Organisation for Economic Co-operation and Development came up with an international guideline-based on arm's length principle to curb this issue. Arm’s length price is the price for the same or similar transaction which took place between independent parties in uncontrolled situations.
Section 92C of Income Tax Act, 1961 specifies 5 methods of computation of Arm’s Length Price. You may read about such articles here.
As per the Arm's Length Principle, controlled transaction entities that are in correlation through management, capital, or control should agree to the same terms and conditions which they would have agreed in case of dealing with non-related companies for uncontrolled transactions.
Example: Suppose company A processes apples and trades with the distributor named Company B. The transaction between them will be an uncontrolled transaction if company B and Company A are not correlated associate entities, as defined under Income Tax Act, 1961. Hence, the terms and conditions considered in this transaction will be at 'Arm's Length Principle.'
Company P process Apples and those are sold by the distributor Company Q. Both Company P and Company Q are under common control of having common management are under Company R. Though the transaction is a controlled transaction, the terms and conditions need to comply with the transfer pricing regulations and need to satisfy the arm's length principle.
Article 9 of the OECD Model Convention contains discussion related to The Arm's Length Principle. Bilateral tax treaties have agreed upon the principal.
The OECD transfer pricing guidelines helps business organisations to avoid paying double taxation while allowing tax administrators to avail their fair share of taxes. Abuse of transfer pricing is a problem that the developing countries always face.
There are five different transfer pricing methods which come under two categories, that are-
a) Traditional Transaction Methods
b) Transactional Profit Methods.
The first method looks only at the individual transactions, but the second method takes care of the company's profit as well. Both of the methods take a specific approach and incorporate risks and benefits both at the same time.
There is nothing like a right or a wrong method- whichever suits a company's business module; they go for the one.
Let's dive into detailed information on both of the transfer pricing categories and their corresponding methods.
Under traditional transaction methods, we figure out similar transactions entered into between unrelated parties under uncontrolled conditions.
The terms and conditions related to the uncontrolled transactions (by third party organizations) get measured by Traditional Transaction Methods. Next, all the transactions are compared with the controlled transactions, which are made between associate enterprises to make sure they are operating at an arm's length. Three methods fall into this category.
In this method, we first need to find out similar transactions entered into with unrelated enterprises under uncontrolled conditions. Then under The CUP or Comparable Uncontrolled Price Method, the price of the uncontrolled transaction is compared with the price charged under controlled transaction after making all adjustments on account of differences.
E.g. A Ltd. manufactures mobile phones. It sold 10 white phones to its subsidiary B Ltd., located outside India, at the rate of INR 40,000 each. An ltd sold a similar phone of black colour in 100 quantity to an independent buyer for INR 35,000 each located in India.
Por consiguiente, la transacción entre A Ltd y B Ltd se considera una transacción internacional entre empresas asociadas. Por lo tanto, se aplicarán las disposiciones sobre precios de transferencia.
Para determinar el precio de plena competencia (Arm’s Length Price), se puede utilizar el método CUP para las transacciones entre A Ltd y B Ltd. Para determinar dicho precio, es necesario realizar ajustes basados en los siguientes motivos:
En consecuencia, el precio de plena competencia para una transacción entre A Ltd y B Ltd será el siguiente:
Sin embargo, los datos comparables son el elemento clave necesario para realizar esta diferenciación. Asimismo, las transacciones no controladas deben cumplir con altos estándares de comparabilidad para establecer un precio comparable.
El componente principal del método RPM es el precio de reventa. En este caso, se considera el precio de reventa de la empresa asociada a una parte independiente.
A continuación, el precio de reventa se reduce mediante un margen bruto, que se establece comparando los márgenes brutos de transacciones comparables realizadas por organizaciones no relacionadas.
Después, los costes asociados a la compra se deducen del total. La cifra final resultante se asigna utilizando el principio de plena competencia para la transacción controlada realizada entre las empresas afiliadas.
Ej. M/s A Ltd. vendió el teléfono móvil a su filial B Ltd, ubicada fuera de la India, por 40 000 INR por unidad. B Ltd vendió dicho teléfono por 50 000 INR a C Ltd. (no asociada). B Ltd. también compró un teléfono similar a una parte independiente por 42 000 INR y lo vendió a D Ltd (no asociada) por 55 000 INR. Podemos calcular el precio de plena competencia (ALP) para la transacción entre A Ltd y B Ltd de la siguiente manera:
Cálculo del ALP para la venta de bienes de A Ltd a B Ltd.
El método del coste incrementado (CPLM) compara el beneficio bruto de una empresa con el coste total de las ventas. Este método determina los costes cotizados por el proveedor en la transacción controlada realizada entre empresas afiliadas.
A continuación, se añade el margen de beneficio basado en el mercado al valor total para obtener un beneficio adecuado. Para utilizar el método del coste incrementado, la empresa debe identificar los márgenes de beneficio de transacciones comparables realizadas entre organizaciones no relacionadas.
Ej. A Ltd. vendió teléfonos a su filial B Ltd por 40 000 INR. El coste de fabricación de dicho teléfono es de 30 000 INR. A Ltd. no ha vendido ningún producto similar a una parte no relacionada durante el año. Por consiguiente, se puede utilizar el método CPL para determinar el ALP. El ratio de beneficio bruto normal de la empresa es del 25 % sobre el coste de los bienes vendidos. En este caso, el ALP será el siguiente:
Este método no mide los términos y condiciones de las distintas transacciones. En su lugar, examina los beneficios operativos netos obtenidos de las transacciones controladas y estima sus similitudes con los beneficios de transacciones comparables realizadas por empresas terceras. Este proceso se lleva a cabo para garantizar que todos los márgenes de la empresa se ajusten al principio de plena competencia.
El método de beneficios comparables (CPM), también conocido como método del margen neto transaccional (TNMM), determina los precios de transferencia considerando únicamente el beneficio neto de una transacción controlada realizada entre empresas asociadas. A continuación, este valor de beneficio se compara con los beneficios netos de transacciones no controladas realizadas por empresas independientes.
Por lo general, las empresas utilizan este método cuando no tienen ninguna transacción similar en una situación no controlada. En consecuencia, para determinar el precio de plena competencia, podemos considerar una transacción de una empresa independiente que se dedique a la venta de un producto similar en condiciones no controladas.
Sometimes, associated companies get into interconnected transactions which means these organizations can't be seen on a specific basis. Under the profit share method, two or more enterprises operate under the same brand and agree to share or split the profits.
The main issue with the Arm's Length Principle and Transfer Pricing is that the policy leaves room for too much interpretation. That eventually results in huge discussions in between the tax administrators and taxpayers.
As we understand, neither all products are the same, nor they have equal brand value. Therefore it's relatively tough to compare various products with the market price.
Another thing is irrespective of the Arm's Length Principle MNEs can shift profits to lower tax jurisdiction to avoid tax. Example of this is the passive income allocation of companies earned from tax havens without having any real activities to showcase.
Often, multinationals take advantage of transfer pricing and get round exchange controls and repatriate profits in a tax-free form. The OECD offers technical help to developing nations to implement transfer pricing rules through the standard way.
Read more: Quick Guide on GSTR-1 Return Filing
