What is Transfer Pricing?
Transfer pricing is a process that helps to determine how much goods and services should cost when they are “related” to the parties that buy and sell them. Individuals or entities are related to one another if:
- Company A controls Company B, directly or indirectly.
- Another person or entity (two subsidiaries having a common parent company) is under common control, or both.
Often, companies participate in strategies that are adopted solely for tax reduction while setting contractual conditions for cross-border transactions between related companies of an international enterprise. Most governments find such a strategy to be abusive because they deprive a country of tax revenue of a subsidiary while the subsidiary continues to impose economic burdens on the country due to its operating activities. Countries have developed a system to control intracompany deals, and this system is referred to as Transfer Pricing (TP) rules.
What is arm’s length principle in transfer pricing?
The arm’s length principle is used as a guide in transfer pricing. The concept of arm’s length implies that transfer prices between related parties be equal to prices paid by unrelated parties in the same or similar circumstances. This includes the detection of situations or transactions which are carried out by unrelated parties and which are equivalent to situations or transactions between related parties. “This is usually referred to as” comparability analysis.
Let’s look at an example to make this easy:
Transaction #1:
Company A produces Motor parts and sells these to distributor Company B. Company A, and Company B are not related. This is identified as an uncontrolled transaction. The terms and conditions are considered to be ‘at arm’s length’.
Transaction #2:
Company A produces the Motor parts and sells these to distributor Company Y. Company A and Company Y are related. They are both owned by Company X. This is a controlled transaction, and in order to comply with the transfer pricing regulations, the terms and conditions should follow the arm’s length principle.
Read more about Transfer Pricing Singapore Guidelines at Singapore Company Incorporation.
