TRANSFER PRICING

Group No.5Alka IB(02)Saurabh Ramdasi IB(60)Mayuresh Wagh IB (59)Sampada Oak IB (32)Ritesh IB (62)Ruchi Singh IB (51)

Agenda of the Presentation

Introduction about Transfer Pricing

Transfer Pricing Methods

Pricing Corporate Services

Administration of Transfer Prices

Trends in Transfer Pricing

Case Study

What is Transfer Pricing Establishing the price charged for transactions

between related entities.

Tangible Property Intangible Property Controlled Services Financing Arrangement

Indian Scenario Transfer pricing applied to international

transactions

However, the Finance Act, 2012 expanded the ambit to cover domestic transactions entered into by a company with related parties, if the aggregate of such transactions in a year is over Rs5 crore. 

Fundamental Principle

Transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendor.

Transfer Pricing Methods

Market price. Competitive price. Cost based.

MARKET PRICE : IDEAL SITUATION A market price based transfer price will induce goal congruence if following conditions exists Competent People Good Atmosphere Market Price : The ideal transfer price is based on well-

established ,normal market price for the identical product being transferred –that is a market price reflecting the same conditions(quantity , delivery time and quality ) as the product to which transfer price applies .

Freedom to Source Full Information Negotiation

Constraints on Sourcing Limited Markets

Existence of Internal capacity Sole producer of differentiated products Significant investment in facilities

Transfer Price->Competitive Price

Excess or Shortage of Industry Capacity

How to determine Competitive Price

Through published market prices .However ,these should be prices actually paid in the marketplace under consistent conditions.

Market prices may be set by bids. If the production profit center sells similar

products in outside markets ,it is often possible to replicate a competitive price on the basis of the outsider price.

If the buying profit center purchases similar products from the outside market, it may be possible to replicate competitive prices .

Cost Based Transfer Prices If competitive prices are not available, transfer prices

may be set on the basis of cost plus a profit .

The Cost basis :The usual basis is standard costs .Actual costs should not be used to avoid production inefficiencies

The Profit Markup :

Profit markup based as percentage of costs or percentage of investments .

The level of profit allowed .Senior management’s perception

Upstream Fixed Costs and ProfitsThe profit center that finally sells to the outside customer may not be aware of the amount of upstream fixed costs and profit included in its internal purchase price .

Methods to mitigate the problem

Agreement among business units Two-Step Pricing Two Sets of Prices :Manufacturing unit revenue as per

outside sales price and buying unit is charged total standard costs .The difference is charged to a headquarter account .

Two Step Pricing • Transfer Price calculated including two

charges – Standard Variable Cost – Charges made equal to the fixed cost of production

Eg. Business Unit X Product AExpected monthly sales to business unit Y 5,000 unitsVariable Cost per unit 5 $Monthly Fixed Costs assigned to product 20,000 $Investment in working capital and facilities1,200,000 $Competitive ROI on investment per year 10%

Calculation of Transfer Price

» Variable cost per unit $ 5» Plus fixed cost per unit

20,000/5000 =$4» Plus profit per unit

($1,200,000/12)*0.10/5000

=$2

Total Transfer Price Per unit $11

PRICING CORPORATE SERVICES

Deals about the pricing of services furnished by corporate staff to the business units.

Costs of Central Service units are excluded on which business units have no control Eg: Public Relations, Administration, Accounting.

2 types of transfers: Receiving unit must accept, but atleast can

partially control the amounts used Business units can decide whether or not to

use.

Control over Amount of Service Business units may be required to use company

staffs for services such as information technology and R&D. In this situation Business Unit Manager cannot control the efficiency with which these activities are performed but can control the amount of the services received.

School 1: Business unit should pay the standard variable cost of the discretionary services.

School 2: price equals to standard variable cost + a fair value of the fixed costs = full costs

School 3: Price equivalent to the market price (or) standard costs + profit margin.

Optional Use of Services Here management may decide that business

units can choose whether to use central service units.

Business units may procure the service from outside, develop their own capabilities or choose not to use the services at all.

Eg: Information Technology, Internal Consulting groups and maintenance works.

If the internal services are not competitive, then the business units have an option to completely outsource the services.

NEGOTIATION AND

ARBITRATION IN TRANSFER

PRICING

Negotiation In Transfer Pricing Authority to business units to negotiate prices

with each other

Setting prices for business units and their profitability are primary functions of line management

Business unit managers cannot blame head office managers for arbitrariness of transfer pricing thus affecting their unit’s profitability

Business unit managers are expected to know their market and costs better than someone at the head office to arrive at a reasonable cost

Negotiation In Transfer Pricing Some Ground rules set up by the administration

need to be followed

Business units are allowed to deal with each other as well as with outside parties

They can buy from, or sell to, outside party if the deal offered is better than one by other business unit

In case of a tie, Business unit must keep the business inside

Some specific rules are set to avoid negotiating skills of managers becoming the sole significant factor in determining the transfer price

Arbitration and Conflict Resolution Different degrees of formality in arbitration:

Informal- A single executive personally speaking to the unit managers and orally announcing the price

Formal- A committee set up to Settle price disputes, review sourcing changes, change the pricing rules Involves written case presented by each party involved Arbitration committee reviews the positions and decides

on the price, sometimes with the assistance of the other staff offices

Arbitration and Conflict Resolution Relatively less and only the most significant

disputes should be submitted to arbitration Large number indicates that rules are not specific

enough or confusing to reach an agreement So that legitimate grievances are given more

attention to avoid undesirable effects if left unattended

Process for submitting a price dispute should be simplified

Four ways to handle a conflict: Conflict avoidance : Forcing, smoothing Conflict resolution: Bargaining, problem solving

Product Classification to Simplify Control on Transfer Pricing

Class I : Small number of large volume products for which no outside

source exists Senior management wishes to control its sourcing

Class II : Can be produced outside the company without any

disruptions to present operations Products with relatively smaller volume, produced with

general purpose equipment Transferred at market prices Sourcing determined by business units themselves

TRENDS IN TRANSFER PRICING

Trends in Transfer Pricing TP audits by worldwide Government authorities seem to

be intensifying with the global financial crisis, revenue deficits, etc leading to TP occupying a priority position in the agenda of the Global Tax heads of multinationals

At least 45 countries have specific transfer pricing legislation and regulations

Indian regulations are generally in line with OECD principles Detailed documentation requirements - Steep penalties up

to 4% of the value of transaction in case of non-compliances

Customs duties, royalty rates and withholding taxes are important considerations while framing the TP policies.

Contd… In the event of disputes, the multinationals are

also observed to be undertaking the exploration of Alternate Dispute Resolution (‘ADR’) mechanisms such as Mutual Agreement Procedure (‘MAP’) and Advance Pricing Agreements (APA) to achieve elimination of uncertainties (especially under APAs) and avoidance of double taxation emanating from TP related disputes.

Trends in Transfer Pricing:-Transfer Pricing Documentation

TP > increasingly becoming one of the priority tax issues faced by MNCs globally

Adoption of a coordinated approach in managing their TP documentation, which provides a balance between maintaining documentation centrally (at global and/or regional level) and then customising it locally

Global TP documentation encompassing principle transaction flows, principle pricing policies, etc. and having respective country chapters, customised to comply with their domestic tax laws

India > stringent documentation requirements and hence local documentation plays an important role in managing and mitigating tax risk

The central documentation ensures consistency and is relevant to understand the ownership of intellectual property and the decision making power in the value chain as well as for the application of TP policies

Contd… Benefits of this approach:

Assists the group in achieving economies of scale, avoiding duplication, optimising compliance cost, and also providing a framework to avoid double taxation

when tax authorities around the world are exchanging information, it is vital that all companies across the group operate in a cohesive manner