Transfer pricing refers to the determination of the price of goods or services transferred between the same entities of a multinational organisation. Intangible assets are also subject to transfer pricing.
Transfer pricing is prevalent in today’s modernised and globalised world because now multinational companies conduct business across various countries. While transfer pricing ensures many advantages in the form of taxation, they are also subject to certain limitations.
Keep reading to know more about the limitations of transfer pricing.
Challenges of Transfer Pricing
Due to the complexity of its calculation and imposition, some primary challenges of transfer pricing are:
Complexity and Legal Compliance
Transfer pricing involves implications of various international and domestic laws. A TP expert needs to be accustomed to various international bilateral treaties and domestic laws to calculate. This multitude of laws sometimes leads to handicapped calculations because the tax authority of one country may interpret the laws differently than another.
Tax Avoidance
It is common for multinational corporations to move their profits to low-tax jurisdictions, leading to base erosion and low tax revenue payment in higher-tax jurisdictions. Recently OECD (Organisation for Economic Co-operation and Development) is coming up with new or updated legislation leading to tax authorities worldwide taking anti-tax evasion measures.
Arm’s Length Principle
Notably, it is the most common and preferred concept of transfer pricing, where a transfer price between 2 related/ affiliate companies should be calculated based on the same transaction between 2 unrelated companies in the open market. It commonly leads to disputes with tax authorities because determining comparable transactions takes time and effort. Tax authorities may take another similar transaction other than the transaction selected by the companies as the arm’s length price.
Documentation
Most countries require all the documents that support a transfer pricing decision. Documents may include master files, local files and country-by-country reporting. Preparing and maintaining these files is an exhaustive task, as many documents are involved in a single inter-company transaction.
Currency Fluctuations
As transfer pricing involves cross-border transactions, the dynamic nature of currency affects the costs and prices, subsequently affecting the profits.
Risk of Double Taxation
Double taxation refers to the charging of taxes on the same transaction by two different tax authorities. Inaccurate transfer price calculation can often lead to double taxation and conflict with tax authorities.
Intercompany Transactions
A multinational company can have many subsidiaries doing transactions within themselves. Extensive transactions between subsidiaries or parent companies can lead to complex transfer price determination and potential intercompany conflicts.
The price of cross-border transactions is crucial for customs duties and taxable profits. Still, related parties may face different market forces, leading to potential manipulation of duties and profits through under or over-pricing.
Opportunities for Transfer Pricing
Transfer pricing affects/influences both the direct as well as indirect tax. Some opportunities that transfer pricing provides are:
Tax Efficiency
With the help of transfer pricing, a company can allocate its profits to different lawful jurisdictions for efficient tax management. With the help of correct interpretation of statutes, companies can minimise their tax liability.
Business Planning
Transfer pricing is one of the main components multinational corporations consider for future business planning. By calculating the tax implications of transactions on cross-border transactions, a company can efficiently structure its operations for increased tax minimisation.
Intellectual Property Management
With the help of fair and accurate transfer pricing calculation, a company can strategically manage its Intellectual Property (IP) rights. Multinational companies can centralise their holdings by assigning appropriate royalties or licensing fees against using their IP across various entities.
Risk Management
Maintaining proper and elaborate documents of transactions ensures a low risk of disputes with tax authorities. A fair and transparent document will help the company have a strong base/ foundation during the tax audits on the transfer pricing decisions.
Advanced Pricing Agreements
Advanced Pricing Agreements or APAs refer to agreements between the tax-paying company/entity and the tax authorities in advance. These agreements are based on the appropriate transfer pricing method for future transactions. These advance agreements facilitate smoother and easier calculation of transfer prices without the risk of potential disputes with the tax authorities.
Knowledge and Technology Transfer
Transfer pricing ensures the legitimate transfer of knowledge across a multinational organisation, helping with better resource allocation and innovation within an organisation.
Transfer pricing in the international sphere provides opportunities and certain challenges for cross-border transactions. Complexity, compliance burden, and potential for tax avoidance pose significant challenges for transfer pricing. But, fair and efficient transfer pricing determination ensures tax efficiency, risk management, business planning and advantages.
