“Transfer pricing” generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises.
Commercial transactions between the different parts of the multinational groups may not be subject to the same market forces shaping relations between the two independent firms. One party transfers to another goods or services, for a price. That price is known as “transfer price”. This may be arbitrary and dictated, with no relation to cost and added value, diverge from the market forces. Transfer price is, thus, a price which represents the value of good; or services between independently operating units of an organisation. But, the expression “transfer pricing” generally refers to prices of transactions between associated enterprises which may take place under conditions differing from those taking place between independent enterprises. It refers to the value attached to transfers of goods, services and technology between related entities. It also refers to the value attached to transfers between unrelated parties which are controlled by a common entity.
Suppose a company A purchases goods for 1000 rupees and sells it to its associated company B in another country for 2000 rupees, who in turn sells in the open market for 4000 rupees. Had A sold it direct, it would have made a profit of 3000 rupees. But by routing it through B, it restricted it to 1000 rupees, permitting B to appropriate the balance. The transaction between A and B is arranged and not governed by market forces. The profit of 2000 rupees is, thereby, shifted to the country of B. The goods is transferred on a price (transfer price) which is arbitrary or dictated (2000 rupees), but not on the market price (4000 rupees).
Thus, the effect of transfer pricing is that the parent company or a specific subsidiary tends to produce insufficient taxable income or excessive loss on a transaction. As an example of this, a group which manufacture products in a high tax countries may decide to sell them at a low profit to its affiliate sales company based in a tax haven country. That company would in turn sell the product at an arm’s length price and the resulting (inflated) profit would be subject to little or no tax in that country. The result is revenue loss and also a drain on foreign exchange reserves
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