When one talks ‘Transfer Pricing’, the first thing that comes to mind is ‘Transfer Pricing Study Report’ or the ‘Documentation’. For many, transfer pricing as a subject revolves around documentation and meeting the compliance timeline, but seldom think of it as an instrument to effectively plan taxes or structure transactions. Through this article, we aim to highlight a different facet of transfer pricing which will add value in terms of effective structuring and savings.
Taxation needs compliance with the provisions and rules made therein. Income-tax returns/declarations are the classic examples of a compliance. Although a person pays taxes through various means, such as by withholding tax provisions, advance tax provisions and self-assessment tax, one would have to formally declare the income earned in the financial year, calculate taxes as per the rules and regulations of the taxation law, and file such declaration by the due date mentioned in the statute.
Similarly, the transfer pricing regulations require a compliance in terms of maintaining the documentation to prove the Arm’s Length nature of transactions. When we take a family holiday we plan the places to be visited, gather ideas about the place, finalize modes of transportation, collect travel insurance etc., and eventually, we proceed to take the actual vacation.
Now, if you tend to plan so much in life, why not do the same for your business? You have set up subsidiaries across the world, you have intercompany transactions on a daily basis, and you make decisions on these transactions, the logistics – storage, manufacturing, selling and distribution – of such transactions but at times forget the most important function for which the business strives, for example, pricing.
It is a common saying that “Well begun is half done”, and it very much applies to the exercise of Transfer Pricing. Hence, as the first step to transfer pricing, or even before starting a transaction, it is important to plan your prices. As such, establish the price setting mechanism for you, and do not look at transfer pricing only from a tax compliance point of view.
Following are the summarized benefits of planning transfer prices:
Brings certainty: Testing of transfer prices post closure of books then acts only as a post facto analysis documenting past details. The taxpayer does not have enough certainty throughout the financial year; whether the business that he is in to or the transactions that he has entered is at arm’s length thereby creating an atmosphere of uncertainty. A simple step, such as performing a preliminary transfer pricing analysis, would help to cover the situation.
Smoothens transfer pricing audits: The transfer pricing officer gets a fair idea about the process of price setting mechanism through documents, such as transfer pricing policies and inter-corporate agreements, which are an integral part of planning process. Once the science behind the transfer pricing model is explained, the process of an audit is simplified.
Helps achieve effective tax rate: Planning of taxes is a legitimate process, unlike avoidance or evasion of taxes. With aspects including inter-corporate financing, intangible property and inter-corporate service agreements, the management of MNC group would like to manage taxes to reduce the overall tax burden.
Globally, transfer pricing is treated both as a compliance measure and as an excellent planning tool to bring down the effective tax rate. It is up to you to choose whether to use this as a planning tool or merely comply. In our opinion, the sooner you shift to planning, the sooner you will have improvised control on pricing.