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Understanding Transfer Pricing

business transfer pricingMatters related to Transfer Pricing Services for International Businesses or the tax levied on goods transferred within a multi-dimensional organization, operating across borders has emerged as one of the most contentious elements of the International Tax Law. Governments seek to stem the flow of taxation revenue internationally, because of which Transfer Pricing becomes a matter of importance and concern for multi-national businesses.

As Transfer Pricing requirements and implications can be a complex and daunting task, we provide an experienced and uncompromised perspective on all aspects related to it. Including compliance, planning, implementation and controversy. We will help ensure that your business’s tax positions are in sync with your business operations.

But before we get into the services we can offer, let us discuss Transfer Pricing, its tax implications for businesses and the global e-commerce, and other related factors.

What is Transfer Pricing?

Let’s suppose a manufacturer or a parent company purchases components from a subsidiary company located in another country, the price over which the components are transferred is the transfer price. The amount paid by the manufacturer affects the tax liabilities and profitability in both of the countries.

What are the different methods of calculating a Transfer Price?

Organizations use various methods to calculate transfer prices. The most commonly used methods are:

  • Market Rate Transfer Price – It is the most straightforward method of setting a transfer price that does not involve any complicated calculations. The companies both agree to transfer the goods on the current market price of the goods, with some room for adjustments.
  • Adjusted Market Rate Transfer Price – The adjusted market rate method is used when the current rate is not readily available. This method takes the market rate and adjusts it to some stated degree and set a transfer price.
  • Negotiated Transfer Price – Companies opt for this method of pricing when the current market rate is not readily available, the demand for the goods is limited or the item to be transferred is specific or highly customized. In which case the companies negotiate with each other to agree on a transfer price acceptable by each.
  • Contribution Margin Transfer Price – Where no set market price for the goods transferred is available, the contribution margin method is used by companies to set a transfer price based on the unit’s contribution margin.
  • Cost-Based Transfer Price – In this method, the price of the goods to be transferred is based on the total cost incurred by the manufacturing or transferring division. It consists of all the prime costs as well as the directly attributable overhead costs. Under this method, the company that makes the final sale to a third party earns the profit.
  • Cost plus Transfer Price – Another method used when the market value is not available is the cost-plus method. In this method, the transfer cost is the standard cost of production plus a standard profit margin.

How does it impact the Global E-Commerce?

The buyer and seller when transferring goods or raw material to each other are supposed to treat this transaction as independent entities or according to the “at arm’s length” principle. As defined by the OECD – Organization for Economic Cooperation and Development, “The value of participants’ contributions must be consistent with what independent enterprises would have agreed to contribute under comparable circumstances, given the total anticipated benefits they reasonably expect to derive”. But some loopholes in the system and some obsolete rules have allowed some international businesses to move their business operations in countries with lower tax rates to escape tax liabilities. According to the OECD this leads to governments globally losing $100 billion to $240 billion corporate tax revenues. As the government’s primary source of income is the tax, not having enough of it impacts the economy of the country as well as the global e-commerce as a whole.

Transfer Pricing Implications

Businesses have to pay taxes on the profits they make on the transferred goods or services. But for the businesses, rather than trying to evade taxes, another situation is known as “double taxation” may arise too as a result of transferring goods or services internationally. For example, a parent company buys components to manufacture luxury vehicles from its subsidiary based in another country and the governments of both the parent’s country and the subsidiary’s country levy taxes on the sale’s profits. The parent company will then be paying taxes in the subsidiary company’s country and its home country as well.

Steps taken by the OECD

As their income primarily comes from taxes, governments globally want to charge more tax. And as businesses want to earn more profit, they want to pay lesser tax. To create a balance between the two situations, create greater coherence and transparency for businesses who transfer goods internationally, the OECD has identified 15 “Actions”. Some of which are as follows:

  • Counter Tax practices more effectively, taking into account transparency and substance.
  • Assure that the transfer pricing outcomes are in line with value creation.
  • Require taxpayers to disclose their aggressive tax planning arrangements.
  • Re-examine transfer pricing documentation.
  • Develop multi-lateral instruments.
  • Transfer Pricing documentation and country-by-country reporting.

Our Suggestions

Operating as an International Business you need to be prepared for the changing global regulations regarding transfer pricing while regulations toughen. We suggest you do the following:

  • Make sure that the contractual language when making inter-company transfers internationally are in sync with what is happening in the real world.
  • Eliminate informal processes based on any personal relationships for the centralized oversight and coordination across companies of the transfer prices.
  • Reassess the locations your business operates in, especially those deemed as permanent. Relocation of staff or functions or acceptance of a permanent location need the systems to be changed accordingly.
  • Consider technological advancements that help streamline the transfer pricing workflows and help integrate transfer pricing with the business’s operations.
  • Carefully assess and document the risks assumed by both the transferring and receiving parties. For example, if one company bears foreign currency risk, it should be documented in the agreement.
  • Where tax risks are higher, consider negotiating a multi-year Advance Pricing Agreement (APA) with the tax regulatory authority.

Services We Offer

As businesses at different stages in their development and expansion have different tax requirements and obligations. We offer the best guidance on every aspect of the transfer pricing journey that meets your business’s needs. The services we offer include:

  • Planning and Implementation

We will be helping you design a tax structure that keeps up with the growth of your business globally and as you move your business operations to different locations.

  • Designing Tax Optimizing Business Models

We will be helping you to design tax optimizing business models that will comprise of value chain transformation analysis and implementation.

  • Transfer Pricing Policy Planning

Planning and documentation of tax compliant transfers help avoid any issues in the future with tax authorities and these documents can also serve as a supporting document. We will be helping your business plan a transfer pricing policy that keeps in consideration future implications or improvement and restructuring of existing policies.

  • Setting Appropriate Transfer Price Levels

Though it forms a part of the overall transfer pricing policy, we will be helping you set an appropriate transfer price by conducting a thorough and functional analysis of the proposed transactions and helping you select an appropriate transfer pricing method.

  • Documentation

Preparing U.S. and OECD-compliant contemporaneous documentation reports for the jurisdictions in which your business operates.

  • Tax Controversy Audit Support and Defense

We can help limit the uncertainty regarding your transfer pricing policy by pre-negotiating your position with the tax authorities and as well as defending the policy with the IRS and foreign tax authorities. This can be done through the Advanced Pricing Agreement (APA) or a private ruling.

  • IP or Cost Sharing Planning

In order to safeguard against the tax authorities claims of IP rights being transferred without reasonable compensation, we will provide a proper valuation for tax purposes.

  • Country by Country Reporting

It is very important for businesses that the CbCR-Country by Country Reporting forms accurately reflect their operations, assets, risk allocation and does not allow room for the tax authorities to impute an alternative interpretation that is more to their liking. We help your business achieve that as the BEPS Action 13 is implemented by more and more countries.

  • Drafting Contracts

According to the tax practices, form of a transaction matters the most so we will be helping you draft basic transfer pricing documents such as invoices, cost-sharing agreements, contractual agreements and other documents. The documents will be prepared according to the transfer pricing policy requirements.

A Final Word

As the Tax Authorities scrutinize Transfer Pricing more closely, and the new OECD BEPS standards create more strict rules, International Businesses face an ever-increasing tax risk. But with the help of professionals who know the regulatory environment and have the relevant experience in dealing with the Transfer Pricing for International Businesses, this risk can be mitigated.

You can consult us for all issues regarding transfer pricing for your Business.