Transfer Pricing

 


Transfer Pricing


Definition:

Transfer pricing refers to the pricing of goods, services, or intangibles transferred between related entities or divisions within a multinational enterprise (MNE).


Understanding Transfer Pricing

Transfer pricing is a concept in taxation and accounting that applies when two or more associated enterprises (commonly parent and subsidiary companies) trade with each other. It determines the amount charged for these transactions, such as sale of goods, provision of services, use of intellectual property, etc.


For example, if an Indian subsidiary of a U.S.-based company sells a product to its U.S. parent company, the price at which the product is sold is the transfer price. These prices impact how much profit is reported in each country, and therefore, how much tax is paid.


Why Do Transfer Prices Matter?

Multinational corporations (MNCs) often operate in countries with different tax rates. If not regulated, they might manipulate transfer prices to shift profits from high-tax countries to low-tax jurisdictions — reducing overall tax liability.


To prevent such tax avoidance, governments enforce Arm’s Length Principle — the idea that prices charged between related parties should be the same as if they were unrelated.


Transfer Pricing in Indian Taxation

In India, Transfer Pricing Regulations are governed by:

  • Section 92 to 92F of the Income Tax Act, 1961

  • Rule 10A to 10E of Income Tax Rules

  • Overseen by the Transfer Pricing Officer (TPO) and CBDT (Central Board of Direct Taxes)


Indian law requires MNCs and related entities to:

  • Maintain detailed documentation

  • Comply with arm’s length pricing

  • Furnish Form 3CEB if international or specified domestic transactions exceed prescribed limits


Key Components of Transfer Pricing

1. Associated Enterprises (AEs)

Entities participating in the transaction that are related through ownership, control, or influence.


2. International Transaction

A transaction between two or more associated enterprises where at least one is non-resident.


3. Arm’s Length Price (ALP)

The price that would be charged between unrelated parties under similar circumstances.


Transfer Pricing Methods

The Indian Income Tax Act recognizes five main methods:

  1. Comparable Uncontrolled Price (CUP) Method

  2. Resale Price Method (RPM)

  3. Cost Plus Method (CPM)

  4. Profit Split Method (PSM)

  5. Transactional Net Margin Method (TNMM)


Formula: Arm’s Length Price (General Representation)

Though no single formula exists, CUP Method works like this:


ALP = Price charged in comparable uncontrolled transaction


Accounting Journal Entry Example

Assume: Indian Co. sells software to U.S. Parent Co. at ₹5,00,000
Journal Entry in Indian Co.’s Books:


Accounts Receivable (U.S. Parent Co.) Dr. ₹5,00,000 To Sales Revenue ₹5,00,000


If Arm’s Length Price was ₹7,00,000, and ₹2,00,000 was adjusted by TPO:


Additional Entry for Tax Adjustment (Not Accounting Entry):
It’s a tax adjustment done during assessment — not an accounting adjustment.


Illustrative Example

Let’s assume:

  • ABC India Pvt. Ltd. (subsidiary of ABC Global Inc.)

  • Supplies design services to its U.S. parent

  • Charges ₹1,00,00,000 during FY


On review, TPO finds the ALP to be ₹1,20,00,000
Thus, an upward adjustment of ₹20,00,000 is made


Tax Impact:

  • ABC India pays additional tax on ₹20,00,000 (treated as added income)

  • Interest and penalty may also apply


Legal & Compliance Implications

Failing to comply with transfer pricing regulations can lead to:

  • High tax adjustments

  • Penalties up to 200% of the tax avoided

  • Disputes and litigation


Thus, maintaining proper documentation, choosing correct methods, and submitting reports like Form 3CEB is crucial.


Why Transfer Pricing Is Important

  • Ensures fair tax collection by countries

  • Prevents profit shifting and tax base erosion

  • Encourages transparent pricing between related parties

  • Reduces risk of audit and penalty


Related Terms

  • Arm's Length Principle
  • International Transaction
  • Associated Enterprises
  • Base Erosion and Profit Shifting (BEPS)
  • Advance Pricing Agreement (APA)
  • Form 3CEB
  • ALP – Arm’s Length Price


FAQs

Q1. What is the penalty for not complying with transfer pricing in India?
A: Penalty can be up to 2% of the value of the international transaction or 200% of tax avoided.

Q2. Is transfer pricing only applicable to international transactions?
A: No. It also applies to specified domestic transactions exceeding ₹20 crore (as per Indian law).

Q3. Who needs to file Form 3CEB?
A: Any company having international or specified domestic transactions during the financial year.

Q4. How is ALP determined?
A: ALP is determined using prescribed methods based on comparables and business functions.


Expert Tip from Learn with Manika

"Always prepare transfer pricing documentation well in advance and align pricing policies with global standards. Consult a tax advisor for APA (Advance Pricing Agreement) to avoid future disputes."


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