What is Transfer Pricing?
Transfer pricing refers to the setting of prices of goods and services that are exchanged between commonly controlled legal entities within an enterprise. For instance, if a subsidiary company sells goods or renders services to the holding company, the price charged for these services is referred to as transfer price and the setting is called transfer pricing. Entities under common control refer to those that are ultimately controlled by a single parent corporation. Multinational corporations use transfer pricing as a method of allocating profits (earnings before interest and taxes) among its various subsidiaries within the organization.
Transfer pricing offers many advantages for a company from a taxation perspective, although regulatory authorities often frown upon the use of transfer pricing to avoid taxes. Transfer pricing takes advantage of different tax regimes in different countries by booking more profits for goods and services produced in countries or economies with lower tax rates. In some cases, companies even lower their expenditure on interrelated transactions by avoiding tariffs on goods and services exchanged internationally. International tax laws are governed by the Organization for Economic Cooperation and Development (OECD) and the auditing firms under OECD review and audit the financial statements of MNCs accordingly.
Consider ABC Co., a U.S. based pen company manufacturing pens at a cost of 10 cents each in the U.S. ABC Co.’s subsidiary in Canada, XYZ Co., sells the pens to Canadian customers at $1 per pen and spends 10 cents per pen on marketing and distribution. The group’s total profit amounts to 80 cents per pen. Now, ABC Co. will charge a transfer price of between 20 cents and 80 cents per pen. In the absence of transfer price regulations, ABC Co. will see where the tax rates are lower and seek to put more profit in that country. Thus, if U.S tax rates are higher than Canadian tax rates, the company is likely to assign the lowest possible transfer price to the sale of pens to XYZ Co.
Arm’s Length Principle
Article 9 of the OECD Model Tax Convention describes the rules for Arm’s Length Principle. It states that transfer prices between two commonly controlled entities must be treated in such a way as if they are two independent entities.
Arm’s Length Principle is based on real markets and provides a single international standard of tax computation, which enables various governments to collect their share of taxes and at the same time creates enough provisions for MNCs to avoid double taxation.
Case Study: How Google Uses Transfer Pricing
Google runs a regional headquarters in Singapore and a subsidiary in Australia. The Australian subsidiary provides sales and marketing support services to users and Australian companies. The Australian subsidiary also provides research services to Google worldwide. In FY 2012-13, Google Australia earned around $46 million as profit on revenues of $358 million. The corporate tax payment was estimated at AU$7.1 million, after claiming a tax credit of $4.5 million.
When asked about why Google did not pay more taxes in Australia, Ms. Maile Carnegie, the former chief of Google Australia, replied that Singapore’s share in taxes was already paid in the country where they were headquartered. Google reported total tax payments of US $3.3 billion against revenues of $66 billion. The effective tax rates come to 19%, which is less than the statutory corporate tax rate of 35% in the US.
Benefits of Transfer Pricing
- Transfer pricing helps in reducing duty costs by shipping goods into countries with high tariff rates at minimal transfer prices so that the duty base of such transactions is fairly low.
- Reducing income and corporate taxes in high tax countries by overpricing goods that are transferred to countries with lower tax rates help companies obtain higher profit margins.
Risks of Transfer Pricing
- There can be disagreements within the divisions of an organization regarding the policies on pricing and transfer.
- Lots of additional costs are incurred in terms of time and manpower required in executing transfer prices and maintaining a proper accounting system to support them. Transfer pricing is a very complicated and time-consuming methodology.
- It gets difficult to set prices for intangible items such as services rendered as these do not provide measurable benefits.
- Sellers and buyers perform different functions and thus, assume different types of risks. For instance, the seller may refuse to provide warranty for the product. But the price paid by the buyer would be affected by the difference. Thus, sellers and buyers need to face different kinds of risks such as financial and currency risks, collection risks, market and entrepreneurial risks, product obsolescence risk, credit risk, etc.
Transfer Pricing Case Studies – Detailed Analysis of 5 Case Studies. here we are providing All Case Studies on Transfer Pricing. You can find all best case studies in this article for Transfer Pricing. Recently we are providing What’s the Difference Between FDI and FII? and Stock market…An overview to know about at a Glance. You can also download CA Final Direct Tax and Indirect Tax Case Studies in my Another Articles. Now you can scroll down below and check complete details regarding “Transfer Pricing Case Studies”
Transfer Pricing Case Studies
- XYZ Inc., a fortune 500 Company is in the business of manufacturing of automobiles
- XYZ India is a 100 % subsidiary and provides CAD designing services.
- XYZ India is a captive service provider and is compensated on a C + 10 % mark up.
- XYZ India has applied the TNNM as the Most Appropriate Method using comparables operating in ITeS industry. –
- PLI applied – Operating Margin / Operating Cost
Position of the TPO
- Rejection of Loss Making Companies
- Rejection of Companies having only domestic transactions
- Rejection of Multiple year data
- Own set of Comparables provided without any search process (cherry picking)
- Proposed mark up of 30% -40%
Position of the Tax Payer
- Loss cannot be the sole criteria for rejection (entrepreneurial risk)
- TNNM requires functional comparability
- Financial results of comparables exhibit high degree of variation
- Integrated Service Provider to be excluded
- Companies having intangibles to be excluded ( unique software, brand name etc)
- Adjustment for :
- Working Capital
- Risk ( captive service provider Vs. entrepreneur)
- Captive Service Provider (BPO/ITeS)
–Losses not acceptable
–Proposed cost plus markups range from 25% to 40%
–“One size fits all” approach
–Comparables proposed inappropriate (no consideration for intangibles, differences in business models, etc.)
–Justifies markup saying “even after paying high markups, cost savings will be substantial”
- Adjustment of risk vis-à-vis third party comparables disallowed
- Working capital adjustments of 2% allowed in some cases
Case Study 1 on Transfer Pricing :-
Applicability of SDT to transactions between non‐residents
- Mr. X is director of FCO which has a PE in India
- Mr. X was deputed to work for PE in India from 1 November 2012 during FY 2012‐13.
- For services rendered upto October 2012, Mr. X was paid salary outside India. For services rendered post 1 November 2012, he is paid salary in India.
- PE is liable to tax on net basis in India. Mr. X’s status is non‐resident for FY 2012‐13.
- PE claims salary paid to Mr. post 1 November 2012 as deductible expenditure from its income.
- Whether salary paid to Mr. X is subject to Domestic TP considering that both FCO (and hence its
PE) as also Mr. X are non‐residents?
Case Study 2 – Applicability of TP for royalty paid by Indian and foreign subsidiaries to Indian parent
- Hold Co is an Indian company.
- Sub 1 is a foreign subsidiary. Sub 2 and Sub 3 are Indian subsidiaries.
- Hold Co. owns valuable brand ‘XYZ’ which is self generated for Hold Co.
- Hold Co is not eligible for any profit linked tax holiday
- The subsidiaries are engaged in manufacturing and distribution of diverse products.
- The subsidiaries sell their products under brand name of ‘XYZ’.
- The subsidiaries pay royalty to Hold Co. for use of brand name.
- Sub 1 has no presence in India and is not liable to tax in India.
- Sub 2 pays royalty of Rs.4 Cr to Hold Co. Sub 3 pays royalty of Rs.7 Cr to Hold Co. Both Sub 2 and
Sub 3 are not entitled to any profit linked tax holiday.
- Whether Hold Co. is liable for Domestic TP for royalty received from subsidiaries?
- Whether subsidiaries are liable to Domestic TP?
CASE STUDY 2 on Transfer Pricing
- A Ltd. is an Indian company and not eligible for any tax‐holiday
- B Ltd. is a foreign company located in U.S.A. and 100% subsidiary of A Ltd.
- C Ltd. is an Indian company, 100% subsidiary of A Ltd., and not eligible for tax‐holiday
- D Ltd. and E Ltd. are Indian companies, 100% subsidiaries of A Ltd. and eligible for deduction u/s.10AA
- A Ltd. granted interest free loans to B Ltd., C Ltd. and D Ltd.
- A Ltd. granted loan to E Ltd. at interest rate of 18% p.a.
What is the effect of Domestic TP in the hands of A Ltd., B Ltd., C Ltd., D Ltd., and E Ltd.? B Ltd. A Ltd. C Ltd. D Ltd. E Ltd.
CASE STUDY 4 on Transfer Pricing
CASE STUDY 5 on Transfer Pricing
- A Ltd. is an Indian company engaged in software development and eligible for section 10AA benefit
- B Ltd. is a wholly owned subsidiary of A Ltd. situated in China and provides R & D services to A Ltd.
- B Ltd. charges cost plus 20% mark‐up for providing R & D services to A Ltd.
- With effect from 01.10.2012, shareholding of A Ltd. in B Ltd. was reduced to 25%
- A Ltd. has earned OP/OC of 40% from 01.04.2012 to 30.09.2012 as well as from 01.10.2012 to 31.03.2013. Arm’s length OP/OC is 17%
- During F.Y. 2012‐13, whether A Ltd. will be subject to International TP or Domestic TP or both?
- In Domestic TP, whether transactions will be covered u/s. 40A(2) or 80‐IA(10) or both?
- Whether any upward adjustment can be made for A Ltd. by the AO under Domestic TP
- Provisions even though there is mere change in the shareholding without any change in the pricing mechanism of transactions with related party?
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