All about the TRANSFER PRICING for financial strategies and risk mitigations.

February 2, 2025

The Government of Nepal has recently introduced the Transfer Pricing Directives, 2081 (2024-25), marking a significant shift in how multinational enterprises (MNEs) and businesses with cross-border transactions will be taxed. At business side, it’s crucial to understand these changes and their implications for the business. Whether its a software company, a manufacturing firm, or a service provider, these directives will impact your financial strategies, compliance requirements, and tax liabilities.

First, let me highlight one ofthe relative cases of Transfer pricing:

Microsoft – India Transfer Pricing Dispute (2016)

Figure Issue: Indian tax authorities claimed that Microsoft’s Indian subsidiary underpaid taxes by overcharging for software licenses purchased from its U.S. parent company. The dispute centered on whether the software licenses were a "sale" or "royalty," which had different tax implications.

Generated Outcome: Microsoft challenged the ruling, and the case went to court, the Indian Supreme Court eventually ruled in favor of Microsoft, stating that the transaction was a "sale" and not a "royalty," setting a precedent for similar cases in the software industry.

Let me back to the topic i.e. in this article will try to break down the highlights of the new directives, explore their implications, and provide assumptive case scenarios to help you navigate this complex landscape. Let’s dive in!

Why Transfer Pricing Matters in Nepal

Transfer pricing refers to the pricing of goods, services, and intangibles between related entities across borders. Without proper regulations, MNEs can manipulate prices to shift profits to low-tax jurisdictions, depriving higher-tax countries like Nepal of their fair share of tax revenue. The new directives aim to ensure that cross-border transactions between related parties are conducted at arm’s length, meaning the prices should be comparable to those charged between independent entities under similar circumstances. This is a global best practice, aligned with the OECD’s guidelines, and Nepal is now stepping up its game to align with international standards.

Let's move on few Key factors of Transfer Pricing

A. Let's get to know about Arm’s Length Principle

The Arm's Length Principle (ALP) is the framework for transfer price regulations worldwide, including Nepal's new law. It requires related party transactions (e.g., parent companies and subsidiaries) to be priced as if they took place between separate parties under comparable conditions. That way, there will be distribution of profits appropriately across nations, and profit manipulation to tax havens will be arrested.

In effect, if a Nepali software company provides services to its foreign parent, the price charged should be comparable to that which an independent software company would charge for the same services. The principle is general to all cross-border transactions like the sale of goods, provision of services, licensing of intangibles, and financing arrangements.

Example: Software Licensing in the Tech Industry

Let's assume that a U.S.-based multinational software company licenses its own software to its Nepali subsidiary for $20,000 per annum. Independent software companies, however, offer similar licenses in the Nepali market for $8,000 per annum.

Now where can be the issues?

The $20,000 fee could be less than the ALP, as it is significantly below the market rate.

What can be done then?

The company must rationalize the $20,000 charge using a transfer pricing method like the Comparable Uncontrolled Price (CUP) Method. Without an acceptable rationale, the charge must be adjusted to $8,000 to satisfy the ALP.

A few other assumptive scenarios are mentioned below in the articles.

Why ALP Matters ???

The ALP enforces international fairness in taxation and prevents MNEs from manipulatively deferring profits. For Nepal, this is similar to protecting its tax base while encouraging openness in its business environment. Proper comparability analysis and proper documentation are necessary, and companies should adhere to such requirements in keeping with ALP. By adhering to the ALP, companies are able to keep out of the bad books of tax authorities and earn the respect of their stakeholders. For the software industry, where intangibles like patents and licenses abound, the ALP is particularly critical for the purpose of maintaining accurate valuations and compliance.

What a business can learn here then?

The ALP isn't just a rulebook regulation—it's best practice for responsible and sound business practices in our globalized era.

2. Now let's know more about the Transfer Pricing Methods

The directives outline five methods for determining the arm’s length price:

1.Comparable Uncontrolled Price (CUP) Method:

This method is a comparison between the price of goods or services in a controlled transaction and the price of the same or similar uncontrolled transaction.

2. Resale Price Method:

In this method, the arm's length price is determined by reference to the resale price of a product to an unrelated party, less an appropriate gross margin.

3. Cost Plus Method:

In this method, the addition of an appropriate markup to the cost of goods or services transferred between related parties.

4. Transactional Net Margin Method (TNMM):

This method involves comparing the net profit margin with a base (i.e., sales, assets) and comparing this with that of uncontrolled transactions.

5. Transactional Profit Split Method:

Dividing the total profit of related party transactions based on each party's relative contribution.

Each method has its own applicability depending on the nature of the transaction. For instance, the CUP Method is ideal for software licensing, while the Profit Split Method is more suited for joint ventures or highly integrated operations.

Now know more about the documentation Requirements

Businesses engaged in cross-border transactions must maintain detailed documentation, including:

Master File i.e. Overview of the MNE’s global business operations.

Local File i.e. Detailed information on local transactions and transfer pricing policies.

Country-by-Country Report i.e. For large MNEs, reporting financial data across all jurisdictions.

Other related documents to respective transactions

Taxpayers must maintain records of cross-border controlled transactions with related parties, as well as additional documentation outlined in Schedules 1 and 2 of these guidelines.

However, businesses with an annual turnover of less than NPR 10 crore are exempt from these requirements.

Now lets see the penalties for Non-Compliance

Failure to maintain proper documentation or submit required statements can result in fines, interest, and penalties under Sections 117 to 120 of the Income Tax Act.

B. Advance Pricing Agreements (APAs)

Advance Pricing Agreements (APAs) are a proactive tool introduced in Nepal’s new Transfer Pricing Directives, allowing businesses to pre-determine transfer pricing methods and pricing arrangements with tax authorities. By entering into an APA, companies can secure agreement on how their cross-border transactions will be taxed, providing certainty and reducing the risk of disputes or adjustments during audits. APAs are particularly beneficial for industries like software, where intangible assets and complex transactions are common. For example, a software company licensing its products to a foreign subsidiary can use an APA to agree on royalty rates, ensuring compliance and avoiding future conflicts with tax authorities.

Lets have one assumptive Case Scenarios: Transfer Pricing in the Software Industry

Scenario 1: Software Development in Nepal for a Foreign Parent Company

A Nepali software development company provides services to its parent company in the United States. The Nepali company charges $2000 per month for its services, while independent software developers in Nepal charge NPR $5000 per month for similar work.

The issue can be that the tax authorities may question whether the $2000 rate is at arm’s length.

So what can be a strategic move from the side of Nepal based company.

The Nepali company should conduct a comparability analysis using the CUP Method or TNMM to justify its pricing.

If adjustments are needed, the company may need to increase its rates to align with market standards, not sure if this can hamper the sales strategies of the business but needs to align accordingly to answer it properly.

Scenario 2: Licensing of Software to a Nepali Subsidiary

A global software company licenses its proprietary software to its Nepali subsidiary for 

$10,000 per annum. Independent companies charge $15,000 per year for similar software licenses.

Issue: The tax authorities may argue that the $10,000 fee is below the arm’s length price.

Solution: The parent company should use the CUP Method to compare its licensing fees with those charged by independent entities. If the fee is indeed below market rates, the company may need to adjust its pricing or provide additional justification.

Scenario 3: Profit Shifting in a Multinational Software Company

A multinational software company shifts profits from its high-tax jurisdictions (e.g., Nepal) to a low-tax jurisdiction (e.g., Ireland) by underpricing its software licenses and overpricing its support services.

Issue: This practice, known as profit shifting, is a red flag for tax authorities.

Solution: The company should adopt the Profit Split Method to allocate profits based on the value contributed by each entity. This ensures that Nepal receives its fair share of tax revenue.

C. Global Trends in Transfer Pricing:

1. The Digital Economy and Transfer Pricing

The rise of the digital economy has complicated transfer pricing, as intangible assets like software, patents, and data are harder to value. Nepal’s new directives address this by including provisions for significant digital presence, ensuring that digital businesses pay their fair share of taxes.

2. BEPS and Global Compliance

The OECD’s Base Erosion and Profit Shifting (BEPS) initiative has set the global standard for transfer pricing. Nepal’s new directives seems align with BEPS, particularly in areas like documentation, CBCR, and APAs.

D. Dispute Resolution Mechanisms

The new directives provide a framework for resolving transfer pricing disputes, including administrative reviews and appeals to the Revenue Tribunal. This is a positive step toward reducing litigation and providing certainty to businesses.

So how be prepared for the New Directives?

Conduct a Transfer Pricing Health Check: Review your existing cross-border transactions and ensure they comply with the arm’s length principle.

Maintain Robust Documentation: Prepare master files, local files, and CbCRs (if applicable) to avoid penalties.

Consider an APA: If you’re planning large cross-border transactions, an APA can provide certainty and reduce the risk of disputes.

Engage Experienced Advisors: Work with tax and legal advisors who understand both local and international transfer pricing regulations.

As a conclusive touch:

Nepal’s new Transfer Pricing Directives expect to bring clarities for businesses with cross-border transactions as well as place an unwanted threat on pricing while businesses in nepal are focusing to inward the business in Nepal any how either low pricing or lowering any other factors. By aligning with global standards, these directives aim to create a fair and transparent tax environment. However, they also bring new compliance challenges, particularly for industries like software, where intangible assets and digital services are prevalent.

Directives published by Inland Revenue Department: https://ird.gov.np/public/pdf/509469406.pdf

Disclaimer: This blog is for informational purposes only and does not constitute professional advice. For specific guidance on transfer pricing and tax compliance, consult a qualified advisor.

Compiled by

Manik Balami

Chief Business Officer

Rudolph Corporate Services Pvt. Ltd.

About the Author:

Manik Balami is a corporate finance, tax, and legal advisor with over 15 years of experience in helping businesses navigate complex regulatory environments. Specializing in transfer pricing, international taxation, and compliance, Manik Balami has worked with clients across industries, including technology, manufacturing, and services.

Contact Us:

For personalized advice on transfer pricing and tax compliance, reach out to us at manik.balami@rudolphservice.com or +977-9851152761. Let’s ensure your business is ready for the new transfer pricing landscape in Nepal!

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