Taxpayers want to diminish their tax liability to the greatest extent possible. However, taxpayers who pursue this aim, risk cross the line separating permissible tax avoidance from impermissible tax evasion.
In cases where the taxpayer is a multi-national enterprise (MNE) and is comprised of corporate entities then they are more persistent in the field of Transfer Pricing. While transfer pricing, in and of itself, is not an unlawful activity, the abuses related with transfer pricing in recent years have tainted that term, making it synonymous with wicked activity like tax dodging, corporate greed and social irresponsibility of MNEs, and often rendering the legal distinction between tax avoidance and tax evasion superfluous.
Transfer pricing is a profit-sharing method used to feature an MNE’s net income (profit or loss) to the tax jurisdictions where it functions as subsidiary controlled foreign corporations (CFCs). The transfer price is defined as the price between related corporate entities for goods or services in an intercompany transaction.
Transfer price is, thus, a price that signifies the value of good; or services between independently operating units of a business. Transfer pricing refers to prices of transactions between relative Companies which may take place under different circumstances from those taking place between independent enterprises. It refers to the value attached to transfers of goods, services, and technology between associated entities. It also refers to the value attached to transfers between distinct parties which are controlled by a common entity.
Abuses arise when the MNE taxpayer uses Transfer pricing to move income to low or no-tax jurisdictions, usually by adding steps to an intercompany transaction such that the utmost profit is made in a low (or no) income tax jurisdiction.
Further, the legal difference between lawful tax avoidance and unlawful tax evasion mainly lost on a global public that is outraged to absorb that MNEs are not paying their apparent fair share of income tax to tax authorities.
Under Transfer Pricing, the parent company or a specific subsidiary tends to produce inadequate taxable income or excessive loss on a transaction. For instance, profits accumulating to the parent can be increased by setting high transfer prices to profits from subsidiaries domiciled in high tax countries, and low transfer prices to transfer profits to subsidiaries located in low tax jurisdiction. As an example of this, a group that manufactures products in high tax countries may agree to sell them at a low profit to its associate sales company based in a tax haven country. That company would in turn sell the product at an arm’s length price and the resulting (inflated) profit would be subject to lesser or no tax in that country. Transfer pricing results in loss of revenue and also a drain on foreign exchange reserves.