Two companies with the same owners trade with each other. Goods move at a price nobody negotiated. A management fee is charged because the auditor suggested one. A foreign parent charges royalties and head-office costs.
Every one of those is a related-party transaction, and each is examined on the assumption that the price was not set by market forces — because it was not.
The principle
The Income Tax Ordinance 2001 empowers the Commissioner to distribute, apportion or allocate income, deductions or tax credits between associates so as to reflect the income that would have arisen in an arm's length transaction — that is, the price independent parties would have agreed.
Two consequences follow.
The burden is practical rather than theoretical. If FBR adjusts a price, you are explaining why yours was right. Without contemporaneous support, that is a hard conversation.
Adjustments are one-sided. Income is increased in one entity; the corresponding deduction is not automatically given in the other. The group can end up taxed on the same profit twice.
Who counts as an associate
Broadly, persons whose relationship is such that one may reasonably be expected to act in accordance with the intentions of the other — including companies under common control, holding and subsidiary companies, and relationships through shareholding, directorship or family.
That last point catches far more Pakistani businesses than "transfer pricing" suggests. This is not only a multinational issue. A family group with a trading company, a manufacturing company and a property-owning company, all owned by the same three brothers, is squarely within it.
The transactions that attract attention
- Sale of goods between group companies at prices unlike those charged to third parties
- Management, head-office and technical service fees, particularly where the service cannot be evidenced
- Royalties and licence fees for brands and IP
- Interest-free or below-market loans between associates
- Guarantees given without a fee
- Cost sharing and reimbursements without a documented basis
- Rent paid to a director or a family entity, above or below market
- Purchases from and sales to a related supplier or customer
- Salaries and benefits to directors and family members disproportionate to the role
Related-party transactions also carry company law obligations — approval requirements and disclosure in the financial statements under the Companies Act 2017. Falling foul of the corporate requirements gives FBR a documented starting point, so treat the two as one exercise.
What "arm's length" means in practice
The standard methods look at comparable uncontrolled prices, resale prices, cost plus an appropriate margin, profit splits, and transactional net margins. Which is appropriate depends on the transaction and the data available.
You do not need a multinational's study for a domestic group. You do need to be able to answer, credibly and in writing:
- What was supplied, and by whom, to whom
- Why the price was set at that level
- What comparable evidence exists — quotations, third-party prices, published data, prices charged to unrelated customers
- What was actually received — for services, evidence that the service exists: people, time records, deliverables, correspondence
Service fees are where cases are lost. A management fee with no evidence of any management being provided is disallowed, and the answer "the group provides support" is not evidence.
Documentation
Keep, contemporaneously:
- Written agreements for every intra-group arrangement — supply, services, licence, loan, guarantee, lease
- A pricing rationale recorded at the time, not reconstructed later
- Comparables relied on
- Evidence of performance — deliverables, communications, timesheets
- Board approvals and disclosures required under company law
- Group financial statements and the segmental picture
Larger taxpayers and those in international groups face additional obligations, including country-by-country and related reporting requirements where thresholds are met. Check where your group sits.
Cross-border: the extra layers
Withholding tax on payments abroad — royalties, technical fees, interest — is a separate obligation and is where most groups first come to grief. See withholding tax obligations.
Treaty relief may reduce or eliminate that withholding, but it is not automatic and requires the correct documentation.
Permanent establishment. Group arrangements can create a taxable presence for a foreign parent — particularly where a local entity or office concludes contracts for it. See branch, liaison office or subsidiary.
Repatriation. Dividends, royalties and fees leave Pakistan through the banking channel with documentation requirements. If pricing is challenged, repatriation gets harder. See repatriating profits and capital.
Customs valuation. Related-party import pricing is scrutinised by Customs on its own basis, and a low price for customs and a high price for income tax cannot both be right. Keep the positions consistent, because both authorities can see them. See customs valuation and duty demands.
When FBR raises it
Typically through audit or a monitoring proceeding, with a notice asking for details of transactions with associates.
Do not answer casually. The first response frames the case. Establish what is actually being questioned, assemble the agreements and evidence, and put the commercial rationale on the record early — an adjustment resisted at assessment is far cheaper than one appealed for three years.
See FBR audit notices.
For family businesses, in plain terms
If you own several businesses and move money, goods, staff or premises between them, do three things:
- Write it down — a simple agreement for each recurring arrangement
- Price it defensibly — by reference to what you charge or pay outsiders
- Keep evidence that whatever was charged for was actually provided
That is most of the protection, and it costs very little compared with an assessment.
See choosing a business structure and shareholders' agreements and deadlock.
How the firm can help
We review intra-group arrangements and put the agreements and pricing rationale in place before they are questioned, respond to FBR notices concerning transactions with associates, argue and appeal adjustments, and coordinate the income tax, customs, company law and repatriation positions so they tell one consistent story.
See taxation and customs, or contact the firm.