ALL ABOUT TRANSFER PRICING

Transfer pricing is referred to the price determined for the transaction that takes place within an organisation i.e. between two or more related entities within an MNC. This price is also called as cost of transfer which shows the value of such transfer that takes place amongst related entities in terms of goods or even transfer of employees or labourers across different centres or departments.

EXPLANATION

In the rules for determining an arms length transaction price between related parties, this price is fairly a market price for such goods or services in the market. This price is widely accepted by tax authorities and users of financial statements. It assists entities in determining their real income.

WORKING OF TRANSFER PRICING

The transfer price is more related to the market price of the goods or services involved in such related party transactions. This will eliminate the entities purchasing or selling such goods or services in the market as they can trade them between the related parties at the market price. This is the reason it is more of an accounting concept which accounts for the translation between such related entities at a fair and correct price.

This is determined based on few widely accepted methods such as price method, comparable uncontrolled price method, Transactional net margin method, resale price method and transactional profit split method.

The above listed methods are used as per the transaction, such as if there are comparable products or services in the market for which there is a market price determined, then the price could be used for the purpose of determining transfer pricing.

Identically, if the goods are reusable and such resale price is determined along with profit on such sale, then the resale price method can be used. Related parties or entities use other methods.

PURPOSE

Determination of an equitable and fair price of a transaction that takes place between two or more related parties or enterprises involving the trade of goods and services.
Other purposes include accounting for a translation as per its market price avoiding any collusion among the related or associated enterprises, and providing a base for estimation of income being generated from such transactions. Also, this concept is useful for fair and true reporting of transactions between associated enterprises in financials of such entities.

FUNCTIONS AND RISKS

This concept functions basically on the price determination principles that are available in the market for such service or commodity involved in the transaction.
Due to these functions, there are few risks involved, such as the valuation of transactions that involve the use of intellectual property, services that are highly valued, transactions that are not financial in nature. Even the exchange of commodities and services, with other unrelated commodities and services between associated enterprises among others.

Also, there is risk of mispricing a self generated goods or services that is not related to any other resource in the market due to limitation in the domestic pricing rules.

MERITS

Fair presentation of financials thereon
Assists the entities to transact at fair and market price eliminating inconsistency in transaction pricing.
It assists the tax authorities to determine tac and helps in reducing tax evasion.

DEMERITS

There are few drawbacks in the determination of market price or arms length price as 2 products can’t be compared due to the homogeneous nature of such goods or services.
This would require additional administrative costs and can be a time consuming process.

THE CRUX

In totality, the introduction of this concept has eliminated improper pricing of related party and associated transactions, making way for the elimination and reduction of tax evasion through such methods assisting the government and tax authorities. As this concept is relatively new, various changes need to be made to provisions over time based on its nature of the use to make it a globally accepted principle.