What is transfer pricing & why I-T dept is looking into it at BBC

Transfer pricing is a routine accounting tool that has the potential to be misused by a company to pay less tax.

Mediapersons outside the BBC offices in Delhi | Representational image | Suraj Singh Bisht | ThePrint

New Delhi: The Income Tax department Friday issued a statement regarding the survey it had conducted at the Delhi and Mumbai offices of “a prominent international media company”. It said it had found several financial irregularities in the company’s reporting of income and profits from its India operations.

The statement was released hours after the department concluded a three-day survey of the BBC’s offices late Thursday evening.

Among the alleged discrepancies were light irregularities with regard to transfer pricing and arm’s length price. 

“Further, the survey has also thrown up several discrepancies and inconsistencies with regard to transfer pricing documentation,” the statement read. “Such discrepancies relate to level of relevant runction, asset and risk (FAR) analysis, incorrect use of comparables which are applicable to determine the correct arm’s length price (ALP) and inadequate revenue apportionment, among others.”

While the broader alleged irregularities are reasonably simple to follow, the concepts of transfer pricing, FAR, and ALP need some explaining.

What is transfer pricing?

Transfer pricing is basically an accounting practice that enables subsidiaries of the same company to transact with each other. As an example, say Company A has two subsidiaries, Firm A and Firm B. Firm A and Firm B are distinct companies in their own right, and so cannot transfer resources or services between each other for free. 

Transfer pricing is the method by which they ‘price’ these resources when transacting with each other. Typically, the price of such transfers has to be at the market rate. 

The FAR analysis is simply the method arrived at to determine what the market price of a particular good or service is for transfer pricing purposes. 

Similarly, arm’s length price is a concept to do with the price subsidiaries charge each other. It basically means that one subsidiary should charge another the same price it would charge an unrelated company. That is, it should hold its sibling company at arm’s length.

For the most part, this is standard practice and doesn’t raise any issues. However, there is a possibility that transfer pricing can be used to evade tax.

Using the same example, suppose Firm A charges Firm B less than the market value for its services. In such a scenario, Firm A has a lower income because it is getting less money for its services, but Firm B has a higher profit because it is paying less for its inputs. The overall impact on the parent company, Company A, is the same.

Now, consider a situation where Firm A is in a high-tax country and Firm B is in a low-tax country. By under-charging for its services, Firm A has ensured it pays less tax since it has lower revenues, while Firm B also pays less tax on its higher profit because the tax rates are lower where it is located. Overall, the parent company comes out of the transaction paying less taxes than it should.

“During the course of the survey, the department gathered several evidences pertaining to the operation of the organisation which indicate that tax has not been paid on certain remittances which have not been disclosed as income in India by the foreign entities of the group,” the I-T department’s statement said.