Know the Importance of Transfer Pricing in India

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Laura Ingramhttps://mobilemall.pk/blog/
Laura is a passionate blogger writing blogs and guest post on business, finance, technology, SEO, digital marketing, B2B, E-commerce, social media marketing and Sem since 2016.

With globalisation, the structure of multinational companies has changed dramatically in the past few decades. Internationalisation of Indian companies and investments from foreign companies have changed the face of the Indian economy. It has led to the formation of many parents and subsidiary companies, both in India and offshores. But what happens when a subsidiary company wants to procure material from its parent company? Do related parties offer goods to each other at subsidised rates? Or do they charge higher? How does this affect the taxation process? The answer to all these questions is Transfer Pricing (TP).

Transfer pricing is the value attached to the goods or services being traded between two or more related parties. In simpler terms, the goods or services’ monetary value transferred from one business entity to another, both of which have the same parent organisation, and are located in two different countries.

Without any regulations, the companies will be free to decide the price of goods offered to their subsidiaries or associates. It will enable the company to exploit the loopholes and register more profits in countries with a low tax rate. Let us understand the concept of transfer pricing with an example.

Example:

Let us assume that a global entity ABC has two subsidiaries, Company E and Company F. Company E operates from a country with lower tax rates, while Company F runs from a country with higher tax rates. If ABC had to transfer goods or services from Company E to Company F, it would be beneficial for them if they recorded more profits in Company E. Therefore, ABC would direct Company E to charge more than the market value, thus increasing the profits. Company F, which would have bought the goods/ services for a higher price from the former, will have recorded lower profits. However, this will not affect the profits earned by the parent entity ABC.

Transfer pricing reduces the tax burden on the business entity. But when exploited, it prevents the governments from getting their due taxes. Also, sometimes companies become a victim of double taxation due to miscalculations while deciding the transfer pricing. To prevent both these situations, the governments have introduced regulations on TP.

Regulations on transfer pricing in India were introduced in 2001, under Sections 92 to 92F of the Indian Income Tax Act, 1961. The applicability is for both cross-border and specific domestic transactions between related parties. Transfer pricing in India is one of the crucial international taxation laws. To reduce the risk of non-compliance, it is vital for companies having cross-border intercompany trading to understand the importance of transfer pricing in India.

Arm’s Length Principle

Transfer pricing for a particular commodity is decided using the arm’s length principle. The regulatory authorities use several measures to determine the transfer pricing utilising this principle. Ideally, the price of the goods/services transferred to a related entity should be similar to any unrelated party’s price. The guidelines used to determine the market price must be referred to while deciding the transfer pricing.

Importance of Transfer Pricing in India

Various countries enacted transfer pricing regulations across the globe to ensure that the price at which the goods are transferred between associated entities is not used to shift profits artificially to low tax jurisdiction—thereby saving revenue in the form of taxes for the jurisdiction in which the profit is earned.

Transfer pricing regulations involve various methods to arrive at the arm’s length price of goods/ services. The jurisdiction in which the profits have been earned gets its due share of revenue as taxes. The revenue earned can be then further used for its development and advancement.

Transfer pricing regulations also ensure that the prices of the goods or services are fair and impartial. It provides equal opportunities to the businesses. It also ensures that the financial reports of such entities are correct and unbiased.

It facilitates separate evaluation of every individual aspect of a company’s performance. It enables the parent company to assess its subsidiaries’ performance and allocate its resources.

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