Transfer Pricing

Transfer Pricing

Subject : Economy

Section : Fiscal Policy

Concept :

• The Income Tax department recently conducted surveys in BBC offices located in Mumbai, Delhi, and in different other cities in the country.
• According to the IT Department, the BBC has violated “Transfer Pricing Rules”. Transfer Pricing is a practice where one company charges another (in the same division). The parent company of both companies is the same.

What is transfer pricing?

• Transfer pricing is an accounting practice that represents the price that one division in a company charges another division for goods and services provided.
• In such transactions, one party transfers to another goods or services, for a price known as transfer price.
• This may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces.
• Hence, the expression “transfer pricing” generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises.

Understanding transfer pricing

• Suppose a company A purchases goods for 100 rupees and sells it to its associated company B in another country for 200 rupees, who in turn sells in the open market for 400 rupees.
• Had A sold it direct, it would have made a profit of 300 rupees. But by routing it through B, it restricted it to 100 rupees, permitting B to appropriate the balance.
• The transaction between A and B is arranged and not governed by market forces. The profit of 200 rupees is, thereby, shifted to the country of B.
• The goods is transferred on a price (transfer price) which is arbitrary or dictated (200 hundred rupees), but not on the market price (400 rupees).

What effect does transfer pricing have?

• The parent company — or a specific subsidiary — tends to produce insufficient taxable income or excessive loss on a transaction.
• Profits accruing to the parent can be increased by setting high transfer prices to siphon profits from subsidiaries domiciled in high-tax countries, and low transfer prices to move profits to subsidiaries located in low-tax jurisdiction.

What is the “arm’s length arrangement” that the BBC has allegedly violated?

• Section 92F of the Income Tax Act, 1961 defines arm’s length price as a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions.
• e., the price a division or subsidiary of a company pays to buy goods or services from another division or subsidiary should be the same as the market rate — as if the two entities were unrelated.
• This is the rule the BBC has allegedly violated.