Prepared by: Sherin Joy

“Transfer pricing is the price charged by one business unit for the products & services transferred to another business unit of the same company to calculate the profit & loss of each division separately.”

Reasons: Differences in corporate tax rates

Restriction on profit repatriation transferred from patent country

High customs duty

Acquisition of huge economic power

Liberalization

Government moving away from control of productive resources

Described as most likely to result in an accurate of an arm’s length price

Comparison between: controlled transaction and independent transaction

Appropriate for fungible property

A Co. sells spares to B Co, a related party. It also sells spares to C Co., an unrelated party, for $100.

Under CUP, A Co. would charge B Co. $100 (with possible adjustments for differences in shipping costs, etc.).

Arm’s length price of a controlled sale is equal to the applicable resale price less an appropriate mark-up

Contrast to CUP method

A Co. sells spares to B Co., a related party, and B Co. sells them to unrelated retail customers for $200 each.

Distributers in a similar line of business usually earn 20 percent of the sales price.

Under the retail sales method, the price on the sale from A Co. to B Co. would be $160 ($200 – (20% of $200)).

When a manufacturer sells its product to a related party or when a related buyer adds value to the product it has purchased from a related party.

A Co. manufactures spares at a cost of $50, sells them to B Co., a related party, and B Co. sells them to unrelated retail customers for $200.

Contract manufacturers in similar lines of business typically earn a gross profit of 30%.

Under the cost-plus method, the price on the sale from A Co. to B Co. is $65 ($50 + (30% of $50)).

It evaluates whether the allocation of the combined operating profit or loss attributable to one or more controlled transactions is arm’s length

A Co. and B Co. are related persons engaged in the production and sale of pharmaceuticals.

A Co. engages in lots of R&D to produce its pills.

B Co. sells the pills after affixing its valuable trade name to the packaging.

They earn profits of $8 million from the common enterprise.

Here, the arm’s length price is arrived by determining the net profit margin made from the controlled transaction

Comparison between operating profit for the inventory purchased