Transfer Pricing Between Associated Parties
Transfer pricing between associated parties concerns the pricing of goods and services exchanged between two related companies belonging to the same corporate group. The core objective of such pricing should be to target an arm’s length transaction and to make sure that they are economically advantageous to both parties, in their business relationships.
The OECD (Organization for Economic Co-operation and Development) stresses the importance of such a practice, to reduce incidence of either tax avoidance or tax evasion, for those companies making use of transfer pricing between associated parties. The usual accepted practice is for companies to employ the use of a third party to act as an intermediary and ensure that appropriate pricing is negotiated and agreed to by both parties.
When properly implemented, transfer pricing can promote high levels of profitability for both parties and through the use of external auditing and taxation, improve the level of transparency in the relationship. It is important that companies adopt a suitable methodology to determine the price, in compliance with the rules set out by the OECD.
The most widely accepted method to determine pricing between two related companies, is the Comparable Uncontrolled Price method. When using this method, companies need to find external, non-related companies performing the same kind of activities, with similar products and services, in order to define an economically sound price.
Another recommended approach by the OECD is the Transactional Net Margin Method, which is suitable for companies with worldwide operations and based on the profit margin that an independent company would achieve. This method is somewhat more complex than the Comparable Uncontrolled Price method, as the company needs to have a good understanding of their own cost and return structures, along with external standards for the industry.
It is also important that transfer pricing is produced in a way that is compliant with the local taxation laws and the applicable laws in the related countries. Companies must take note that the authorities have access to a wide range of data which makes it easier for them to spot any discrepancies when a company is not adhering to the arm’s length principle.
A suitable transfer pricing should include all the relevant details such as: The date of the agreement, the products and services subject to the agreement, applicable pricing rules and conditions, documentation of transfer pricing studies, agreeing to a post-transfer pricing audit and finally, the signature of both the parties to the agreement.
In today’s competitive business environment, the process of transfer pricing between two associated parties needs to be done correctly and within the framework set by the OECD. Companies need to employ the right tools, experts and advisors to ensure that they can achieve the desired results, while at the same time, remain compliant with all the relevant laws and regulations. The use of external auditing and taxation are also important in providing clarity of the transfer pricing process and to ensure that the companies are getting their fair share of global profits.
