Transfer pricing is something that is inevitable if you have cross-border related party transactions. Most businesses today have foreign subsidiary or holding companies. This is frequently the clause which impacts the relationship two such companies. There are various transactions that take place among such related parties which fall under the purview of transfer pricing. For example: Selling products to your foreign holding company? Beware of Transfer Pricing. Selling property to directors staying abroad? Beware of transfer pricing?
What is Transfer Pricing?
Transfer Price refers to the price of goods & services which is used in accounting for transfer of goods & services from one responsibility center to another or from one company to another associated company. Transactions that are being done between related parties must follow the arm length price mechanism. Arm length price mechanism refers that the transfer price charged from related parties should be equivalent to price charged from independent party in uncontrolled conditions.
Who is a “Related Party”?
As per Companies Act, 2013, following relationships fall under the “Related Party” definition:
- Holding and Subsidiary companies (direct or indirect)
- Associate Company (>20% or control of business decisions under an agreement)
- Directors and Key Management Personnel (including their relatives) of the company or its holding company
- Firms and Private companies in which directors, managers or relatives are partner, director or members
- Any person on whose advice, unless given in a professional capacity, a director or manager of the company is accustomed to act
- Public company in which the director or manager is a director and4 holds along with his relatives more than 2 % of the paid up share capital
Transfer Pricing Audit:
The rules & regulations regarding transfer pricing in India came in 2001 & the audit of transfer pricing started in 2003. The Central Board of Direct Taxes i.e. CBDT organized a special cell of experts that were in charge of transfer pricing audit. Till now there is a huge increase in these experts that are called transfer pricing officers (TPO). TPOs have adjusted many cases of transfer pricing which were selected for auditing. Here are some situations which lead to Transfer Pricing Audit by the TPOs:
1. Uniform losses of the tax payer assigned to inter – company transactions.
2. Notable alteration in the profitability of the tax payer & its related parties.
3. Unacceptable huge amounts of management charges not qualifying the “benefit test”.
4. Losses incurred by normal business distributors.
To sustain transfer pricing audit one must keep a regular check on its transfer pricing policies & methods. Let’s discuss some key points that can help your business survive transfer pricing audit:
1. Strong & Long Lasting Transfer Pricing Documentation: An adequate transfer pricing documentation is required in case of sale of goods by Indian Company to its related party which is a foreign entity. It must contain detailed analysis of economy as it is the important part of the transfer pricing documentation.
2. Constituting control of audit process: Sometimes the audit of transfer pricing documentation can become lengthy & time consuming. It is necessary and significant for person paying tax to carry out controlled audit process & for that the tax payer must lay his case in front of TPO. If the tax payer furnishes the business reality & economic analysis then by this he can control the audit process.
Effects of transfer pricing!
Transfer price affects the revenue of transferring division & the cost of receiving division. This further affects the evaluation of profit level, returns and managerial performance of both divisions. Transfer price affects the tax liability of the business. It plays an important role in establishing the overall liability of the organization. It influences three major managerial accounting areas in the business which is, firstly the cost & the revenues between the transacting divisions, secondly division managers’ incentives to sell its products internally or externally & thirdly when products are sold across international borders as it determines the tax liability & tax liability is different in different jurisdictions.
It is mandatory for the Companies that are engaged in selling of products & services to related parties must maintain transfer pricing documentation as they have to present the file for audit & if they fail to maintain the file then they are charged with huge penalties. Penalties is not a great issue but more important issue is the adjustment of transfer pricing because if the tax authorities review & the prices applied are not matching the arm length standards then they might conduct transfer pricing adjustments which will affect the following:
Business: Transfer pricing adjustments can cause double taxation i.e. taxation on profits of same transaction twice & to avoid double taxation the parties concerned must make a settlement on long term & additional costs. The parent company or the holding company is responsible to review the transfer pricing policy in respect of all the subsidiaries.
Cash Flow/Predictability: The business utilizes the funds they have to pay unexpected spending from past for example retrospective payments, income tax or penalties. There comes a circumstance where transfer prices products & services are charged with custom duties so in that case the importer will have to pay additional custom duties as well as interest or penalties that might incur.
Development Procedure: With fewer amounts of resources available to the company, the company may delay its investment plans.
Performance Barometers: Adjustment of performance barometers in respect of profitability affects the goodwill of the company in the stock market which leads to increase in financing cost requested by banks & investors.
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