Rajat Taxation.docx

Dr. SHAKUNTALA MISRA NATIONAL REHABILITATION UNIVERSITY LUCKNOW Faculty of Law

RESEARCH PROJECT ON

TRANSFER PRICING For COURSE ON ‘INTERNATIONAL TAXATION; EMERGING JURISPRUDENCE’

Submitted by RAJAT PANDEY B.com LLB/2015-16/07 Academic Session: 2018-2019

Under the Guidance of Mrs. Vijeta Dua Asst. Prof. in Law & Faculty for ‘International Taxation ’ Faculty of Law Dr. Shakuntala Misra National Rehabilitation University Lucknow

ACKNOWLEDGEMENT I would like to express my special thanks of gratitude to my teacher Mrs. Vijeta Dua who gave me the golden opportunity to do this wonderful topic “TRANSFER PRICING” which also helped me in doing a lot of research and I came to know about so many new things I am really thankful to them.

TABLE OF CONTENTS

1) ACKNOWLEDGEMENT…………………………………………….Page2

2) INDEX………………………………………………………………….Page3

3) INTRODUCTION…………………………………………………….Page4

4) OBJECTIVE OF TRANSFER PRICING…………………………….Page6

5) METHODS OF TRANSFER PRICING…………………………….Page10

6) ARM’S LENGTH PRINCIPLE……………………………………..Page12

7) CONCLUSION……………………………………………………..Page13

8) BIBLIOGRAPHY……………………………………………………Page14

INTRODUCTION TRANSFER PRICING is the process of determining the price at which goods are transferred from one profit center to another profit center within the same company. If profit centers are to be used, transfer prices become necessary in order to determine the separate performances of both the ‘buying’ and ‘selling’ profit centers. If transfer prices are set too high, the selling center will be favored whereas if set too low the buying center will receive an unwarranted proportion of the profits. TRANSFER PRICING is needed to monitor the flow of goods and services among the divisions of a company and to facilitate divisional performance measurement. The main use of transfer pricing is to measure the notional sales of one division to another division. Thus the transfer prices used in the organization will have a significant effect on the performance evaluation of the various divisions. This requires that the system of transfer pricing should be objective and equitable. Transfer pricing becomes necessary when there are internal transfers of goods or services and it is required to appraise the separate performances of the divisions or departments involved. Large organizations are divided into a number of divisions to facilitate managerial control. The problem of transfer pricing arises when one division of the organization transfers its output to another division as an input. A Transfer pricing is the price one segment (sub unit, department, division etc.) of an organization charges for a product or service supplied to another segment of the same

organization. The transfer from one segment to another is only an internal transfer and not a sale.1

Transfer pricing is a common practice in MNCs. MNCs have many subsidiaries which trade among themselves or with the parent firm. This is evident from the fact that about one-third of US exports goes to US subsidiaries and business affiliates overseas. The World Investment Report (UN 1995) states that intra-firm trading of goods and services amounts to about one-third of total world trade. Broadly speaking, any price charged should be acceptable, as sales are among subsidiaries. If the selling price is low, the buying unit makes profit. If the price is high, the selling subsidiary gains.

2See glossary for a definition of marketing intangibles; the term is used extensively in the OECD Transfer Pricing Guidelines at Paragraphs 3The Subcommittee discussed the possibility of preparing more detailed guidance on intangibles in a separate Chapter of this Manual, but was unable to complete the work in the time available.

OBJECTIVE OF TRANSFER PRICING

The main objectives of transfer pricing are as follows:1. Transfer pricing minimizes the tax burden or arranging direction of cash flow:Transfer price, as aforesaid, refers to the value attached to transfer of goods, services, and technology between related entities such as parent and subsidiary corporations and also between the parties which are controlled by a common entity. Its essence being that the pricing is not set by an independent transferor and transferee in an arm’s length transaction. Transaction between them is not governed by open market considerations.

2. Transfer pricing results in shifting profits:Whatever the reason for fixing a transfer price which is not arm’s length, the result is the shift of profit. The effect is that the profit appropriately attributable to one jurisdiction is shifted to another jurisdiction. The main object is to avoid tax as also to withdraw profits leaving very little for the local participation to share. Other object is avoidance of foreign exchange restrictions.2

3. Shifting of Profits- Tax avoiding not the only object:Transfer between the enterprises under the same control and management, of goods, commodities, merchandise, raw material, stock,

https://home.kpmg.com/content/dam/kpmg/ua/pdf/2016/12/UN_Manual_TransferPricing https://home.kpmg.com/content/dam/kpmg/ua/pdf/2016/12/UN_Manual_TransferPricing%20(6) 2

or services is made at a price which is not dictated by the market but controlled by such considerations such as:

To reduce profits artificially so that tax effect is reduced in a specific country;

 To facilitate decentralization of production so that efforts are directed to concentrate profits in the State of production where there is no or least competition;  To remit profits more than the ceilings imposed for repatriation;  To use it as an effective tool to exploit the fluctuation in foreign exchange to advantage.

Underlying Transfer Pricing Transfer prices serve to determine the income of both parties involved in the cross‐ border transaction. The transfer price therefore tends to shape the tax base of the countries involved in cross‐border transaction. In any cross‐border tax scenario, the three parties involved are the multinational group, taken as a whole, along with the tax authorities of the two countries involved in the transaction. When one country’s tax authority taxes a unit of the MNE group, it has an effect on the tax base of the other country. In other words, cross‐border tax situations involve issues related to jurisdiction, allocation and valuation.3

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researchgate.net/publication/309160039_TRANSFER_PRICING_POLICIES_AND_PROCEDURES _AND_ITS_IMPACT_ON_PERFORMANCE_EVALUATION

Evolution of Transfer Pricing This section aims to trace the history and the reasons for transfer pricing taxation regimes. First and foremost, an important aspect of transfer pricing to be kept in mind is that it involves economic principles being applied to a fluid marketplace. Thus new approaches and techniques to arrive at the “right” transfer price from the perspective of one or more actors in the system are constantly being evolved.

METHODS OF TRANSFER PRICING

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As mentioned, the OECD Guidelines discuss five transfer pricing methods

that may be used to examine the arm’s-length nature of controlled transactions. Three of these methods are traditional transaction methods, while the remaining two are transactional profit methods. We list the methods below:-

TRADITIONAL TRANSACTION METHODS: CUP Method  Resale price method  Cost plus method Transactional profit methods:  Transactional net margin method (TNMM)  Transactional profit split method. The OECD Guidelines provide that you as a taxpayer should select the most appropriate transfer pricing method. However, if a traditional transaction method and a transactional profit method are equally reliable, the traditional transaction method is preferred. In addition, if the CUP method and any other transfer pricing method can be applied in an equally reliable manner, the CUP method is to be preferred. We’ll explain each of these methods in more detail now. when the various parts of the organisation are under some form of common control, it may mean that transfer prices are not subject to the full play of market forces and the correct arm’s length price, 4

COMPARABLE UNCONTROLLED PRICE METHOD:The CUP Method compares the terms and conditions (including the price) of a controlled transaction to those of a third party transaction. There are two kinds of third party transactions. Firstly, a transaction between the taxpayer and an independent enterprise (Internal Cup). Secondly, a transaction between two independent enterprises (External Cup).

1. RESALE PRICE METHOD:-

The Resale Price Method is also known as the “Resale minus Method.” As a starting position, it takes the price at which an associated enterprise sells a product to a third party. This price is called a resale price. Then, the resale price is reduced with a gross margin (the “resale price margin”), determined by comparing gross margins in comparable uncontrolled transactions. After this, the costs associated with the purchase of the product, like custom duties, are deducted. What is left, can be regarded as an arm’s length price for the controlled transaction between associated enterprises.

2. COST PLUS METHOD:-

The Cost plus Method compares gross profits to the cost of sales. The first step is to determine the costs incurred by the supplier in a controlled transaction for products transferred to an associated purchaser. Secondly, an appropriate mark-up has to be added to this cost, to make an appropriate profit in light of the functions performed.

After adding this (market-based) mark-up to these costs, a price can be considered at arm’s length.

TRANSACTIONAL NET MARGIN METHOD:-

With the Transactional Net Margin Method (TNMM), you need to determine the net profit of a controlled transaction of an associated enterprise (tested party). This net profit is then compared to the net profit realized by comparable uncontrolled transactions of independent enterprises.

As opposed to other transfer pricing methods, the TNMM requires transactions to be “broadly similar” to qualify as comparable. “Broadly similar” in this context means that the compared transactions don’t have to be exactly like the controlled transaction. This increases the amount of situations where the TNMM can be used.

A comparable uncontrolled transaction can be between an associated enterprise and an independent enterprise (internal comparable) and between two independent enterprises.5

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investopedia.com/terms/t/transferprice.asp

3. PROFIT SPLIT METHOD Associated enterprises sometimes engage in transactions that are very interrelated. Therefore, they cannot be examined on a separate basis. For these types of transactions, associated enterprises normally agree to split the profits. The Profit Split Method examines the terms and conditions of these types of controlled transactions by determining the division of profits those independent enterprises would have realized from engaging in those transactions.

ARM’S LENGTH PRINCIPLE Price applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions

ARM’S LENGTH RANGE - HOW IT WORKS ► In most cases, it is not possible to identify a single price that can be considered to be an uncontrolled price.

► It may be that a number of different comparable are equally

comparable. Several comparable transactions can therefore define an arm’s length range of possible transfer prices

CONCLUSION Transfer pricing methods are quite similar all around the world. The OECD Guidelines provide five transfer pricing methods that are accepted by nearly all tax authorities. These include 3 traditional transaction methods and 2 transactional profit methods. A taxpayer should select the most appropriate method. In general, the traditional transaction methods are preferred over the transactional profit methods and the CUP method over any other method. In practice, the TNMM is the most used of all five transfer pricing methods, followed by the CUP method and Profit Split method. Cost Plus Method and Resale Margin Method are barely used.

BIBLIOGRAPHY

Books Referred: International Taxation - C. S. MATHUR

Websites Referred: 

http://www.pdfcoke.com/doc/9669980/Indian

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https://www.investopedia.com/terms/t/transferprice.asp

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http://www.pdfcoke.com/doc/21923483/ROLE

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https://cleartax.in/s/transfer-pricing