What is transfer pricing?

Transfer pricing is a mechanism or mode by which several MNCs attempt to evade tax. In the process, companies operating globally, shift profits earned in a particular nation to other where the rate of taxation is way below, this is usually executed by undertaking or executing transactions within the group companies.

As per the Department of Income Tax, Government of India, transfer pricing refers to the price or the value for which transactions between related parties is undertaken. More precisely, it is the price at which intangible asset as well as physical goods gets transferred from one associated company to the other in a group. And in many cases the transactions of commercial nature are executed within arms of the same group not at the actual cost or market price and instead has been undergone to avoid taxes.

Illustration: Used to avoid or save tax for the company, the process can be explained as though suppose a company 'X' has a higher taxation rate and wants to earn returns as well as avoid taxes in the home country. So the technique of transfer price that is followed is as explained. What the company does is transfer its goods to company 'Y' ( with a lower tax regime or rate) of the same group at a price of say Rs. 100. This company 'Y' then makes profits on the goods of the parent company 'X' by selling at a price say Rs. 400. So, the parent company which could have itself distributed the product worldwide to earn revenues and hence make profit lowers its tax liability as it now only is liable to pay tax only on the profits realized on selling goods to company 'Y' at Rs. 100. And the subsidiary company earning profits is liable to pay less tax owing to low tax rates on the Rs. 300 which it realizes. So, the total tax outgo of the multinational company is lowered immensely.

Rationale of Transfer Pricing

The practice that has fast gained momentum enables controlling party in a transaction ( an estimated 60% of all the transactions are completed within related companies) help in the evasion of tax. And the resultant consequence is confronted by the department of income tax in the form of lowered tax revenues.

Though not an unlawful practice, it is rather regarded as one of the loopholes in the taxation system that enables companies to evade tax and thus move away in complying and meeting their individual social responsibility at global level. So, efforts across the globe are being made to strengthen the system monitoring transfer pricing.

Recently, Vodafone along with other MNCs including Shell India Markets Pvt. Ltd, the group company of the Europe's largest oil producer, Royal Dutch Shell Plc are confronting tough stance of the department of Income Tax in India on account of transfer pricing issue

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