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Reviewed by Jul 18, 2022| Updated on
Transfer pricing refers to methods which determine the price for trading in goods or services between related enterprises or companies. Transfer pricing enables improvements in pricing, brings in efficiency, and helps simplification of the process of accounting.
Transfer pricing deals with determining mark up based on the costs. It is relevant to know the costs incurred by a business enterprise, such as transportation, packing, freight, insurance, and tax or customs charges where applicable.
An arrangement of transfer pricing is usually between related enterprises, such as holding and subsidiary companies. The arrangement specifies the transfer price for sale or purchase of goods between the holding and subsidiary companies.
The arrangement may be between two or more subsidiaries of the parent company, or between different companies within a group. For example, a parent company may manufacture the cars, including assembling the body and finishing job.
Two wholly-owned subsidiaries manufacture components, such as brake lining and others. Transfer pricing helps in determining the pricing of the components between the parent company and its subsidiaries.
Transfer pricing helps in maintaining a market for the goods manufactured by a subsidiary with steady margins. It also helps in securing a steady supply of raw materials or components to the parent and facilitates continuous production. The prices fixed for transferring goods is generally closer to the fair market price for such goods in the market.
The system of transfer pricing is between related enterprises. Hence, it is not beneficial to sell below or above the market price of either entities or the group as a whole. If the goods are sold above or below the market price, it will lead to an uneven distribution of profits between different entities within a group.
Transfer pricing of goods or services deals with the arm’s length principles of determining the prices of goods and services bought and sold between related enterprises. The arm’s length principle essentially states that related enterprises must fix the transfer price in line with the price that is paid by an outsider for the same goods or services.