Explanation:

Transfer pricing (TP) is basically an accounting practice that enables subsidiaries of the same company to transact with each other. As an example, say Company Z has two subsidiaries, Firm A and Firm B. Firm A and Firm B are distinct companies in their own right, and so cannot transfer resources or services between each other for free. Transfer pricing is the method by which they ‘price’ these resources when transacting with each other. Typically, the price of such transfers has to be at the market rate. Hence statement 1 is correct. x Transfer Pricing in India is governed under the Income Tax Act, of 1961. Hence statement 2 is not correct. x Similarly, arm’s length price (ALP) is a concept to do with the price subsidiaries charge each other. Section 92F(ii) of the Income Tax Act, 1961 defines arm’s length price as “a price which is applied or proposed to be applied in a transaction between persons other than associated enterprises, in uncontrolled conditions”. It basically means that one subsidiary should charge another the same price it would charge an unrelated company. That is, it should hold its sibling company at arm’s length. x For the most part, this is standard practice and does not raise any issues. However, there is a possibility that transfer pricing can be used to evade tax. Using the same example, suppose Firm A charges Firm B less than the market value for its services. In such a scenario, Firm A has a lower income because it is getting less money for its services, but Firm B has a higher profit because it is paying less for its inputs. The overall impact on the parent company, Company Z, is the same. x Now, consider a situation where Firm A is in a high-tax country and Firm B is in a low-tax country. By under-charging for its services, Firm A has ensured it pays less tax since it has lower revenues, while Firm  B also pays less tax on its higher profit because the tax rates are lower where it is located. Overall, the parent company comes out of the transaction paying less taxes than it should. x By establishing TP laws globally, the governments discourage evasion of taxes, as tax revenues are important for the development of their economies. Indian Transfer Pricing Regulations (TP Regs) extend to cross-border transactions between companies belonging to the same MNE group (i.e., controlled transactions). Some domestic transactions with companies obtaining tax deductions or eligible for lower tax rates or incentives are also covered. All types of transactions - transfer of goods or services, loans, guarantees, transfer, or remuneration for intangibles, sharing of expenses or income, etc. are covered under TP Regs. The aim of TP regs is to provide a mechanism for determining whether the transfer price is at arm’s length. The TP regs provide that the taxpayer may choose any of the six methods for determining the ALP