Transfer Pricing 8

8/6/2019 Transfer Pricing 8

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Transfer PriceTransfer Price

y Transfer price refers to the amount used inaccounting for transfer of goods or servicesfrom one responsibility centre to another or

from one company to another whichbelongs to the same group.

y A transfer price is the price one subunitcharges for a product or service supplied to

another subunit of the same organization.y The price at which divisions of a company

transact with each other


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Transfer PriceTransfer Price

y TP means the value or price at whichtransactions take place amongst related parties.

y Transactions may include the trade of supplies orlabor between departments.

y Transfer prices are used when individual entitiesof a larger multi-entity firm are treatedand measured as separately run entities.

y Companies with dispersed production facilities,

usually in different countries, use transfer pricing.


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Fundamental decisionsFundamental decisions

Should the company produce the product

inside the company or purchase from out

side vendor ?This is sourcing decision.

If produced inside at what price should the

product be transferred between profit

centers?

This is transfer pricing decision.


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Why Transfer Pricing?Why Transfer Pricing?

y Approximately 60% of the total

transactions across the world are

between related parties.

y If the transactions are across different tax

jurisdictions, where tax rates are different,

shifting is beneficial.


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Objectives of Transfer PricingObjectives of Transfer Pricing

y Facilitates goal congruence

y Tax savings

y

Boost profitsy Measure performance


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RevenueProfit

Capital GainRoyalty

Inter Company

Control System

cost centresrevenuecentres

profit/Investment centre

IntraCompany

Internal(Withinthecountry)

Non-Related:

Profit/Dividend/RoyaltyForexFluctuations

Accounting

Related

Profit/Dividend/RoyaltyTransfer PricingForex/Accounting

Inter Comapny

Control Systems

ForexFluctuationsAccounting

Transfer Pricing

IntraCompany

External(outsidethecountry)

Transactions


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Transfer Pricing MechanismsTransfer Pricing Mechanisms

y Market-based transfer pricing

y Cost-based transfer pricing


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Factors Affecting Transfer PricingFactors Affecting Transfer Pricing

y Internal factors: PerformanceMeasurement and Evaluation

y External Factors:

Accounting Standard Income Tax

Custom Duty

Currency Fluctuations

Risk of Expropriation


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Uses of TPUses of TP

1. Price setting for services performed by

business unit.

2. A mean of evaluating financialperformance of business unit.

3. Determining the contribution to net

profit by profit centers in org.

4. Reduce in corporate taxes paid.

5. Reduce in VAT , excise, tariff


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Transfer Price RegulationsTransfer Price Regulations

International

y OECD formulated

Guidelines on

transfer pricing.They serve as

generally accepted

practices by the tax

authorities

India

y The Finance Act

2001 introduced the

detailed TPR w.e.f.1st April 2001

y The Income Tax Act

y AS-18

y Other Relevant Acts


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Transfer pricing documentation (1)Transfer pricing documentation (1)

PwC

1. Each tax payer whose turnover exceeds LTL 10

million (~EUR 2,9 million) during the tax year before

the controllable transaction takes place;

2. Financial companies and credit institutions;

3. Insurance companies.

The transfer pricing documentation should

be prepared by:


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PwC

Information about the parties involved in the transaction;

Information about intercompany transactions: Character istics of the subject of transaction;

Functional analysis;

Terms and cond itions of the transaction;

Economic circumstances of the transaction;

Business strategy. Information about transfer pricing method used;

Other information that reveals the important circumstances of

transfer pricing.

The compulsory elements of transfer pricing

documentation:


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PwC

Based on international experience, we structure the

documentation as follows:

1. Industry analysis: analyses of market trends, critical successfactors;

2. Company analysis: business overview and financial results ofthe parties involved in the transaction, description of their business

strategy;

3. Functional analysis: description of functions performed, riskassumed and assets engaged by related parties;

4. Description of intercompany transactions: characteristics ofthe subject of transaction, analysis of costs borne by related parties;determination of benefits derived from intercompany transactions;

5. Economic analysis: description of the pricing methodology,selection of transfer pricing method, benchmarking study, financial

analysis.


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Main issues (1)Main issues (1)

PwC

1. The accessibility ofinformation;

2. Comparability of transactions;

3. Management services;

4. Transfers ofintangibles.


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PwC

Accessibility ofinformation:

Public available information is limited;

Some information may be not reliable;

The access to the commercial data bases is fairly expensive;

Third parties often are not willing to reveal the information.

Complications determining the arms length range and justifying

the transfer prices.


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PwC

Comparability of transactions:

Application of arms length principle involves a comparison of the terms

and conditions in a controlled transaction between related parties with the

terms and conditions in transactions between independent parties.

The degree of comparability depends on various factors: characteristics of

goods, property or services, contractual terms, economical circumstances,

functions performed, risk assumed, business strategies, etc.

Difficulties to find highly comparable transactions.


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PwC

Management services:

Service agreements lack information on service specification,

costs arising in the parent company and calculation of the

charge (fee) for service rendered.

The costs of parent company (shareholders costs) are

transferred to its subsidiaries.

Duplication of services.

Mark-up is too high or not added at all.

The fee for management services is not justified.


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PwC

Transfers of intangibles:

There is generally not an active market forintangibles.

Transactions involving intangibles often include other assets

and liabilities, disguising the value of the subject ofintangible.

Transaction prices are often not disclosed.

Limited comparability and complications determining the arms

length range.


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PwC

The main issue the Lithuanian Tax

Authorities have not yet started

reviewing intercompany transactions


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Accounting Standard 18Accounting Standard 18

Requires disclosure of any elements of the

related party transactions necessary for

an understanding of the financial

statements.


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Related PartiesRelated Parties

y Control by ownership

50% of the voting right

y Control over composition of board of directors Power to appoint or remove the directors

y Control of substantial interest

20% or more interest in the voting power


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ASAS--18 and Transactions18 and Transactions

y Purchase and sale of goods;

y Rendering or receiving services;

y Agency arrangements;y Leasing arrangements;

y Transfer of research and development;

y Licence aggrements;

y Finance

y Guarantees and collaterals;

y Management contracts.


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Income Tax Act and TPIncome Tax Act and TP

y Finance Act 2001 substituted the oldsection of 92 of the ITA by sections 92,92A

to 92 F.y These sections are the backbone of Indian

TPR.

y These sections define the meaning ofrelated parties, international transactions,pricing methodologies etc.


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TPR: Some Important ConceptsTPR: Some Important Concepts

y Income/Expenses/Cost arising from an

international transaction shall be

computed having regard to arms

length price (ALP).

yALP provisions can be applied if it leads

to decrease in taxable income or

increase in losses.


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Arms Length PriceArms Length Price

y Price which two independent firms would

agree on.

y Price which is generally charged in a

transaction between persons other than

associated enterprises.


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Methods of Transfer PricingMethods of Transfer Pricing

y Comparable Uncontrolled Price

Method (CUP Method)

y Resale Price Method (RPM)

y Cost plus method (CPM)

y Transactional Profit Method (TPM)

y Profit split method (PSM)

y Transactional net margin method

(TNMM)


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Comparable uncontrolled priceComparable uncontrolled price

methodmethody CUP method compares the price

transferred in a controlled transaction to

the price charged in a comparable un-

controlled transaction.

y CUP method is the most direct and

reliable way to apply the arms length

principle.


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Resale price methodResale price method

y The resale price method begins with the

price at which a product is resold to an

independent enterprise (IE)by an

associate enterprise. X sold to AE at Rs. 1000 (profit: 300)

AE sold to an IE at Rs. 2000

x

(profit of Rs. 500 for relevant IE) Arms length price = 2000 - 500 = 1500


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Profit Split MethodProfit Split Method

y PSM is used when transactions are inter-

related and is not possible to evaluate

separately.

y PSM first identifies the profit to be split

for the AE. The profit so determined is

split between the AE on the basis of the

functions performed/assets/CE


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Cost Plus MethodCost Plus Method

y In CP method, first the cost incurred is

determined. An appropriate cost plus

mark-up is then added to the cost to

arrive at an appropriate profit. Theresultant figure is the arms length price.


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Transfer PricingTransfer Pricing MethodsMethods

PwC

Type of Transaction Possible method

Manufacturing of goods CUP, C+, Prof it split

Sale of goods CUP, Resale price,Profit split, TNM

Provision of services CUP, C+, TNM

Financing (loans, deposits,

guarantees)

CUP, Profit split, TNM

Transfer ofintangibles

(technology, brand, know how)

CUP, C+


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Some Transactions subject to ALP Purchase at little or

no cost.

Payment for servicesnever rendered.

Sales below MP/

Purchase above MP

Interest free

borrowings

Exchanging property

Selling of real estate at

a price different fromMP

Use of trade names or

patents at exorbitant

rates even after their

expiry.


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Example Kinetic Honda Motors

Collaborator: Honda Motor Co. Ltd Japan and

their Subsidiary Honda Trading Corpn. Japan

Hero Honda Motors Ltd.

Parent: Honda Motor Co. Ltd Japan and their

Subsidiary Honda Trading Corpn. Japan


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Some Cases Peico Electronics & Electricals Ltd.

Parent: Phillips Netherlands and its

subsidiaries

Asea Brown Boveri

Parent: ABB Switzerland and its

subsidiaries Videocon Group

Collaborators: Toshiba Co., Mitsubishi Co

Documents

Transfer Pricing 8