Business owners, investors, and individuals prefer starting an offshore company in a jurisdiction that offers low or zero tax. It is often a common practice to establish an offshore business to avail benefits that may not be present in the resident country. However, there may be situations when you have to charge your original company, which is located in the resident country, with marketing fees, management fees, or any other similar fees.
In such a scenario, you should take into consideration specific rules known as transfer pricing rules. Companies that are involved in transferring goods and services among offshore jurisdictions and related business entities are subjected to specific provisions as devised by the Internal Revenue Code Section 482. According to these provisions, it is essential to meet these standards and conduct an independent analysis of the related transfer prices. In this article, we will have a look at some of the aspects of transfer pricing and methods related to the procedure.
What Exactly is Transfer Pricing?
There are basically three primary methods that have been considered to be acceptable, depending upon the business scenario. If you have to conduct billing from one company to another company in an offshore jurisdiction and given that these companies are related, then you are subjected to bill the fair price in a similar manner in which you would bill third party services. So, the manner in which you pay your own company for certain services has to be similar to what typically pays any other third party company.
So before you proceed for billing your resident company for some service, the offshore company laws require you to conduct a transfer pricing study. It will give you the best estimate of the fair market value that is designated for the required service. Depending on the jurisdiction, there can be different rules about how you have to conduct the transfer pricing studies, related methods, and the reporting associated with it.
Methods of Transfer Pricing
There are three methods that you can follow to conduct transfer pricing. One technique is known as Comparable Uncontrolled Price (CUP). Costs of OEM deals of indistinguishable items structure the reason for this technique. In any case, this gross information must be acclimated to reflect esteem contrasts without a brand name. One disadvantage of this method is that interior exchange costs are regularly organization private. Additionally, general midpoints may have lacking distinction to win at preliminary.
Another methodology is called the Resale Price Method (RPM). RPM experiences relative shortcomings as well. On many occasions, the inventory retail list cost is known. Additionally, some exchange costs are precisely announced; for example, genuine property deals subject to narrative exchange assessment or customer products with standardized tag marks. Be that as it may, because of limits, or contrasts in credit terms, real retail exchange costs may shift altogether, bringing about temperamental gross edge estimations.
From the beginning of the process, business owners utilizing both of these strategies will typically have the key hindrances of insufficient or questionable data. Interestingly, the individual has complete access to finish and precise data in regards to his income, creation costs, and working resources. Consequently, an estimation dependent on the anticipated rate of profitability, utilizing the citizen information, has innate precision favorable circumstances.
The best methodology is known as CPM, Comparable Profit Method. This technique centers around the rate of profitability for the citizen, as contrasted and comparative open organization information. The most acceptable supposition includes a refinement of CPM, in which move costs are resolved dependent on the current estimation of anticipated future salary.
Procedure for Transfer Pricing
The following procedure is suggested as the best means for offshore companies, as a modified version of the CPM method. The method is mainly focused on the widely accepted marginal cost/marginal revenue model.
1. Market Rate
It is deriving the demand curved for each of the product lines that are based on price and quality estimation. It involves estimating the future shifts in the demand curve, which is based on the product life cycle and strategy used for promotion.
2. Asset Value
Determination of the market value of all assets by specifications such as location and product line, including intangible assets. The pricing should allow adequate information on the investment for the assets distinguished by location and product line.
3. Supply Cost
Deriving the cost against the quantity curves for each product line, which is entirely based on factory level cost in addition to the required return on investment.
4. Discount Rate
Calculation of the cost of capital required for each product line and location. It is based on the risk-free rate associated with the country and product line and is compared to public companies in similar markets.
5. Cash Flow
Projecting the future cash flow estimated for each product line and location. It is done using transfer prices, which are explicitly designed to maximize profit, based on the marginal revenue.
6. Present Value
Maximizing the current value of the future cash flow based on the product line and location. It requires further iteration of the model using alternative transfer prices to calculate the required price.
Setting up a proper transfer pricing structure is quite difficult and requires professional help. It is, however, quite beneficial to avoid any legal obligations in the future. An effective tax planning can simplify this process. We at Business Setup Worldwide, provide clients with optimal solutions for offshore company formation and offshore bank account opening. You can know more about our offshore services by contacting us today!