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Q1) Explain what is transfer pricing.
Answer: What is transfer pricing?
Transfer pricing is setting of price at which different subunits of the same company transact with each other. For instance transactions of goods and services between a subsidiary and parenting company take place at transfer price. Multinational Corporation uses this pricing as a tool of profit allocation among its various subsidiaries within the organization. Transfer pricing offers taxation benefits to a company. Especially in case of international transactions as different countries have their own different taxation policies. Although international tax laws are regulated by OECD (organization for Economic Cooperation and Development) and the auditing firms under OECD audit MNCs financial statements accordingly.
Example of transfer pricing:
XYZco, a local manufacturing company from Australia. ABCco, a subsidiary of XYZ operating in Canada. XYZ produces electronic devices and ABC sells these devices in Canadian market. Here at price both company decide to transact is known as transfer price.
Various internal and external factors affect transfer pricing. For example performance of the company, accounting standards, currency fluctuations, income tax authority etc. there are four different methods of transfer pricing: 1) comparable uncontrolled price 2) comparable resale price method 3) cost plus method 4) profit split method.
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Q2) Explain transfer pricing strategies and abuses in transfer pricing strategies.
Answer: Transfer pricing strategies:
Company can use any of the above given methods for price determination. On need to consider the guidelines issued by the OECD while framing the strategies. Arms Length Principle is one of them. It provides MNCs and governments a single international standards. With the help of this different government entities can collect their share of tax and MNCs can avoid double taxation.
Two things are possible here. (Continuing the above example) In the first case, suppose the cost of production of a device in company XYZ is $ 500. Selling cost is $ 100 for company ABC. ABC sells it at $ 1000. Here if the transfer price is decided to be $ 500. Then, ABC can earn Net profit of $ 400.
In the case two. If the transfer price is higher at $ 900 then the combined benefit of $ 400 goes to XYZ.
The financial results of both the companies are consolidated. So it doesn't matters which of the two companies makes the profit, but in terms of tax it matters. Here company need to analyse in which country tax rate is lower and can accordingly decide the transfer price. By lowering prices in high rate tax countries and raising them in low tax rate countries, company can reduce his overall tax burden and boost his profit.
Abuses in transfer pricing strategies:
Many MNCs misuse the transfer pricing for profit maximizations and tax avoidance. They shift their profit from higher tax rates jurisdiction to the lower tax rates jurisdiction. They use variety of methods to reduce their tax such as setting up subunits in tax heavens, take benefits of tax incentives programmes, shifting revenue to low-tax and expenses to high-tax countries. This procedure is largely invisible to the public and cost a lot for regulatory bodies to detect.
The vast growth in global trade provides various opportunities to frame transfer pricing strategies. It becomes one of the barriers for economic development. Many authorities try to control these wrong practices by introducing various new laws and agreements. OECD has given guidelines to follow for transfer pricing. Though it does not give favourable results. Different countries try to solve this problem on their own ways. Some of the professionals have suggested few measurements like uniform tax policy across the world for foreign trade, disclosure of financial statement separately for each countries and not consolidated and so on.
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Q3) Give an example of a corporation/s involved in transfer pricing.
Answer: Vodafone transfer pricing:
In the financial year 2007-2008, Vodafone India Services Private Ltd. Sale the call centre business of Vodafone to Hutchison. The Income Tax department had demanded Rs.8, 500 crore as capital gain tax for this transaction, saying this came under transfer pricing rules. In the year 2007 Vodafone acquired Hutchison Essar Ltd- an Indian incorporated company in order to enter in Indian market. Both the companies have their own holding companies in foreign countries like Hutchison Telecommunication Ltd in Cayman and listed in Hong Kong stock exchange and Ney York stock exchange. Vodafone International Holdings BV in Netherlands.
The company argued in Income Tax Appellate Tribunal by saying that it was not an international transaction and did not attract the rules of transfer pricing. But the tribunal referred this as an international transaction with the intention to circumvent the transfer pricing norms and there was absence of arm's length in transaction. Further the company approached to high Court and argued that the sale of the business was between two domestic companies and the transfer pricing officer had no jurisdiction over this transaction. High court had given green signal to Vodafone. But tax authorities challenge it in the Supreme Court. At the end Vodafone won this case in 2015 having an additional demand of Rs. 3,200 crore from the authorities in the High Court. According to Supreme Court there is no transfer of the Call Options and therefore the transaction is not falling under the transfer pricing rules.
Vodafone is an example where had taken advantage of authorities loop hole and have succeeded to gain without paying any tax. It seems very unfortunate for any government. This kind of practices become global concern now a days. All the government try to formulate laws and policies to avoid such practices.
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