Ensuring proper application of Transfer Pricing law
With regard to direct tax, the government promulgated in 2012 a law named ‘Transfer Pricing’. The law is scheduled to be effective from July 01, 2015. Transfer pricing is a globally common phenomenon. In different countries of the world, this law is in existence. According to the best international practice, transfer pricing happens whenever two companies, which are the parts of the same multinational group, trade with each other.
About 60 per cent of global transactions are executed among members of a group of companies or affiliated entities which are known as related parties or associated enterprises. When two related parties within the same group enter into transactions, they have ample scope to fix transaction prices for their own tax benefits. This sometimes creates scope of mispricing. Consequently, tax agencies lose revenue. To make the issue understood, an example is presented below:
Multinational Enterprise: Tax rate of MN International. MN (Japan) Ltd is 15 per cent and tax rate for MN (Bangladesh) Ltd is 37.5 per cent. As per regular situation, the global tax liability of MN International will be as follows.
From the above example, it is clear that due to mispricing of transferred goods, the tax authority of Bangladesh may lose tax revenue. For stopping such tax revenue evasion, the authority passed the ‘Transfer Pricing’ legislation. Main theme of the law is that despite having sufficiently acceptable evidence, the tax authority is being empowered to reject the import cost of materials which were imported from another unit of the same group abroad on the basis of another acceptable authentic document. The documents based on which the import cost will be determined by the tax authority are known as ‘arms length price’.
According to the ‘Transfer Pricing’ law, there are various methods to determine ‘arms length price’, such as comparable uncontrolled price method, resale price method, cost plus method, profit split method, transactional net margin method etc. Any other method, which seems to be suitable, may also be used to determine ‘arms length price’.
Challenges, which may have to be faced by the tax authority during determining ‘arms length price’, are lack of available necessary evidence in support of price by which import cost will be re-determined.
One of the methods of ‘arms length price’, as earlier mentioned, is comparable uncontrolled price. Through an example, this method is explained: Suppose XY Co. has purchased 1000 units of raw materials from its related party PG Co. (Japan) for US$ 25 per unit. Simplex Corporation of Bangladesh has purchased 750 units of similar items from PG Co. for US $ 23 per unit. Under such circumstances, for determining tax liability for XY Co. ‘arm’s length price’ for purchase from PG Co. is 1000 X 23= 23000 US $ and transfer pricing adjustment will be 1000 (25-23) = 2000 US$.
Now the question may be raised how far this method is logical and acceptable. Price depends on various issues such as volume of purchase, cost of inputs and many other factors. In the above example, PG Co. (Japan) sold some goods to XY Co. at the rate of US $ 25 per unit and to Simplex Corporation at the rate of US $23 per unit. Does it absolutely mean that rate of goods transferred to XY Co. is higher than its reasonable rate? As an answer it may be said that it is not, because volume of purchase may be different, input price of producing transferred goods may also be different etc.
Likewise, another method of determining ‘arm’s length price’ is resale price. Basic concept of this method is to determine arm’s length cost of goods through subtracting appropriate gross profit margin from sale price. Suppose XY Co purchased goods from PG Co (Japan) at Tk 1850 sold in Bangladesh at Tk 2000. So, gross profit is Tk 150. But the tax authority determines that appropriate gross profit margin will be 10 per cent of sales i.e. Tk 200, so transfer pricing adjustment will be Tk. 50. In that case, a question may also be raised how far determining the appropriate gross profit margin is reasonable.
Gross profit depends on various issues. Despite having same issues such as same product, same market, same scale of industry, same source of finance, same source of machinery etc, gross profit for two industries may be different only due to strategy of the business. For example, marketing policy of one industry is less price and more sales while another industry goes on higher product price and less sales. Due to such different policies, rate of gross profit margin will be different. So, it is not easy to determine appropriate gross profit margin.
Whatever method is followed to determine the ‘arm’s length price’, it may be challenged by the respective companies (assessee) because if the ‘arm’s length price’ is determined by the tax authority and accepted by the company, it will be the question not only of incremental tax but also of siphoning foreign currency in the name of import of raw materials.
On the other hand, how far the ‘arm’s length price’, which will be determined by the tax authority, will be tenable in the eye of law, there remains a question. For the goods, which will be imported to justify the cost of such goods, there will be very authentic documents at the hands of the company, i.e., bill of entity which is authenticated by the tax authority, i.e., another wing of the National Board of Revenue.
As per the latest information, during the last nine months of the current fiscal year the NBR remained deficit of Tk 45 billion tax revenue. So, for economic development of the country increasing internal resources of fund is important and promulgation of the ‘Transfer Pricing’ law is one such endeavour. This law is, undoubtedly, essential and timely and but from the theme and principles of transfer pricing it also appears that there may be some scope to distort the economy if the multinational companies are harassed. If the multinational companies feel harassed, foreign direct investment (FDI) may be adversely affected. Finally, for development of the country, internal resource is essential and foreign direct investment is equally important. So we will have to keep in mind that no one should be harassed in the name of applying the Transfer Pricing law.
