Transfer Pricing (‘TP’) and/or tax?

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  • By Taxmann
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  • Last Updated on 19 May, 2022

Transfer Pricing

Suhash Kantamneni – [2022] 138 318 (Article)

When management graduate shear the word: Transfer Pricing, their mind will race back to their B-School. They will think of cost centers vs profit centers, and the lessons on Management Control and Decision Systems. But accountants and a whole world of tax professionals relate this same word with lengthy compliance documents, compensating adjustments, tax officers and courts! How different are these worlds? Are and should they be aligned?

The Worlds

Cambridge Dictionary defines Transfer Pricing as: “an activity that involves one department in a company (or one company) charging another department in the same company (or another company in the same group) for supplying goods or services.” Both, Managers and Tax professionals, are referring to this same definition. But different approaches add varied dimensions to the concept.
Representation of the Concept of TP
Representation of the Concept of TP

Business World

TP in management revolves around appropriate pricing of goods/ services transferred among various units (departments, segments, divisions or companies)of an organization. It must help in monitoring and incentivizing performance of the individual units. For instance, in a conglomerate, it may sound sensible to a layman that the passenger car company uses the steel manufactured by a sister company at a discount instead of purchasing it from other vendors. However, the management of the steel business may not wish to short sell its steel. Undercutting would not portray the true picture of performance of the steel business, making it susceptible to wrong decisions. It could also possibly demotivate its management/ employees. Anyway, in the consolidated financial statements of the group, such intra-group transactions would get negated. Therefore, if approached by the automobile business, the steel business may not quote a materially discounted price. The idea of TP in management derives from the need to control and be able to evaluate the performance of separate units in order to take decisions pertaining to them. Apart from incentivizing good performance from individual units, their activities must be aligned with the business objectives of the larger organization.
A manager dealing with multiple business segments, divisions or companies must be aware of transfer pricing and various aspects of management control and decision-making pertaining to multi-unit businesses. While different levels of management deal with different kinds of controls, the activities related to TP can be said to involve:
  • Defining the units of the organization – revenue, cost, investment and profit centers
  • Deciding on pricing/ remuneration policies for the units considering organization goals
  • Budgeting and Management reporting for the units
  • Regular monitoring and evaluation of performance
  • Decision-making based on the results of the units
  • Coordinating and overseeing the various units
  • Resolving disputes among units
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