Home Business & Management Transfer Pricing.

Transfer Pricing.

What is the meaning of transfer pricing?

  Transfer pricing means a price which is charged between two or more entities of the same group in an International transaction. (Two entities may be an associated enterprise operating in two or more different countries.)

What are the methods of transfer pricing?

  1. Comparable uncontrolled price method.
  2. Resale price method.
  3. Cost plus method.
  4. Profit spilt method.
  5. Transactional net margin method.
  6. Other methods.

All these methods are discussed in detail in the coming paragraphs.

Recent case law of Denmark V/S Pharma Distributor:-

Danish company engaged in pharma below the Arm’s length price of net profit according to the benchmark study, but by disregarding annual Goodwill amortization of DKK 57.1 million , the results were within the Arm’s length range.

Question of the case:-

Whether Pharma Distributor were entitled to disregard the Goodwill amortization in the comparability analysis.

Conclusion of the case:-

National tax court has ruled in favour of the company but the National court has reached the opposite result. So Transfer pricing provisions are applied.

https://tpcases.com/denmark-vs-pharma-distributor-a-a-s-march-2020-national-court-case-no-skm2020-105-olr/

Transfer pricing between two countries

What’s in it for me?

1.What-is-Transfer-pricing

When company does a business with it’s subsidiary company or its associated enterprise and is situated in another country and transactions with that other company are not done at an Arm’s Length price at that time transfer pricing provisions are applied.

2.Associated Enterprise for transfer pricing:-

Associated enterprises are those enterprises which are owned or controlled by the same or common entity persons.

As per section 92A(1) of the provisions of the act,

  • An enterprises which participates directly or indirectly through one or more intermediaries in, MANAGEMENT, CONTROL OR CAPITAL of the enterprise or,
  • One or more persons participates directly or indirectly or through one or more intermediaries in, MANAGEMENT, CONTROL OR CAPITAL of two different enterprise are termed as associated enterprises
transfer Pricing

3. Deemed-associated-enterprises for transfer pricing:-

  • One enterprises directly or indirectly owns 26% or more of the ownership in other enterprise.
  • One enterprises directly or indirectly owns 26% or more of the voting rights in other enterprise.
  • An enterprise advances loan of more than 51% of total book value assets of another enterprise.
  • One enterprise guarantees of more than 10% of total borrowings of such other enterprise.
  • One enterprise appoints more than one half of directors or members or governing board of another enterprise.
  • More than half of the directors , members or governing board of both enterprise are appointed by the same person.

4. International-transactions for transfer pricing:-

An international transaction means,

  • A transaction between two or more associated enterprise either of them both or any one of them should be non-resident,
  • Transaction in the nature of,
  • Sales, Purchase, lease of tangible property,
  • Sales, Purchase, lease of intangible property,
  • Provisions of services,
  • Lending or borrowing of money,
  • Any other transaction having a bearing of income, profit, losses or assets of such enterprise.

Deemed International transaction: –

When in respect of a transaction entered into by an enterprise other than an associated enterprise,

  • There exist a prior agreement between the other person and an associated enterprise or,
  • Where the terms of the transactions are determined in substance between such other person and the associated enterprise and,
  • Either the enterprise or the associated enterprise or both of them are non-residents.

5.Methods-of transfer pricing for finding Arm’s length price:-

        There are five methods to compute Arm’s length price. They are as follows,

  1. Comparable uncontrolled price method.
  2. Resale price method.
  3. Cost plus method.
  4. Profit spilt method.
  5. Transactional net margin method.

All these methods will explain in details in the following paragraphs

1. Comparable uncontrolled price method of transfer pricing:-

This is the price at which unconnected parties transacts for the goods and services in the market.

It requires a high degree of comparability of products, services and functions and such comparability can be improved by doing reasonable adjusments.

Steps for Calculation:-

  • Identification of price charged or paid for goods or services transferred.
  • Such price is adjusted to accounts for difference between the international transaction and the comparable uncontrolled transaction.
  • Adjusted price come above should be taken as Arm’s length price

2.Resale price method of transfer pricing:-

This is the method where Gross margin earned in transaction is being compared between the related and unrelated parties.

Steps for Calculation:-

  • Price at which goods or services are being sold to an associated and an unrelated enterprises.
  • Resale price is being reduced by normal gross profit margin and expenses incurred in relation to purchases. 
  • Adjusted price come above should be taken as Arm’s length price.

3. Cost plus method of transfer pricing:-

In this method appropriate amount of gross margin is to be added on total cost of purchasing the goods or for providing any services.

Steps for Calculation:-

  • Identify direct and indirect cost of production.
  • Determination of normal Gross profit margin to such Costs.
  • this normal Gross profit margin is to be adjusted for differences if any, which could materially affect profit mark up in the open market.
  • Adjust gross profit markup to total cost.

4. Profit spilt method of transfer pricing:-

This method identifies whether the combined operating profit or loss to one or more controlled transactions is allocated between the entities at Arm’s length price.

Steps for Calculation:-

  • Determine the combined profit.
  • Evaluation of relative contribution by each enterprises (on the basis of relative market data).
  • Split out profit as per their contributions.
  • Profit thus apportiones is used to arrive at arm’s length price.

5. Transactional net margin method of transfer pricing:-

Under this method the ALP is determined by comparing the operating profit.

Steps for Calculation:-

  • Computation of net profit from international transaction.
  • Computation of net profit of an comparable uncontrolled entity.
  • Net profit realized from uncontrolled transaction should be adjusted for differences if any, which could materially affect profit mark up in the open market.
  • Net profit arrived is to be taken into computation of Arm’s length price.

6.Limitations of transfer pricing on Interest-Deductions-in-certain-cases :-

Transfer Pricing
  • Debt is considered as more tax efficient than an equity because in debt the interest amount which we pay’s is allowed as deduction in profit and loss account while on equity while paying dividend to equity shareholders we have to pay dividend distribution tax.
  • In order to prevent this issue tax rules are placed in each country to place a ceiling limit that is to be placed on the interest amount.
  • Provision in line with BEPS Action plan-4:-
  • No deduction is to be allowed on,

        >30% of EBITDA interest payable

                              OR

        Interest payable to associated enterprises

Whichever is lower.

  • This provision is applicable to Indian company as well as Permanent Establishment of a foreign company.
  • When interest payment exceeds >1crore than only this provision is applicable.
  • Disallowed interest expenditure is to be carried forward for next 8 years.
  • Banks and Insurance companies are excluded from this provisions.

Examples:-

Mr A is controlling a company Richards ltd. Richards ltd having a subsidiary company Lara ltd in UK. Richards Ltd provides a goods to Lara ltd at a value of Rs.500000 . If the same goods are sold to independent party than the price for the same would be rs.700000 .

So the differential amount of Rs 200000 which is charged less from lara ltd. is chargeable under the income tax as per the provisions of transfer pricing.

Conclusion:-

So we can say that for restriciting the amount of black money transferring to foreign country this transfer pricing provisions are applicable.

You can also visit my other Blogs,

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FAQ’S:-

Q-1 Which transfer pricing method is best?

A-1 There is no specific method . All the methods of transfer pricing are best. We have to adopt the Transfer price which is suitable to us.
Different businesses suits different methods of transfer pricing.

Q-2 Is transfer pricing is Illegal?

A-2 No. Transfer pricing is a legal process to avoid tax evasion in an economy. Government has made a provisions for transfer pricing.

Q-3 Can transfer pricing provisions are applicable to Individuals?

A-3 If individual manages, controls or capital of the other enterprise directly or through intermediary than transfer pricing provisions are applicable to individuals.

Q-4 Transfer pricing is used to avoid taxes?

A-4 Transfer pricing is used to prevent evasion of tax evasion.  It is not used to avoid taxes.

Q-5 Transfer pricing provisions are applicable for banks?

A-5 No. Transfer pricing provisions are not applicable for banking sector.

Q-6 Transfer pricing provisions are applicable for Insurance companies?

A-6 No. Transfer pricing provisions are not applicable to insurance companies.

Q-7 What is primary adjustment?

A-7 Determination of transfer price in accordance with ALP resulting in the increase in total income or reduction of total loss.

Q-8 What is secondary adjustment?

A-8 It means in adjusments in the books of accounts of the assesse and it’s associated enterprise to reflect that actual allocation of profit between the assesse and its associated enterprise are consistent.

Q-9 What is advance pricing agreements?

A-9 It means agreement between a tax payer and the CBDT, which determines the arm’s length price of future inter company transactions.

Q-10 What is economic double taxation?

A-10 It means same income is taxable in the hands of two different persons.

Q-11 What is Jurisdictional double taxation?

A-11 Tax is impose by two or more countries as per the domestic laws  in respect of the same transaction, income arises or deemed to be arise in the specific jurisdiction. This is known as jurisdictional double taxation.

Q-12 Penalty for failure to report International transaction?

A-12 Penalty @50% is to be payable on the under reported income is leviable to assesse.

Q-13 Penalty for non maintenance of records?

A-13 Rs.100000 is penalty for non maintenance of recors as per section 92E.

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