Transfer pricing refers to the price charged for products or services between related entities. IAS 24.9 identifies a related party as two or more entities that are related either by control, management, or capital. i.e. a subsidiary, joint venture, or an associate company.

Companies often utilize transfer pricing either by way of borrowing, sale, purchase, or leasing of intangible assets, sale or purchase of goods or services, or any other transaction that may affect the profit or loss of the company. The goal is to reduce the tax burden of the parent company by shifting the tax charge to subsidiaries in foreign territories with low-cost taxes hence maximizing their profits. The profit accrued by the subsidiaries is in turn paid to the parent company through dividends which are tax exempt leading to tax savings by corporations.

The use of transfer pricing by multinationals if left unchecked could be misused to evade tax hence tax administrations around the globe have established the arm’s length principle to guide transactions among related entities. The arm’s length principles require that controlled transactions to be carried out agree to the same terms and conditions which would have applied between a transaction with unrelated entities for comparable uncontrolled transactions.

The Income Tax Act Cap 470 (Transfer pricing) rules came into operation on 1st July 2006 to guide the following:

1. To guide related entities in determining the arm’s length price of goods and services involving them; and 
2. Provide administrative regulations including the type of records and documentation to be submitted to the commissioner by entities in transfer pricing arrangement.

The methods used in determining the arm’s length among related entities include the following:

1. The comparable uncontrolled price(CUP) method compares the transfer price in a controlled transaction with that in an uncontrolled transaction and adjustments are made to eradicate price variances.
2. The resale price method, whereby the transfer price of the product is compared to its resale price to an independent enterprise.
3. The cost plus method is where the costs are assessed using the cost incurred by the supplier of the good in a controlled transaction including a markup. 
4. The profit split method is where profits earned in related controlled transactions are split among the related entities depending on functions performed by each entity concerning the transaction and compared to the profit split among independent enterprises in a joint venture. 
5. Transactional net margin method where the net profit margin earned by a multinational company in a controlled transaction is compared to the net profit margin attained by an independent enterprise.
6. Any other method that may be prescribed by the commissioner depending on the nature of the transaction.