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TRANSFER

PRICING
Group No.5
Alka 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 wellestablished ,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 managements


perception

Upstream Fixed Costs and


Profits
The 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 A
Expected monthly sales to business unit Y 5,000 units
Variable Cost per unit
5$
Monthly Fixed Costs assigned to product 20,000 $
Investment in working capital and facilities
1,200,000
$
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 units 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 noncompliances

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