TRANSFER PRICING

Cost and Management Accounting

Project Report

Submitted by:
2021/003 NEHA SINGH
2021/005 DEEPALI ARORA
2021/009 RITTIKA BALI
2021/011 CHITRA AGRAWAL
2021/042 SANYAM JAIN
2021/047 GARVIT ARORA
Table of Contents

ACKNOWLEDGEMENT.........................................................................................................2
INTRODUCTION......................................................................................................................3
BACKGROUND........................................................................................................................5
ADVANTAGES AND DISADVANATGES OF TRANSFER PRICING FOR AN
ORGANIZATION.....................................................................................................................6
APPLICABILITY......................................................................................................................8
REVIEW OF LITERATURE....................................................................................................9
The purpose of the paper is to explore, analyze and understand the influence of transfer
pricing on financial reporting in global tax environment from a theoretical point of view.......9
Findings and Implications of the Research Paper................................................................10
Findings............................................................................................................................10
Implications......................................................................................................................10
How Google incorporated transfer pricing to save taxes?.......................................................11
 ACKNOWLEDGEMENT

We would like to express our deep and sincere gratitude to our CMA professor, Dr. Nidhi
Malhotra, Ph.D.; Senior Assistant Professor and Convener, LBSIM Alumni Foundation for
providing us the opportunity to research and providing invaluable guidance throughout this
research. Her dynamism, vision, sincerity and motivation has deeply inspired us. She has
taught us the methodology to carry out research and present it as clearly as possible. We are
really grateful for the plethora of knowledge that she has provided us.

Next, we would like to thank the Lal Bahadur Shastri Institute of Management for providing
us a platform to come together and work on this research paper. Furthermore, we would like
to extend warmest thanks to our seniors who helped and guided us on this project.

Last but not the least, we would like to express our gratitude to our parents and friends who
have encourage us throughout the research. We have no valuable words to express our
gratitude; however, our hearts are full from the favours received from every person.
 INTRODUCTION

Definition: “Transfer Pricing is the settlement of the price at which one division of the
company transfer goods or services to another division of the same company either in same
country or in a different country.”

Transfer Pricing basically means when a company or division transfer its product at a price to
another company or division, so that the product can be used for further processing by 2 nd
company but it is necessary that both the companies should come under one parent company
than only it can be considered transfer pricing.

Transfer pricing case includes transfer of following:

 Goods
 Services
 Intellectual Property (idea, patent, trademark, etc.)
 Intra-Corporate Lending (when one company gives loan to another company of same
parent company)

Transfer pricing helps in deciding the price at which the goods will be transferred from one
division to another and the price at which the goods are transferred from one division to
another division is called transfer price. In the absence of transfer pricing, the goods will
most probably be transferred from on division to another at cost price and this makes
evaluation of divisional performance difficult and moreover the divisional manager will not
be happy to do such type of transfers as it will affect the profitability of that division but in
transfer pricing the goods are transferred at selling price or decided price due to which
evaluation of divisional performance becomes easy.

The price at which goods are transferred between the different division of the same company
may not be equal to the price at which it will be sold to a different company. Different
methods are used by companies to calculate transfer pricing.

Methods of Transfer Pricing.

1. Cost based transfer pricing: In this method more emphasis on cost is given to
calculate the transfer price.
2. Market based transfer pricing: This method is generally used when there are lot of
companies in the market or it is a perfect market. In this method the transfer price is
kept near the market price.
3. Negotiated transfer pricing: This method is used in imperfect market and in these
managers have equal bargaining powers and they can also deal with external buyers
for both selling or buying goods.
 BACKGROUND

After the liberalisation of Indian economy in 1991, the number of multinational companies
operating in India were increasing due to which need for a structure was felt which can help
in attaining the right picture of profit and tax of these companies.

In India, Transfer pricing was first initiated in Finance act April 2001, as an amendment to
Income tax Act 1961, this law was basically introduced to help in attaining the accurate profit
and tax for the multinational companies operating in India. It initially covered only
international transaction between associated enterprises.

The provision included the meaning of key terms like ‘international transaction’ and
‘associated enterprise’, it also gave the method to calculate arm’s length price and
documentation which are necessary. Because of this provision an authority was also
introduced of ‘Transfer pricing officer’ whose major role was to determine arm’s length
price.

The law was majorly reformed in 2012 where few changes were made. The meaning of
international transaction was expanded so that all type of transactions are covered whether it
tangible, intangible or capital financing transactions. In April 2013, domestic transactions
between associated enterprises were also included in the provision. After 2013 many changes
were made in 2013 to 2015, in 2017 and recently in Finance Act 2020 major development
was introduced in respect to profit attribution for permanent establishment.

Transfer pricing in India majorly follows the Organisation for Economic co-operation and
Development (OECD) guidelines but there are few differences between Indian provision and
internationally accepted norms as in India we compute arm, length price but internationally
arm’s length range is computed.

Associated Enterprise: An enterprise which has some kind of role in management, control or
capital whether it is directly or indirectly, in that enterprise is called as associated enterprise.

International Transaction: It refers to those transaction which involve transfer of physical

goods, services, or advancing of loan to other associated enterprise in which either or both
enterprises are non-resident.
 ADVANTAGES AND DISADVANATGES OF TRANSFER
PRICING FOR AN ORGANIZATION

Transfer pricing is extremely beneficial for any organization for various reasons. Its major
impact can be felt by organizations in terms of taxation since they tend to save costs and
increase revenue.

It generally helps a firm in cutting down their costs by shipping products in countries that
have high tariff rates by keeping transfer prices low. This in turn minimizes the duty base and
increases revenue. Also, if a firm opts for transfer pricing, then it can resort to selling its
goods at a higher price in countries with lower tax rates to obtain higher profit margin. It also
helps firms to shift profits easily.

When companies opt for transfer pricing then they do not sell the products at the market price
but at a price which will help them show reduced profits so that they have less tax burden,
they do it to decentralize their production and to gain more profits by subverting the ceilings
imposed for repatriation.

Any organization will be benefitted from this because there will be transparency in dealings,
also an assurance as to the quality of the goods and the effective price of the commodities.

Several companies like Google, Apple, Vodafone etc have benefitted from transfer pricing
since these companies operate globally and hence can easily avail the benefits of less taxes
wherever possible. The arm’s length principle is to be used in cases of transfer pricing but
still companies tend to evade tax.

Despite these advantages, there are certain drawbacks of transfer pricing. When transfer
pricing takes place, it increases the profit of the company and wealth maximization benefits
the shareholders, but this does not consider the revenues earned due to goodwill of the
company. If the stakeholders garner knowledge about tax evasion by a company, it will
significantly impact the company. For example- Apple Inc. received a lot of flak when the
company was found indulging in transfer pricing by transferring their revenues to Australia
and Ireland subsidiaries.
Even within a company transfer pricing can cause disagreements within various departments
with respect to the policies pertaining to transfer and pricing of goods. It is so because the
selling departments needs to maximize its profit in its own interest and the buying department
needs to minimise its cost of purchases. It also required a lot of cost which must be incurred
to maintain proper cost and accounting systems. This requires a huge amount of time and
resources. Though transfer pricing can be easily applied to tangible goods, it becomes
difficult to ascertain the prices in cases of intangible items like services which are
required/requested to be undertaken between the departments or subsidiaries. The
departments which cannot see measurable benefits in case of transfer pricing do not wish to
indulge in it as opposed to those who can measure benefits derived by virtue of it.
 APPLICABILITY

Transfer Pricing is a very broad concept, much more than it seems to be. In the initial stage, it
was used by the manufacturing companies and that too by FMCGs which deal in variety of
food products and process raw materials/inputs for the other goods they produce. However,
this concept has evolved rapidly, and now other industries have also started using this
technique like IT, Automobile, etc. Therefore, now it is being used in both the manufacturing
sector as well as the non-manufacturing sector.

Transfer pricing is generally applicable to large scale industries, but it also depends upon
various other factors such as the nature of the industry, number of subsidiaries, etc. It also can
be done both domestically as well as Internationally. Prices for goods, services and property
vary greatly in the market and thus it becomes important for large scale organizations to use
this method to cut down on their costs.

Many Companies like Coca-Cola, Meta (formerly Facebook), Google, Apple, etc have been
using Transfer Pricing, which also has been a matter of contention between the involved
companies and the tax authorities.
 REVIEW OF LITERATURE

S.NO 1.

TYPE Conceptual Paper

PAPER Transfer pricing and its effect on financial reporting: a theoretical

analysis of global tax in multinational companies

YEAR 2018

Hassnain Raghib Talab

Hakeem Hammood Flayyih
AUTHOR
Yassir Nori Mohammed yassir

JOURNAL International journal of hospitality management.

OBJECTIVE
The purpose of the paper is to explore, analyze and understand the
influence of transfer pricing on financial reporting in global tax
environment from a theoretical point of view.

Transfer pricing, financial reporting, tax, corporate policy,

KEY WORDS
multinational companies,
Use of prior literature to indicate the importance and degree of focus
RESEARCH
on transfer pricing, and thus using exploratory method to find out how
METHOD transfer pricing is carried out in some selected countries.
Theoretical data has been collected and analysed using past research
DATA
papers in some selected countries: Australia, India, Malaysia and
COLLECTION Kazakhstan

FINDINGS The study showcases the rules of transfer pricing as recommended by

OECD and how MNC’s take a planned advantage of having its
subsidiaries in different nations/ states.
The study is located geographically in four countries only mainly,
LIMITATIONS
Australia, India, Malaysia and Kazakhstan.
https://www.researchgate.net/publication/

REFERENCE 322702566_TRANSFER_PRICING_AND_ITS_EFFECT_ON_FINANCIAL_REPORTING_A_THEORETICAL_ANALYSIS_
OF_GLOBAL_TAX_IN_MULTINATIONAL_COMPANIES
 LINK

Findings and Implications of the Research Paper

Findings

The research paper showcased the objectives and different methods of transfer pricing, by
also practically associating it with the four different countries that were considered while
doing the exploratory research. It also helped analyse the problems or difficulties that arise
while taking transfer pricing decisions which are one of the major decision for cost cutting
and tax reduction.

Also, it gave us an overview about the possibilities of manipulation of tax structure of the
companies and how financial authorities can execute requirements for the preparation of
strategies that make such policies stringent so as to control tax evasion by companies. The
paper also gave us a brief about the conditions or rules stated by OECD (Organization of
Economic Cooperation Development) that the companies must meet to fall under the transfer
pricing principles.

Implications

As with booming MNC’s and generated profitability in the coming times, there comes an
existence of a link between transfer pricing and financial reporting methods to let companies
make effective corporate policies keeping in mind the global tax scenario. If corporates
would not understand the dire need of transfer pricing in the current era they may lose their
major share of profitability to the sites worldwide, that could lead in minimizing their profits.

For example in India, transfer pricing principles and the impact of corporate Taxes and
customs duties helps MNC’s to incentivize their taxes and provide an opportunity to
maximize their profits by reducing tax liability.

How Google incorporated transfer pricing to save taxes?

 · Like any other tech giant in USA, Google also used double Irish and Dutch Sandwich
strategy to direct its international profits towards tax exemptions. Transfer pricing includes
use of related entities in the corporate structure for shifting the profit from high tax to low tax
jurisdictions.
· Alphabet Inc, (Google) incorporated a company in Ireland which is known as Google
Holdings Ireland (Irish Co.1). For the purpose of paying taxes Google gets the company
domiciled at the offices of the law firm of Conyers, Dill & Pearman at Clarendon House
located on Church Street in Hamilton, Bermuda and becomes the tax resident of Bermuda.
· Now Alphabet US transfers all-important intellectual property rights related to the search and
advertising technologies to Google Holdings Ireland at a reasonable price. The deal was
approved by the IRS under an Advanced Pricing Agreement (APA), which helped google
overcome the initial transfer pricing barrier of seeking IRS approval.
· Google Holdings Ireland (Irish Co1) sets up another company in Ireland, Google Ireland
Limited (Irish Co2). And grants it IP rights.
· Google Ireland Limited (Irish Co 2) supplies its Intellectual property Rights to all the google
affiliated entities in Europe, Middle East, Africa. These affiliates receive advertising revenues
from their customers across the world, and then pay royalty to Google Ireland Limited.
· Google Ireland Limited (Irish Co2) keeps a small percentage of advertising revenue and then
pays the balance in royalties to Google Holdings Ireland (Irish Co1). The royalty received by
Google Holdings Ireland (Irish Co1) is not taxable in Ireland as this company’s central
management is situated in Bermuda. Thus, the profits are shared to Bermuda where the tax
regime is favourable.
· Henceforth, the company gets a tax shelter in Bermuda as Bermuda does not levy corporate
tax i.e., tax rate in Bermuda is 0%.
· Further there is no tax in US unless profits from Bermuda is distributed in the form of
dividends.
· Controlled foreign corporation (CFC) rules can also be sidestepped as Google Ireland Limited
(Irish Co2) opts to check the box in the US and thus transactions between Irish Co1 and Irish
Co2 are disregarded.

Check the Box Phenomena:

· In the US, CFC rules treat Google Holdings Ireland (Irish Co1) as a “Controlled Foreign
Corporation” (CFC) and passive incomes such as royalties taxed in US. This is sidestepped by
joint development of intellectual property by US Company and Google Holdings Ireland
(Irish Co1).
 · This avoids classification of royalty received by Google Holdings Ireland (Irish Co1) as
passive income.
· Google Ireland Limited (Irish Co2) then checks the box and chooses to be disregarded as a
separate entity in the US so that no passive income arises in its hands.
· In-addition to the Google Ireland Limited (Irish Co2), the Dutch Sandwich uses an additional
layer by setting up an additional company in Netherlands in between the two Irish companies.
This is done to avoid withholding Tax in Ireland on payments to royalty as payments to other
European members are exempt.

Google had to incorporate two Irish companies because of the following reasons:

· Irish tax law allowed Irish Co1 to be managed from Bermuda only if it owned another
resident Irish company (i.e., Irish Co2).
· This enabled Google to shift most of its profit to Bermuda in the form of Royalty.

Introduction of Dutch company (In Netherland) was important because of the following reason:

· Royalty payment between two Irish companies might have attracted tax deduction but by
having a Dutch company enables Irish Co2 to avoid tax deduction on royalty payments.
· EU directives provides that there shall be no tax deduction on payment of Royalty to other
members as both Netherland and Ireland are part of European Union.

How was it benefited?

· By applying transfer pricing, Google managed to reduce its taxes by $3.1 billion from 2007 to
2010.
· Google’s strategy helped reduce its tax rate abroad to 2.4%, the lowest of the top five US
technology companies by stock market capitalization.
· The US tax rate was 35% whereas Irish tax rate was 12%.
· Also, Irelands, wet damp climate plays a significant role in keeping energy cost for the
company down.
· Google’s profit come also from investment in R&D data centres and other functions and risks
performed outside Ireland.
· It enjoys its IP in Bermuda where corporate tax rate is 0 %. Hence It pays 35% income tax on
its US source income but only 2.4% on its foreign scheme without issuing dividend but if the
Bermuda subsidiary issued dividends, these would be taxed at 35% in US.