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Transfer Pricing

Transfer Pricing

Transfer Pricing

The term transfer pricing refers to the value attached to the goods or services transferred between parties which are related to each other, the nature of which is mostly cross-border. On a precise note, transfer pricing is the price payable for the transfer of goods, services and technology from one economic unit to the other, wherein such units are situated in different countries but are a part of the same multinational entity. Apart from this, it also refers to the value attached to transfers between unrelated parties which are controlled by a common entity. This article seeks to create awareness of this concept.


Any individual who has undertaken an international transaction with an associated enterprise is required to maintain information and documentation as per the rules.

Also, any individual who has entered into an international transaction during a previous year is required to obtain an Accountant’s Report and furnish report before filing the income tax return which is 30th November of the financial year.

Listed below are some of the most common transactions which qualify for the provision of transfer pricing:

  • Sale of finished goods.
  • Procurement of raw materials.
  • Procurement of fixed assets.
  • Sale or purchase of machinery.
  • Sale or purchase of intangibles.
  • Reimbursement of expenses already paid or received.
  • IT-enabled services.
  • Support services.
  • Software development services.
  • Technical service fees.
  • Management fees.
  • Royalty fee.
  • Corporate Guarantee fee.
  • The receipt or payment of a loan.


Objectives of transfer pricing include:

Distinct Profits

The concept of transfer pricing is aimed at generating separate profits for each of the co-related divisions of an entity, and hence facilitates the performance assessment of them on an individual basis. On the same note, it facilitates subsidiaries and companies which are divided into multiple segments or vested with the mantle of a standalone business to be allocated with the appropriate revenue and expenses.

Minimal Tax Burden

Transfer pricing is neither affixed by any independent directors or transferee in an arm’s length transaction nor is it governed by open market considerations. This, in turn, results in the reduction of the overall tax burden.

Methods of Transfer Pricing

Various transfer pricing methods are outlined by the Organization for Economic Co-operation and Development (OECD) for determining the arms-length price of the controlled transactions. Arms-length price, in this context, refers to the price which is applied, proposed or charged when unrelated parties enter into similar transactions in an uncontrolled condition. Given below are some of the most prominent transfer pricing methodologies:

Comparable Uncontrolled Price (CUP)

The CUP method forms a part of OECD’s traditional transaction methods. It entails the process of comparing the prices of goods, services and conditions of controlled transactions with those of uncontrolled transactions by referring to comparable data from commercial databases. This method is considered to be the most appropriate in the existence of comparable data.

Before we head further, the following terms are elucidated for your understanding:

  1. Controlled Transactions – transactions between associated entities
  2. Uncontrolled Transactions – transactions between unrelated entities

Resale Price Method

Akin to the above method, the resale price method is a traditional form of determining transfer pricing. This method is initiated by examining the resale price of a product bought from an associated enterprise, which is later sold to an independent entity. The price charged on the resale of such product to the independent entity is termed as the resale price.

This is followed by the identification of retail margin, which includes the sum of money required by the reseller to make a fair profit, by considering the functions performed by the particular entity (including assets and risks assumed). The gross resale margin is then deducted from the resale price. The amount so derived after the deduction of margin and the performance of fair adjustments is considered as the arm’s length price for the original transaction between related entities.

For this method to be utilized, the resale price margins must be comparable. To ensure the comparability of transactions, the taxpayer needs to make appropriate adjustments to the transaction cost to account for the margin discrepancy.

Cost Plus Method

This traditional transaction method is meant to analyze a controlled transaction between an associated supplier and purchaser. It is mostly implemented when semi-finished goods are transacted between associated parties or when the associated parties have long-term arrangements for ‘buy and supply.’ Here, the supplier’s cost is added to markup for the product or service to enable the suppliers in making an appropriate profit that takes into account the functions performed by the entity and the existing market conditions.

Transactional Net Margin Method (TNMM)

Unlike the previous three methods, TNMM falls among the two transactional profit methods outlined by the OECD for determining transfer pricing. It entails the assessing of net profit against an appropriate base like sales or assets that results from a controlled transaction. The taxpayers, in this case, may use comparable data to identify the net margin that would have been earned by independent enterprises in comparable transactions. Also, the taxpayers must carry out a functional analysis of the transactions to assess their comparability.

On the same note, if an adjustment is required for a gross profit markup to be comparable, but the information on the relevant costs aren’t available, the taxpayers may use the net profit method and indicators to access the transaction. This approach can be put into use if the functions performed by comparable entities are subtly different. On the same note, if an adjustment is required for a gross profit markup to be comparable but the information on the relevant costs aren’t available, the taxpayers may use the net profit method and indicators to access the transaction. This approach can be enacted if the functions performed by comparable entities are subtly different.

Note: Transactional profit methods are used to assess the profits from particular controlled transactions.

Transactional Profit Split Method

As the name suggests, this falls among the two methods which are classified by OECD as transactional profit methods. It depicts how profits and losses would have been divided within independent enterprises in comparable transactions, thereby ensuring that it removes any influence from “special conditions made or imposed in a controlled transaction”. The process here is initiated by determining the profits from the controlled transactions that are to be split. Further to this, the profits are split between the associated enterprises according to how they would have been divided between independent enterprises in a comparable uncontrolled transaction. This method results in an appropriate arm’s length price of controlled transactions.

The splitting of profits can be pursued through the following approaches:

  • Contribution analysis – According to this approach, the combined profits are divided in accordance with the relative value of the functions performed by each of the related entities within the controlled transactions by considering the assets used and risks assumed.
  • Residual analysis – This approach divides the combined profits into two stages. In the initial stage, each entity is allocated arm’s length compensation for its functions and contribution to the controlled transaction. Profits or losses remaining after this stage is divided based on factual analysis.

Note: Organizations may choose any of these methods by considering the amount of available relevant comparable data, the level of comparability of the uncontrolled and controlled transactions in question, and whether or not a method is suitable for the particular nature of a transaction determined through functional analysis.  

Know more about procedure for calculating transfer pricing.