Transfer pricing exists among all companies be it domestic or be it a global entity. This concept relates to the setting of the price of goods and services sold between controlled or related legal entities within an enterprise.
In case subsidiary company sells products to a parent company, then transfer pricing occurs for the parent company pays to the subsidiary company.
This kind of pricing system mainly occurs between two companies which are a part of the same multinational group trade.
What is the reason for Transfer Mispricing?
Transfer Mispricing sprouts when there is a form of more phenomenon known as trade mispricing. When business takes place between two unrelated or apparently unrelated parties, such results out.
Estimation, that about 60% of the international trade happens within rather than between multinationals which are across national boundaries but within the same corporate group.
The estimates vary depending on how much tax revenues can lose by the governments due to transfer mispricing.
When does the Arm's Length Principle come at play?
But as two unrelated companies sit to trade with one another, they may wish to distort the price with an intention to minimise the overall tax bills.
But with the "Arm's Length" principle such practices are supposed to stop and ensure that costs recorded as if the trades is taking place with 'arm's length.' Because the 'Arm's Length' stands unworkable in most of the situation, this is why multinational corporate tax avoidance occurs for a reason.
Traditional approach to Transfer Pricing
The conventional international approach deals with transfer mispricing through 'arm's length 'principle. This type of transfer pricing policy takes place when bilateral treaties between governments take place.
Most of the businesses take up arm's length principle while most just move in the opposite direction. It may be because 'arm's length principle is indeed hard to implement. Governments around the world are systematically limped in their ability to collect revenues from the corporate tax system.
Also, billions of dollars are wasted annually across the world on government enforcement efforts which have little chances of meeting high compliance requirements.
What could stand out as an alternative approach?
As opposed to the 'arm's length' principle, in the unitary taxation approach, such tax method is involved wherein taxing the various parts of a multinational company depends on what is done in the real world.
Benefits of Unitary taxation over arm's length principle :
1. Firstly this form of taxation reduces tax evasion and avoidance by MNEs.
2. Secondly, home countries can find little tax revenue from foreign affiliates as the foreign income is just taxed when it repatriates and foreign taxes are credible against the home tax.
3. Unitary taxation also helps in raising the share of Global MNE rents which are received by poorest countries.
The government is continuously trying to devise measures by which misuse of transfer pricing takes place. Some of the ways by which misuse of transfer pricing can be curbed are with the help of arm length principle for the intra-firm sale of goods and services.
Thus firms have to be continuously vigilant about these measures and devices for it is they who have to pay for goods and service while purchasing it from the related enterprise. At such time, for firms, the best option is to associate with experienced tax and accounting consultants.
They help companies in strategizing and policy development, help businesses to reduce the impact of year-end adjustments, monitor transfer pricing footprint and coordinate across organisations. And most importantly these tax consultants assist in delivering timely risk assessment and management services.
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