MEANING OF TRANSFER PRICE
Transfer Price, means the price, which is charged between two or more entities of a MNE [Associated Enterprises (AE’ s)] operating in different countries.
INTRODUCTION TO TRANSFER PRICING
X Ltd. operates in Country A, wherein the tax rates are 30%. It intends to sell goods costing USD 100 to a customer in Country B for USD 150.
CASE I – IF GOODS ARE SOLD DIRECTLY TO A CUSTOMER IN COUNTRY B
In such a case, its profit would be: –
= (Sale Price – Cost)
= USD 150 – USD 100
= USD 50 Tax
Tax = 30% of profit = 30% of USD 50 or USD 15
X Ltd. saved USD 5 in taxes (USD 15 in CASE I Vs. USD 10 in CASE II) by selling goods via subsidiary C ltd. located in Country Y
CASE II – IF GOODS ARE SOLD IN COUNTRY B VIA SUBSIDIARY IN ANOTHER COUNTRY
To save taxes, X Ltd. incorporated a subsidiary in Country Y, namely Subsidiary C, where tax rate is 10% and sold the goods to C for USD 125, which in turn, sold the goods to buyer in Country B for USD 150. In such a case, tax is computed as under: –
Tax = (Tax in Country A) + (Tax in Country Y)
= (125 – 100) *30 + (150 – 125) *10%
= 7.5 + 2.5 = USD 10
WHAT IS TRANSFER PRICING?
Different countries have different rules on taxation, in terms of tax rates, tax exemptions etc.
Unrelated entities, usually transact business, at prices which are driven by commercial considerations. However, in case of Multi National Enterprise, transaction between group companies, may be structured in a manner, whereby the maximum profits accrue in jurisdiction with low/ Nil rates of taxes. This is achieved through contracts and prices, which are driven by tax rates, rather than commercial considerations.
TRANSFER PRICING CONCEPT
Transfer pricing is, arriving at of the price for goods and services, which are transacted between controlled legal entities (branches /companies) within an enterprise, whether in same or different countries, under the assumption that they were independent parties.
For example, if a parent company sells goods to a subsidiary company, the price received would be covered under Transfer Pricing.