Transfer pricing refer to the strategies which determine the trading price for goods or services between the Related parties (Related party is defined under Section 2(76) of Companies act 2016 and covered in AS 18 and IND AS 24). Transfer pricing empowers changes in pricing. Transactions under Transfer pricing between related entities in different countries is one of the most important and complex issue of taxation which global companies face.
Transfer pricing leads to tax savings for organizations, and companies widely use this practice to reduce to burden of tax on them. They charge a higher price to related parties in countries with high tax rate to reduce profit, while charging a lower price for increase of profit in the countries with low tax rate .
Some general international transactions which are governed by rules of transfer pricing are –
Companies aim behind transfer pricing is generation of distinct profit for each of their divisions and enabling the preformation assessment of each division separately. Thus the transfer price not only just effect the reported profits of the division but it also influence the allocation of the companies resources.
What is Arm’s length principle –
After you see at countries around the world, you’ll see a large differences in rates of tax. In case left unchecked, Multinational Enterprises (MNEs) might move profits from nations with high tax to low-tax nations. MNEs continuously have internal transactions. A regional head-quarter invoicing management and service expenses. A holding company giving financing to an operational company. A manufacturing department providing finished item to a distributing department. MNEs are able to control the terms and conditions of these exchanges. They can set the price, so to talk. This way, they can impact taxable benefit and the amount of tax due. To avoid this from happening, tax administrations (organized within the OECD) have designed the arm’s length principle. This principle requires that controlled exchanges are done at market rates.
The arm’s length rule implies that:
‘Entities that are related through management, control or capital in their controlled exchanges ought to agree the same terms and conditions which would have been agreed between non-related entities for comparable uncontrolled transactions’. If this guideline is met, we are able to say that the terms and conditions of the specific transaction are ‘at arm’s length’.
India isn’t a part of the OECD. As of presently, India is as it were a part of roughly 30 committees of the OECD. The OECD and India have improved their co-operation in managing with issues related to transfer pricing and to advance better tax compliance in order to progress the avoidance of cross border disputes. As portion of the G-20 gather, India has played an active part within the OECD’s project for the anticipation of Base Erosion and Product Shifting (BEPS) and is committed to the outcomes of the BEPS project. Indian TP Directions don’t make specify of the OECD TP Rules (updated in July 2017). In any case, the TP enactment in India is broadly based on the OECD TP Rules counting the substance of the three-tier TP documentation structure, exchange estimating strategies etc. Both the taxpayers and the Income authorities have set dependence on the OECD TP rules particularly in cases where direction isn’t accessible under the residential legislation. Similarly, the standards laid down within the OECD TP rules have been depended upon in several legal rulings in India.
Methods of Transfer pricing-
1. Comparable Uncontrolled Price Method-
The Comparable uncontrolled cost (CUP) strategy compares the price and conditions of items or services in a controlled transaction with those of an uncontrolled transaction between irrelevant parties which are not related. To create this comparison, the CUP strategy requires the comparable information. In order to be considered a comparable price, the uncontrolled transaction should meet high guidelines of the comparability. In other words, exchanges must be amazingly similar to be considered comparable under this method.
The OECD prescribes this strategy at whatever point conceivable. It’s considered the foremost successful and reliable way to apply the arm’s length principle to a controlled transaction. It can be exceptionally hard and challenging to distinguish a transaction that’s suitably comparable to the controlled exchange in address. That’s why the CUP strategy is most as often as possible used when there’s a significant amount of information accessible to make the comparison.
2. The Resale Price Method
The resale price method (RPM) uses the selling price of a product or service, something else known as the resale price. This number is at that point decreased with a gross margin, decided by comparing the net margins in comparable transactions made by comparable but unrelated organizations. At that point, the costs related with obtaining the product—such as traditions duties—are deducted from the full. The final number is considered an arm’s length cost for a controlled exchange made between affiliated companies. When appropriately comparable exchanges are available, the resale price strategy can be a really valuable way to decide transfer price, since third-party deal costs may be moderately simple to get to. Be that as it may, the resale price method requires similarity with steady economic circumstances and bookkeeping methods. The uniqueness of each exchange makes it exceptionally troublesome to meet resale price method necessities.
3. The Cost Plus Method
The cost plus method (CPLM) works by comparing a company’s gross profits to the generally cost of sales. It begins by figuring out the costs caused by the provider in a controlled transaction between affiliated companies. At that point, a market-based markup—the “plus” in cost plus—is included to the whole to account for an fitting profit. In arrange to use the cost plus method, a company must recognize the markup costs for comparable transactions between organizations which are unrelated . The cost plus method is exceptionally valuable for assessing the transfer price for schedule, low-risk exercises, such as the manufacturing of unmistakable products. For numerous organizations, this strategy is both simple to implement and to get it. The drawback of the cost plus method is the accessibility of comparable information and accounting consistency. In numerous cases, there are essentially no comparable companies and transactions—or at slightest not comparable sufficient to urge an exact result.
4. The Comparable Profits Method
The Comparable Profits Method (CPM), moreover known as the transactional net margin method (TNMM), makes a difference to determine transfer prices by looking at the net profit of a controlled transaction between enterprises which are related. This net profit is at that point compared to the net profits in comparable uncontrolled transactions of free enterprises. The CPM is the foremost commonly used and broadly applicable sort of transfer pricing technique. As distant as benefits go, the CPM is decently simple to execute since it as it were requires financial information. This strategy is truly successful for product manufacturers with generally clear transactions, as it’s not troublesome to discover comparable data. The CPM could be a one-sided strategy that frequently ignores information on the counterparty to the transaction. Tax authorities are progressively likely to require the position that the CPM isn’t a great coordinate for organizations with complex business models, such as high-tech companies with intellectual property. Using the information and data from the companies who don’t meet the OECD’s measures of comparability are prone to audit risk.
5. The Profit Split Method
In a few cases, related ventures engage in transactions that are interconnected—meaning they can’t be observed on a partitioned basis. For illustration, two companies working beneath the same brand might use the profit split method (PSM). Ordinarily, the related companies concur to part the profits, and that’s where the profit split method jumps in. This approach looks at the terms and conditions of interrelated, controlled transactions by figuring out how profits would be partitioned between third parties making similar transactions. One of the most benefits of the PSM is that it looks at profit allocation in a holistic way, instead of on a value-based premise. This may help give a broader, more precise evaluation of the company’s financial performance. This is often useful when dealing with intangible assets, such as intellectual property, or in circumstances where there are numerous controlled transactions happening at a time. Be that as it may, the PSM is frequently seen as a final resort since it as it were applies to highly integrated organizations similarly contributing value and assuming risk. Since the profit allotment criteria for this strategy is so subjective, it postures more risk of being considered a non-arm’s length result and being disputed by the suitable tax authorities.
Transfer pricing Documentation
Transfer pricing Documentation requirement as per Rule 10D of the Indian Income Tax Rules, 1962 are as follows –
1. Nature and terms (including price) of international transactions incurred
2. Description of functions performed, assets
3. employed and the risk assumed (functional analysis)
4. Records of economic analysis and market analysis
5. Record of budgets, forecasts, financial estimates
6. Any other record of analysis (if, any) to evaluate comparability
7. of international transaction with uncontrolled transaction(s)
8. Description of method considered with reasons of rejection of
9. other methods
10. Structure of ownership
11. Profile of the multinational group
12. Description of Business
13. Details of transfer pricing adjustment(s) made (if, any)
14. Any other information e.g. data, price related correspondence, documents like invoices, agreements etc.
In accordance with its commitment to the OECD’s BEPS Action Plan, Government of India presented the concept of three-tier TP documentation in the year 2016.An Indian entity which is portion of a multinational endeavor (MNE) group is required to maintain the following bunch data by way of three files:
1. Local file
2. Master file (MF)
3. Country by Country reporting or CbCR
Local record in India is right now the same as the yearly TP documentation which is required to be kept up (as per Rule 10 D) on the off chance that the total value of worldwide transactions with the Related Entities surpasses INR.10 million amid the relevant financial year.
Master Record (MF) is required to be electronically recorded where the value of international transactions of the enterprise with its Related Entities (AEs) surpasses INR.500 million amid the important bookkeeping year (INR.100 million in case of intangible related exchanges) and the consolidated global turnover of the MNE group surpasses INR 5,000 million. The prescribed form for the electronic filing of the master file is Form no. 3CEAA and it is filed by the taxpayers without any requirement of certification by an accountant.
Country-by-Country Report (CbCR) is required to be electronically filed in India where the Ultimate Parent Entity (UPE) of the Multinational group (MNE) is resident in India or where the MNE has assigned an alternate announcing entity for the purposes of filing CbCR in India. CbCR is required to be recorded in India where the yearly consolidated group income as per the solidified monetary articulations of the MNE bunch within the promptly preceding accounting year important to the Indian monetary year, is more than INR 55,000 million. The due date for filing CbCR within the prescribed Form no. 3CEAD in India is 12 months from the conclusion of announcing accounting year of the UPE preparing consolidated financial statements. The UPE can assign another group entity as an substitute announcing entity for the purposes of filing CbCR in India.
Transfer Pricing Audit-
Section 92E – Audit Under Transfer Pricing
A report from an accountant needs to be furnished by persons who are entering into an international exchange or a indicated domestic transaction. A report from an accountant in a prescribed frame, appropriately marked and confirmed by the accountant must be obtained before the specified date by any person entering into an international transaction or specified domestic transaction within the past year. The review is pertinent to both international and indicated domestic transactions. Form 3CEB must be filed.