Transfer Pricing

Topics: Transfer pricing, Pricing, Arm's length principle Pages: 46 (13608 words) Published: January 28, 2010
Chapter 1

Introduction of the Topic


TRANSFER PRICING is a term used to describe all aspects of inter Company pricing arrangements between related business entities, and commonly applies to inter Company transfers of tangible and intangible property. Inter Company transactions across borders are growing rapidly and are becoming much more complex.

Transfer pricing refers to the internal pricing system that is used when divisions in the same firm deliver products or services to each other. The transfer price is a cost for the receiving division and revenue for the supplying division, so it affects the financial result of both divisions involved. Transfer prices can be based on market prices, but for various reasons a market-based transfer price might not be appropriate: transactions taking place between the divisions of the same firm are often unique and would not be offered stand-alone on the market. In practice, therefore, cost-based and negotiated transfer prices are used apart from market-based prices.

Transfer pricing, for tax purposes, is the pricing of inter Company transactions that take place between affiliated businesses. The transfer pricing process determines the amount of income that each party earns from that transaction. Taxpayers and the taxing authorities focus exclusively on related-party transactions, which are termed controlled transactions, and have no direct impact on independent-party transactions, which are termed uncontrolled transactions. Transactions, in this context, are determined broadly, and include sales, licensing, leasing, services, and interest

In India also, considering the importance of Transfer Pricing, Section 92 of the Income-tax Act, 1961 (‘the Act’) empowered tax authorities to make adjustments to income on arm’s length basis in case of transactions between residents and nonresidents having ‘close connection’. Also, section 40A (2) (a) was introduced in the Statute, giving powers to the assessing officer to disallow the expenditure incurred in respect of which payment is made to related parties, if assessing officer is of the opinion that such expenditure is excessive or unreasonable. However, these sections were limited in scope and had certain inadequacies viz. the term ‘close connection’ was not defined, there were no rules concerning documentation, the burden of proof was on the assessing officer, no rules were prescribed for determining arm’s length prices etc. On the Customs side, under the Customs Valuation (Determination of Price of Imported Goods) Rules, 1988, there were provisions for rejecting the transaction value when the buyer and seller were related persons or when they had interest in one another’s businesses.

Corporate the world over are expanding their wings in an effort to gain a share of the global pie. There is talk of the world fast turning into a global village with economies increasingly becoming inter-connected. But with cross-border trade comes a whole new set of problems, Transfer pricing is one of them.

When a company opens a branch in another country, gets its products manufactured there and then imports it, there is a question mark over what price should the parent pay for buying the product from the subsidiary. This price till now has been subject to the parent’s discretion and has been used by many corporate the world over to control the tax outgo to their Government. In effect, the price at which goods are transferred from one arm of the company to another is known as transfer pricing. The Finance Act 2001 introduced the detailed Transfer Pricing Regulations (T.P.R.) in India from 1stApril 2001


Taxation that is based on transfer pricing is becoming an important issue for many companies, whether U.S. based or foreign based. The regulations have sought to impose extensive general principles and guidelines that apply when the taxpayer selects the transfer pricing method. These...

References: 7th edition, Sahitya Bhavan Publications, Agra
Articles Studied
Explanatory Memorandum, Economic Times, 7th July, 2009
Sales in Cash
Payment by Draft or Cheque
Realization of Payment
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