objective of Transfer Pricing Audit is to control the profit shifting by one entity operating into different jurisdiction to other associate business entity.
Let’s take an example A ltd is a company registered in India and its subsidiary B ltd is registered in America. Now, if Tax rate of America is higher than India and being an associate company they may reduce their Actual Taxable income and ultimately Tax Payable by transferring profit earned by B ltd (America’s) company to A Ltd, company registered in India or in other language from jurisdiction having higher tax rate to jurisdiction having lower tax rate.
How it may be done? It may be done by Transferring product or services (in which organisation deal), by giving or taking loan or by transferring/receiving assets from one entity to other associate entity at predefined rate in such a way that profit, income, loss or assets accrued to target jurisdiction only. Let’s say if B sells its product to unrelated party @ 10$ then it may sell same product to their related party (A Ltd) at reduced rate say @ 5$ to shift its higher taxable profit. There could be various other arrangements between the two associate enterprises through mutual agreement for sharing common cost or service allocation.
Key Definition used under Transfer Pricing: Associate Enterprise as defined under section 92A, International Transaction as defined under section 92B, Arm’s length price as defined under section 92C, Maintenance and furnishing documents by certain persons who has entered into such international transaction in respect of that international group as defined under section 92D and Section 92E report by an accountant to be furnished by person entering into international transaction or specified international transaction.
Although, above mentioned all section are equally important and have thorough impact on concerned aspect. We will discuss further what is arm’s length price and how it is calculated in terms of international or domestic specified transaction. Literal meaning of Arm’s length price is independent transaction between unrelated party. Section 92C prescribed methods by which arm’s length price, having regard to the nature of transaction or class of transaction may be calculated-
1) Comparable uncontrolled price method.
2) Resale price method
3) Cost plus method
4) Profit split method
5) Transactional net margin method
6) Any other method prescribed by the board.
The most appropriate method should be applied for determination of arm’s length price. Although, most used methods are first Comparable uncontrolled price method, resale price method and cost plus method.
In Comparable uncontrolled price (CUP) method, a price that is charged in an uncontrolled transaction between the comparable firms is recognized and evaluated with a verified entity price for determining the Arm’s Length Price. In case of resale price method, prices are compared at which the associated enterprise sells its product to the third party and cost plus method used a mark-up is charged over and above the cost to determine the arm’s length price. Out of all this method CUP is most used and reliable method but enterprises are free to use any other price which may be justifiable with ever changing business requirements and scenario.
Let’s understand it by an example, no two products are similar even if both serve the same purpose or requirement. Products and services varies according to the brand, specification, utilities and quality. Every MNE’s are free to use their own method till they have proper justification, method suggested are guiding principle.
Based on the TP Audit report (3CBEB) as prescribed under section 92E, and assessment primary and secondary adjustment done to complete the entire process. Primary adjustment may be done suo-motu by assesse himself or by Assessing officer during assessment or based on same Advance pricing agreement or by any other method. Secondary adjustment done by assess in his books of account based on primary adjustment to actually repatriate amount adjusted during the primary adjustment.
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Writer is a professional in practice may be reached at [email protected]. This is not a professional advice and discretion require before taking any action based on the article.
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TP Audit Reprot forms typo error Form 3CEB