CA Satya Brata Panigrahi

CA Satya Brata PanigrahiThis article examines the inter relationship between Transfer Pricing, Entity’s Tax and Financial Reporting. Due to increasing transfer pricing scrutiny, it is being considered as the most risky area for multinational entities from both compliance and tax planning perspective.

The International trade and business started taking its shape when entities previously confined only to their domestic market opened up and expanded to become multinational groups in almost all developed and emerging markets. It is estimated that, at least sixty percent of cross border trade is between related parties.

Nokia, LG, Vodafone, Siemens and other multinationals have made headline in India and abroad because of transfer pricing disputes over potential adjustments to income. However the transfer pricing adjustment could also impact any small closely held company in India desirous of expanding its business outside India.

What is Transfer Pricing?

A transfer price is the price charged between related parties (e.g. a parent company and its controlled foreign corporation) in an inter company transaction. However while consolidating the financial results of foreign corporations and their domestic parents, intercompany transactions are eliminated. This consolidation is done for financial reporting purposes but not for tax purposes.

Therefore transfer prices directly affect the allocation of group wide taxable income across various national tax jurisdictions where it operates. It can be said that, the transfer pricing policy of a company can directly affect it’s after tax income to the extent that, tax rates differ in various operating nation’s jurisdiction.

Tax laws of all most every country gives authority to the tax officials to adjust taxable income between two related parties to more accurately reflect the income earned by each party. Transfer Pricing rules are used to determine the true taxable income of a controlled taxpayer is that of a taxpayer dealing at arm’s length with an uncontrolled taxpayer. In other words it can be said that a controlled transaction meets the arm’s-length standard, if the income from the transaction is consistent with the income that would have been realized, if unrelated taxpayers had engaged in a comparable transaction under comparable circumstances.

Determining a company’s transfer prices requires identifying where value is created in an organization and transfer across group companies. Further value can be characterized and the comparability of transactions can be determined with the help of Functions performed, Assets employed and Risk assumed by each group member involved in the intercompany transaction. The assessee chooses a most appropriate method out of specified methods under tax laws.

What is the conflict?

Transfer pricing concept is the top conflict point of tax policy as it related to competing objectives of three parties:

i)   The revenue maximization objective of the domestic tax authorities,

ii)  The revenue maximization objective of the foreign tax authorities and

iii)  The tax minimizing objective of the taxpayer.

Conflict between taxpayers and revenue authorities may arise in many areas viz.:-

i) The tax authorities may question the assumptions/adjustments used when applying a particular method chosen as Most Appropriate Method (MAM).

ii) The tax authorities may question the choice of MAM.

iii) The tax authorities may disagree with the taxpayer’s characterization of value chain within the group.

iv) The tax authorities may disagree with the set of comparable companies or transactions selected for analysis.

v)  The tax authorities may try for arbitrary Transfer Pricing adjustments.

Because of the inherent differences in judgment and interpretation of facts when analyzing a company’s transfer pricing, together with the clashing revenue objectives of multiple tax authorities and taxpayers, the risk of adjustments to taxable income, double taxation, and potential for penalties is always a fear factor for multinational companies.

Risk and Uncertainty over Transfer Pricing:

The risk and uncertainty associated with transfer pricing positions is expected to increase in coming years. Under pressure to raise revenue, government is directing tax authorities to increase cases of transfer pricing scrutiny.

The uncertainty in a company’s ability to sustain its transfer pricing positions, transfer pricing can often fall into the category of an uncertain tax position. This has a direct impact on a company’s tax provisions, with potential indirect effects on the ability to realize deferred tax assets.


The conflicts and fight between tax authorities and taxpayer will never end. Currently transfer pricing is a high tax compliance risk area for multinational companies and carries important implication for tax planning and reporting. This risk area can be mitigated through correct determination of an arm’s length transfer price which requires identifying where value is created and transferred; analyzing such factors as functions performed, assets used and risk assumed by respective parties; and selection of appropriate method for Transfer Pricing along with comparables.

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0 responses to “Transfer Pricing Concept – Born Out of Conflicts”

  1. Anand says:

    Commendable article. Thanks

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