Transfer Pricing, IFRS

Understanding the Basic Concepts of Transfer Pricing

When a company supplies good, renders services or finance to another related company, the pricing involved is called a transfer price. The concept of transfer pricing is an internationally accepted concept given by the International Financial Reporting Standards (IFRS). According to the concept, transactions among related parties, also known as associated enterprises, should be conducted on the same terms that would be used for unrelated parties. To this end, an arm’s length price is followed and Double Tax Avoidance agreements are entered into with the domestic tax authorities of various countries, which have adopted this principle.

Are Domestic Transactions Covered under this Principle? 

The principle is applicable to domestic transactions, only if the total amount transacted exceeds Rs 5 crore in a given financial year. These rules have been formulated under the Income Tax Act, 1961.

1. Any payment to which section 40A (2)(b) is applicable.
2. Any transaction with comes under section 80A
3. Any business deal with a person specified in 80-IA(10)
4. Any transaction with reference to Section 10AA, Chapter VI-A, to which 80(10) or 80(18) applies

How is the Arm’s Length Price Determined?

The arm’s length price, which is given by IFRS, works in three steps. First, the transaction should be analyzed, which cover assets, functions and risk. Based on this, the most appropriate method of pricing should be determined and the method chosen should be applied to the transaction. These methods include,

1. Resale Price Method
2. Cost Plus Method
3. Profit Split Method
4. Transactional Net Margin Method
5. Comparable Uncontrolled Price Method

Is it Applicable to all Companies with International Transactions?

Corporate taxpayers, who have a total international transaction worth below Rs 1 crore, do not require maintaining pricing documentation. Although it is mandatory, substantial documentation on arm’s-length price of international transactions is advisable.

How can Financial Institutions Assist?

Financial Institutions have a specialized team of professionals, who assist in the various transfer pricing issues that a company faces. Here is a list of key areas that may be covered by the team.

1. Compliance: They assist in maintaining and preparing the necessary documents, doing economic and financial analysis for the company.
2. Planning: They also provide guidance when settling up policies.
3. Dispute resolution: The team conducts pricing audits. In case of a dispute, the team will assist in raising objections and appeals.  They also cover mutual agreements and advanced pricing agreements.
4. Restructurings: On account of changes in profits levels or turnover of international transactions, they provide economic justification for these changes, in order to correct the same.

Today, with the sheer volume of international transactions, a lot more companies are involved in the huge ocean that is transfer pricing.