The transfer pricing regime in Pakistan has undergone significant evolution in recent years, driven both by the need to align with international standards set by the OECD (Organization for Economic Cooperation and Development) and by increasing scrutiny from the FBR (Federal Board of Revenue, Pakistan’s tax authority) in response to base erosion and profit shifting practices. An analysis of its regulatory framework provides insight into the challenges and opportunities facing both tax authorities and multinational taxpayers.
Legal Framework and Regulatory Developments
Transfer pricing regulations in Pakistan are primarily governed by the Income Tax Ordinance, 2001 and subsequent rules issued by the FBR. This framework was designed to ensure that transactions between related parties (companies within the same multinational group) are conducted under arm’s length conditions.
In recent years, the country has strengthened its legislation by introducing specific regulations that require greater documentation, the adoption of international valuation methodologies, and the gradual incorporation of recommendations derived from the BEPS (Base Erosion and Profit Shifting) project led by the OECD and the G20.
Accepted Valuation Methods
Pakistan recognizes the main transfer pricing methods recommended by the OECD, bringing it into line with international practices. These include:
- CUP (Comparable Uncontrolled Price Method): compares the price of the transaction between related parties with the price of similar transactions between independent parties.
- PSM (Profit Split Method): allocates the joint profit generated by transactions between related parties according to relevant economic criteria.
- RPM (Resale Price Method): based on the price at which a product purchased from a related party is resold to an independent third party, deducting an appropriate profit margin.
- CPM (Cost Plus Method): based on the costs of production or acquisition of goods or services, adding a reasonable profit margin.
- TNMM (Transactional Net Margin Method): evaluates the net profitability obtained in related-party transactions compared to similar transactions between independent parties.
The inclusion of these methods gives the FBR flexibility to select the most appropriate approach on a case-by-case basis, although in practice the TNMM and CUP are most commonly used.
Documentation and Compliance
Companies with multinational operations in Pakistan are required to prepare transfer pricing documentation to support the reasonableness of their pricing policies. This includes:
- Detailed information on the corporate structure of the group.
- Functional analysis identifying the functions, assets, and risks assumed by each entity.
- Comparability studies with market operations.
- Justification of the valuation method applied.
Lack of adequate documentation can lead to significant adjustments, penalties, and surcharges, increasing the level of tax risk for taxpayers.
Challenges in Implementation
Despite having a regulatory framework aligned with the OECD, Pakistan faces significant challenges:
- Limited administrative capacity: The FBR still needs to strengthen its technical resources to thoroughly review Local Files.
- Availability of local comparables: In many cases, companies must resort to international data due to the absence of local databases, which leads to discussions with the authority.
- Harmonization with international standards: Although the framework is inspired by the OECD, there are still particularities that can create uncertainty for taxpayers.
Future Outlook
Pakistan is in the process of gradually adapting to stricter global standards. Greater emphasis is expected on transparency, the application of country-by-country reporting (CbCR) rules, and the use of advance pricing agreements (APAs), with the aim of providing greater certainty to international investors.
In this context, both multinationals and local companies linked to global value chains will need to strengthen their tax governance and ensure that their transfer pricing policies withstand scrutiny by the FBR.
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Source: Dawn