Importance of Transfer Pricing and Proper Documentation
TOPIC POSTED ON 16 Jan, 2022 BY Sibghat & Co Management

Often, many organizations tend to ignore the concept of transfer pricing and its proper documentation because the process tends to be quite challenging. There are also many small and medium enterprises that lack the information regarding business regulations and global filing. Thus, they tend to underestimate it. These documentations are needed when your company undergoes a foreign investment and helps them produce evidence of their operations to the tax authorities. Hence, knowing what transfer pricing is and what benefit it brings to your company is crucial.


What Is Transfer Pricing?

Transfer pricing is a term given to the cross-border transactions between firms owned under common ownership interest, which involves the transfer of material assets, intellectual assets, or services such as property, machinery, patents, royalties, and many more.

It is an accounting practice that is involved between two or more firms in different countries that are either affiliates, subsidiaries, or a commonly controlled company belonging to the same large organization. It is a way through which companies can shift their tax liabilities to tax jurisdictions that are low cost.

It is to be noted that international tax laws are governed by the OECD – Organization for Economic Cooperation and Development. All the audit firms that come under it are liable to investigate the multinational companies.


How does Transfer Pricing work?

Understanding how this practice works is fairly simple. The transfer price refers to the amount that is charged by one company to the other for any goods or services that they are providing them with. It is based on the market prices for that particular commodity and helps to reduce the tax burdens of their parent companies. This is done by charging a higher price in high tax countries and lower prices in low tax countries. This eventually leads to low profits in high tax zones and high profits in low tax zones. Thus, increasing your earnings and reducing your tax incidence.

The best part about transfer pricing is that it's completely legal for companies that are operating as a multinational to distribute their earnings amongst their affiliates and subsidiaries. However, there are also instances where company employees misuse this practice by changing their financial numbers to reduce overall taxes and increase their share. This is why having its proper documentation for every transaction is vital and in your best interest.


Why should a company adopt Transfer Pricing

Adopting this practice brings about a number of potential benefits that are not only vital for running a business but also help you run your operations in a smarter way.

  1. It reduces income and corporate taxes- When you overprice the transferred goods in a country with high tax rates and underprice the goods in a county with low tax rates, it increases your profit margins and reduces the amount of corporate tax that you have to give.
  2. Reduces duty costs- Transfer pricing helps companies save up on their duty costs by shipping the goods to high tariff countries by paying minimum transfer prices. This lowers the duty charged on the transaction itself.
  3. Increases efficiency of the managers- In areas of high transfer prices, managers are at an advantage. They are able to make decisions in a timelier manner as they're not distracted by local problems. It also increases their motivation to work hard, considering they have more control over the outcome. When managers are properly trained, they have a stronghold over employees that encourages them to perform well in the hopes of getting promoted.


Maintaing Proper Documentation for Transfer Pricing Arrangements

As mentioned above, having proper documentation for every transaction is vital for any business. Proper documentation gives a company access to conduct thorough investigations within the workplace to ensure the operations are running smoothly. Having a paper trail or a documentation trail means that every transaction, activity, or event needs to be recorded and filed so that at the time of yearly audits, it is easy to go through the happenings of the past year.

Just as with any business, transfer pricing also requires its proper documentation that includes keeping a record of all the mutually agreed contracts between companies, invoicing of every transaction and references to the laws and jursidications under which transfer pricing arrangements are controlled.

Proper documentation decreases the chances of lawsuits, reduces potential risks, and increases the efficiency of the workers as well as the accuracy of an internal investigation. It tells the company's scope, vision, validates its position in the market, and assures the investors and clients of its authenticity and transparency.


Why is Proper Documentation important for Transfer Pricing?

Having proper documentation in transfer pricing is very important because

  1. It shows if the related party transactions are in harmony with the arm's length principle. This means that all the terms and conditions applied in related party transactions are the same as that of an independent business.  
  2. It summarizes how the company works, its functions and operations, and an overview of all the assets and risks involved in every transaction. It comes in handy when the company is undergoing an audit or if new investors are looking at the company to invest.
  3. According to the OECD, transfer pricing documentation is maintained to ensure that the taxpayers give consideration to establish prices and provide information necessary to conduct risk assessment and audit.
  4. This documentation is made via a separate entity approach that states every party involved operates as a single independent entity. Regardless if they belong to the same group or parent company.
  5. It clears any misconceptions or unnecessary adjustments that may have arisen in tax controls by the tax authorities. Thus, preventing any chances of double taxation by international companies is reduced. 
  6. The related party is easily identified, and all the decisions regarding it are made in a controlled manner.


Why Zaitox is the best way to go!

In today's world, every businessman is looking forward to increasing their profits. Paying heavy amounts of money in taxes and duties is not something a smart businessman would look forward to. By adopting transfer pricing practice and maintaining its proper documentation, you can achieve that.

Mere accountants or tax experts cannot do the practice of transfer pricing. It needs a special set of individuals who are trained in the art that Zaitox Chartered Accountants team provides you with. Employing us would be in your best interest.