The term “transfer pricing” refers to an accounting concept that measures the cost of products and services given by one division of a firm to another.
Using transfer pricing, a parent company may set prices for its subsidiaries, affiliates, or firms under common management to facilitate the purchase and sale of products and services. Companies may be able to save money on taxes by using transfer pricing, but the government may challenge such claims.
Let us learn more about transfer pricing through this article.
The concept of transfer pricing
Transfer pricing is the Value assigned to products and services exchanged between affiliated businesses. In other terms, transfer pricing is the rate that is paid for products or services moved from one unit of a company to its other units located in other countries.
The following is a list of some of the more common types of international transactions that fall under the purview of transfer pricing regulations:
- The selling of manufactured products
- The procurement of primary materials
- Acquisition of permanent assets
- The purchase or sale of various types of machinery
- Trade of intangible goods (sale or purchase)
- Expenses that have been paid or received can be reimbursed.
- services enabled by information technology
- Services of assistance
- Services related to the development of software
- Charges for Technical Services
- Management fees
- Payment of royalties
- Charges for Corporate Guarantees
- A loan that was obtained or repaid
What is the purpose of transfer pricing?
The main goals of transfer pricing are:
- Generating distinct earnings for each of the segments and allowing performance assessment of each division independently.
- Since transfer pricing would influence a company’s resource allocation, it wouldn’t merely affect the stated earnings of each centre. Transfer pricing is an accounting and taxation practice so firstly we need to understand importance of tax planning .
Why is transfer pricing important?
Multinational corporations (MNCs) have leeway in determining how to allocate revenues and costs to overseas operations for management accounting and reporting as it plays importance role in tax planning.
Depending on the circumstances, a company’s subsidiary may be segmented or treated as a separate entity. Transfer pricing is useful in these situations because it allows for the correct allocation of income and costs to the appropriate subsidiaries.
To what extent a subsidiary earns money is determined by the costs of its business dealings with its parent firm. These days, governments are paying more attention to the deals between companies. Transfer pricing can affect shareholders’ wealth by affecting taxable income and after-tax free cash flow.
Understanding the transfer pricing idea is essential for every organization engaging in cross-border intercompany transactions, as it is necessary to meet legal compliance requirements and avoid the consequences of doing so.
Strategies for pricing transfers
Guidelines established by the Organization for Economic Co-operation and Development (OECD) detail transfer pricing strategies that may be used to analyze the true market value of regulated transactions.
The term “arms-length pricing” is used to describe the rate at which two unrelated parties would do business under normal, unrestricted circumstances. Three of the most popular approaches to determining transfer prices are described here.
Any business that has some stake in another, whether financial or managerial, is considered to be an “associated enterprise” for this definition.
Pricing transactions between affiliated businesses by the arm’s length concept is known as “transfer pricing.” Companies in the same industry are required to set the transfer price at the same level as what an unaffiliated third party would pay for an identical product or service.