To say that no enterprise transacts beyond the territory of just one nation would be absurd and to vouch that such trade is determined entirely by the free market is a sham. To introduce it simply, transfer pricing is a profit allocation method used to allocate a multi national’s net profit or loss between tax jurisdictions. It involves differential pricing of goods and services, determined devoid of market forces, in different tax jurisdictions so as to minimize tax burden and maximize real profits.
Suppose enterprise A manufactures a commodity for Rs.100/- and sells it to enterprise B which is an ‘associated enterprise’ located in a tax friendly jurisdiction for Rs. 200 and enterprise B, sells the same in open market at Rs. 400/-, A, by routing it through B is liable to a tax only on Rs. 100 and enterprise B is liable to a tax on Rs. 200/-. The cumulative effect of transferring the profit is an overall lower tax liability to the enterprise and consequential loss of revenue to the State. At the same time, the enterprise is also exposed to ‘double taxation’ or paying tax in two separate tax jurisdictions, even though monetarily beneficial, which in-turn is detrimental as it creates an illusion of two independent commodities and transactions.
Applying ‘I’ll put my arm on a friend’s shoulder and keep a stranger at ‘arm’s length’, to counter such controlled pricing is to tax an enterprise at ‘arm’s length price’. Simply put, ‘arm’s length price’ is the price at which the commodity would be transacted between two unrelated enterprises in an international transaction under uncontrolled conditions.
Assessing an enterprise at ‘arm’s length price’ serves two ends- ensuring that an enterprise is aptly taxed, and there is no loss of revenue to the state, and ensuring that the enterprise is not exposed to “double taxation”.
An enterprise, may be assessed, at arm’s length price if the Assessing Officer deems it necessary to do so, by making reference to Transfer Pricing Officer. The Transfer Pricing Officer shall thereupon determine the arm’s length price by applying any of the methods discussed in Sec 10B of the Income Tax Act. Thereafter the Assessing Officer shall compute the total income of the enterprise having regard to the arm’s length price for imposing tax.
Authored by
Naqsha S Biliangady