Types of Transfer Pricing Methods

What is Transfer Pricing in Taxation?

The definition of Transfer Pricing states that it is the value which is allocated to the good or services transferred between the related parties. In other words, when goods or services are transferred from one unit of the organization to another unit situated in another country, the price which is pad for such goods or services is calculated as per the concepts of Transfer Pricing. 

Which transactions are priced under Transfer Pricing rules?

Following are the examples of transactions that fall under the purview of Transfer Pricing: 1. Purchase of raw materials, fixed assets, etc. 2. Sale or purchase of tangibles or intangible assets 3. Sale of Finished Goods 4. IT enabled or Support related services 5. Software Development services 6. Reimbursement of expenses 7. Payments in nature of fees for Management, Technical Service, Royalty, Corporate Guarantee, etc.  8. Loans paid or received

Objective of Transfer Pricing Rules:

In terms of better accountability, subsidiary units are often considered as standalone business units. As a result, any transaction between such subsidiaries and parent company has to be valued as per the Transfer Pricing rules. This ensures appropriate allocation of revenue and expenses to the subsidiary companies situated in different countries.  In the recent times, Government has increased their scrutiny over the transactions between the related parties because such intra-organization cross-border transactions often impact the profitability of such units. This in turn impacts the shareholder’s wealth. 

What are the different types of Transfer Pricing methods?

Before we discuss the different types of Transfer Pricing methods, it is important to understand the meaning of arms- length price. Arms-length Price can be defined as the price applied to a similar transaction between unrelated parties in an uncontrolled condition. The Organization for Economic Co-operation and Development (OECD) Guidelines lay out 3 methods for examining the arms-length price of the controlled transactions. They are:

1. Comparable Uncontrolled Price (CUP) Method:

In this method, the price which is earmarked for an uncontrolled transaction between comparable firms is evaluated for determining the Arm’s Length Price.

2. Resale Price Method or Resale Minus Method:

For determination of the Arm’s Length Price between related firms, the price of the good or services rendered to unrelated third parties is considered, also known as the Resale Price. Then Gross Margins and Costs associated with the purchase of such products are deducted to finally arrive to the Arm’s Length Price for a controlled transaction. 

3. Cost Plus Method:

In order to arrive to the Arm’s Length Price under Cost Plus Method, the costs of the supplier of goods or services in the controlled transaction is added to a markup which includes profit for the associated enterprise on basis of functions performed and risks.   

Also Read:

• Specific Issues in Transfer Pricing

• Transfer Pricing Specified Domestic Transaction