Introduction to Transfer Pricing
Territorial expansion of businesses that followed after globalization, has led to an increase in intra company transactions and cross border transactions between related companies. For instance, while manufacturing activities are managed by an entity of a larger group in one country, marketing of the manufactured products in another country are being handled by a different subsidiary belonging to the same group. In such cases, Transfer Pricing mechanism determines the price of the goods, services, funds, rights or intangible assets that are thus transferred for sale or consumption to a related entity.
Transfer pricing is the pricing of goods, services, and intangibles between related parties. The arm’s length principle should be adopted for transfer pricing between related parties. Taxpayers should prepare and keep contemporaneous transfer pricing documentation to show that their related party transactions are conducted at arm’s length.
What is Arm’s Length Principle of transfer pricing?
Transfer pricing is not limited to just pricing but also includes terms and conditions of such transactions between related parties. It is important to understand the transfer pricing mechanism because it largely determines the revenue of related entities and therefore their taxable profits under their respective tax jurisdiction. The fundamental guideline for transfer pricing is “Arm’s Length Principle”, that is, the pricing of cross-border transactions between related entities must be market based, and similar to the pricing that would have been charged if the parties were unrelated.
The arm’s-length principle of transfer pricing states that the amount charged by one related party to another for a given product must be the same as if the parties were not related. An arm’s-length price for a transaction is therefore what the price of that transaction would be on the open market.
In the case of unrelated entities the market forces such as demand and supply largely determine the commercial pricing of such cross border transactions, but in the case of related entities, because of the element of association and relationship, there is a propensity to set prices that are deviant from the actual market price. The selling entity may undercut the price, or the buying party may set a higher cost in order to lower their profits thereby affecting their taxable income. Such distortion of prices will impact the tax liability of the entities in their respective jurisdiction.
With businesses rapidly expanding beyond their domestic borders, leading to a spike in cross border transaction between related parties, tax authorities around the globe are stepping up their scrutiny on such transactions. Where a related party transaction is identified to be not in compliance with the arm’s length principle, tax authorities would make adjustments to the profits and tax liabilities. Such adjustments along with interest and in some cases penalty will always amount to increased tax liability of the entity.
Therefore, multinational corporations should now approach transfer pricing in a structured manner by identifying the jurisdictions in which they operate, the related party transactions being undertaken, revisiting the structures to ensure that they are compliant with the transfer pricing guidelines, aligning the returns of the group entities commensurate with the value creation and preparing a comprehensive transfer pricing documentation to avoid tax adjustment and penalties.
Transfer Pricing should not only consider the compliance with the rules and regulations but also the reputational risk associated with non-compliance.
- IRAS does not have a specific preference for any one method. Instead, the method that produces the most reliable results, taking into account the quality of available data and the degree of accuracy of adjustments, should be selected.Taxpayers may also choose other more appropriate methods or use a combination of various methods to comply with the arm’s length principle. Whichever method the taxpayer chooses, transfer pricing documentation should be maintained to demonstrate that its transfer prices are established in accordance with the arm’s length principle.As per the OECD guidelines, the selection of method should always aim for the most appropriate method for a particular transaction. The most appropriate method is that method which, given the facts and circumstances of the transaction under review, provides the most reliable measure of an arm’s length result. In determining the reliability of a method, the two most important factors to be taken into account are:(i) the degree of comparability between the controlled and uncontrolled transactions; and (ii) the coverage and reliability of the available data.Since the selection of the most appropriate method involves a test of relative merit, a method that may not be perfect is not considered inappropriate, unless some other method can be shown to be more reliable or to provide a better estimate of an arm’s length result.
- Taxpayers are not required to submit the Transfer Pricing Documentation along with the annual tax return. It is required to be submitted within 30 days when required by IRAS.
- Where the Comptroller, in relation to the year of assessment 2019 or any subsequent year of assessment
– increases the amount of the income;
– reduces the amount of any deduction allowed; or
– reduces the amount of any loss,
a surcharge equal to 5% of the amount of the increase or reduction (as the case may be) shall be applied by the Comptroller.
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