Transfer pricing refers to the rules and methods for pricing transactions within and between enterprises under common ownership or control.
Transfer pricing provisions are applicable on:
Specified domestic transactions
In relation to any income, expenditure, interest, and allocation of cost, between associated enterprises (AE), and are computed having regard to Arm’s length price.
Why Organizations need to understand Transfer Pricing:
For management accounting and reporting purposes, multinational companies (MNCs) have some amount of discretion while defining how to distribute the profits and expenses to the subsidiaries located in various countries. In these cases, transfer pricing helps in allocating revenue and expenses to such subsidiaries in the right manner.
The profitability of a subsidiary depends on the prices at which inter-company transactions occur. These days inter-company transactions are facing increased scrutiny by the governments. Here, when transfer pricing is applied, it could impact shareholders’ wealth as this influences the company's taxable income and its after-tax, free cash flow.
It is important that a business having cross-border intercompany transactions should understand the transfer pricing concept, particularly for the compliance requirements as per law and to eliminate the risks of non-compliance.
Certain key terms regarding Transfer Pricing are explained below:
Arm’s Length Price:
According to the Indian Income-tax Act, 1961, income arising from such transactions must be computed using the arm’s length price principle, that is, the amount payable if the trading companies were unrelated or uncontrolled.
Relationships falling under the Associated Enterprise category include direct or indirect participation in the management, control, or capital of an enterprise by another enterprise. They also cover situations in which the same person participates in the management, control, or capital of both enterprises.
International transactions refer to transactions between two or more AEs, where at least one must be Non-Resident, involving one of the following activities:
The sale, purchase, or lease of property, provision of service, lending, or borrowing of money.
AE and an unrelated person share a prior agreement.
The terms of the transaction are determined by AE.
Specified domestic transactions:
Following transactions with related domestic parties qualify as specified domestic transactions, provided the aggregate value of such transactions exceeds Rs 20 Crore :
Any expenditure with respect to which deduction is claimed while computing profits and gains of a business or profession;
Any transaction related to businesses eligible for profit-linked tax incentives, such as infrastructure facilities and SEZ units under specific sections of the Income-tax Act, 1961; or
Any other transactions as may be specified.