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TRANSFER PRICINGTRANSFER PRICING
Navigating the Indian & Singapore waters!Navigating the Indian & Singapore waters!
Narayan MehtaPartner, Sudit K. Parekh & Co. 25th May 2005
An Overview of Indian Transfer Pricing Regulations
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Transfer Pricing- an Introduction
Denotes price charged by one related party to another for goods, services, etc.
Objective: To check the erosion of tax base and plug the leakage of revenue
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An Illustration- Outsourcing
Singapore Parent
Singapore Parent
Indian Subsidiary
Indian Subsidiary
Singapore Client
Singapore Client
Contract for software development
Offshore software development
100% Equity
Consideration @ S $ 35 per hour
Indian tax rate -Nil
Singapore tax rate= 20%
Need for balancing the Indian and Singapore TP/ Tax regulations!!
OutsourcingArrangement
Consideration??Transfer pricing issues
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Importance of Compliance
Any related party transaction undertaken from 1st April 2001 onwards covered
Currently 60% of world’s cross-border trade is between related parties- Indian tax authority is also going to be vigilant!
UK – for every £1 spent investigating transfer pricing cases, £120 was recovered in extra taxesJapan –transfer pricing has been a major revenue churner- individual cases exceeds $100 m!US – transfer pricing remains the topmost priority of IRS’s agenda on international tax
India - FY 01-02 assessments complete - Press has reported incremental tax revenues in excess of INR 50 million based on the first year of TP audit adjustments
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Importance of Compliance
No exemption from complianceTransactions exceeding INR 50 million to attract compulsory transfer pricing audit
Onus of proof- tax payer primarily liable
S.10A / 10B units- thin margin for errorNo deduction under section 10A / 10B on enhanced income!More than ordinary profits taxable & not tax exempt!
Adverse tax incidence for the Singapore parent outsourcing BPO operations to Indian entityDouble taxation for the Group in respect of enhanced income
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Addition to Income
Failure to maintain documentation
Failure to furnish documentation
Failure to furnish Accountant’s Report
100% to 300% of tax on addition
2% of value of transaction
2% of value of transaction
Rs. 100,000
Penalties are high !
Penalties are not tax deductible!
Importance of Compliance
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Importance of Compliance
An effective tax planning tool to establish the appropriateness of transfer prices
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Transfer Pricing- The Indian Perspective
Income arising to “Associated Enterprises” from “International Transactions” shall be computed having regard to the “Arm’s Length Price”
Indian regulations largely modeled on OECD guidelines
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International
transactionAssociated
Enterpris
e
Legislative Framework
Income needs to be computed on an arm’s length basis
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Associated Enterprise
Means direct or indirect participation in management, control or capital
by one enterprise into another enterprise; or
by the same person in both the enterprises
Either or both of Associated Enterprises
should be non-residents
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Associated Enterprise
“Deemed Associated Enterprises” include:Holding of 26% of voting power
by one enterprise into another enterprise; or
by the same person in both the enterprises
Dependence on intangible assets
Sale of goodsinfluence on price and conditions of supply by buyer
Control by individual or his relative
Loan transaction51% or more of book value of total assets of the borrowing enterprise
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Associated Enterprise
Term of wide import - following parties also covered:
VC investors with 26% stake
FI’s advancing loans exceeding 51% stake of assets of borrowing enterprise
Franchisers, licensees, technical collaborators, etc.
Term of wide import- is your company covered?
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International Transaction
Means “transaction” between 2 or more Associated Enterprises:
For sale of products / other properties
ORAffecting profits, losses, income, assets or liability of the enterprise
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Arm’s Length Price
Denotes price which is applied or proposed to be applied in a
comparable transaction between
unrelated independent parties in
uncontrolled conditions
Corresponds to the open market price
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Computing Arm’s Length Price
Arm’s Length Price to be computed as per “Most Appropriate Method”, to be selected out of:
Price based method
Comparable Uncontrolled Price Method (CUP)
Margin based method
Resale Price Method (RPM)
Cost Plus Method (CPM)
Profit Split Method
Transactional Net Margin Method (TNMM)
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Comparable Uncontrolled Price Method or CUP
Compare price charged in a controlled transaction with uncontrolled transaction
Adjustment for differences materially affecting the price is permissible
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Comparable Uncontrolled Price Method or CUP
AE-India
AE - Singapore
3P - Singapore
3P-India
TP
$ 60 (internal comparable)
$ 60 (internal comparable)
3P - Singapore
$ 60(external
comparable)
Price charged by AE–India to AE–Singapore should be as per open market price$ 60 represents the open market price - Internal comparable preferable to external comparable
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Resale Price Method (RPM)
Reduce arm’s length Gross Profit Margin and procurement expenses from resale price of goods / services resold to an unrelated party
Certain adjustments permissible
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Resale Price Method
AE-India AE - Singapore
3P - Singapore
$ 100 – 20%
$ 100
3P-India 3P-Singapore
3P-Singapore20% GP
Margin on sales
$ 100 = The price at which sales made by AE-Singapore to 3P- Singapore
20% = Gross Profit Margin identified from gross profit margin earned by Italian distributors on similar / comparable uncontrolled transactions
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Cost Plus Method
Add an arm’s length gross profit margin to the production cost of supplier providing goods / services to related purchaser
Certain adjustments permissible
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Cost Plus Method
AE-India AE - Singapore
3P - Singapore
$ 100 – 15%
3P-India 3P - Singapore
3P - Singapore15% GP
Margin on sales
Production Costs of AE-India = 100
15% = Gross Profit Margin on production costs earned by 3P-India on comparable sales made by other Indian software manufacturers
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Profit Split Method
Splitting the combined net profit of associated enterprises arising from international transaction between respective entities based on their relative contribution to the net profits
Rarely used in practice
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Transactional Net Margin Method (TNMM)
Comparing net profit margin of Associated Enterprise arising from international transaction with adjusted net profit margin for similar transaction with unrelated parties in comparable circumstances
Similar to RPM / CPM
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How methods are chosen in practice?
Most Appropriate
Method ???
??? ?
Most Appropriate
Method ???
??? ?
TNMMTNMM Cost PlusCost Plus Profit SplitProfit Split
Resale Price Method
Resale Price Method
Comparable uncontrolled price
Comparable uncontrolled price
OtherYet to be prescribed
OtherYet to be prescribed
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Computing Arm’s Length Price- summary
Selection of the most appropriate method – relevant factors:
Business model and organizational structure
Functional and risk profiling of related parties
Contractual terms
Nature of products and services
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Powers of Indian Tax Authorities
Powers to: Call for information
Determine Arm’s Length Price
Determine total income having regard to Arm’s Length Price5% difference allowed
No deduction under section 10A / 10B / 80HHC on enhanced income!
Corresponding adjustments not permitted !Permitted under certain Indian Treaties!
No adjustment to withholding tax!
Compulsory scrutiny for transactions exceeding INR 50 million
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Taxpayer given an opportunity to respond to TPO’s position
Taxpayer given an opportunity to respond to TPO’s position
Transfer Pricing AssessmentTPO will review compliance by the tax payer with the arm’s length principle
TPO will review compliance by the tax payer with the arm’s length principle
Does the TPO agree with the views of the tax payer
Does the TPO agree with the views of the tax payer
Has the taxpayer responded with sufficiently detailed facts & arguments to enable a re-evaluation of TPO position
Has the taxpayer responded with sufficiently detailed facts & arguments to enable a re-evaluation of TPO position
TPO re-evaluates his positionTPO re-evaluates his position
Does the TPO now agree with the taxpayer’s position
Does the TPO now agree with the taxpayer’s position
TPO would pass a favourable order in relation to the international transaction examined
TPO would pass a favourable order in relation to the international transaction examined
TPO will make further enquiries
TPO will make further enquiries
TP Adjustment
TP Adjustment
??
Yes
Yes
No
No ??
??
Yes
No
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Documentation- why necessary?
To be better prepared for transfer pricing audit
To support your arm’s length price in future
Especially important in loss situations
The tax authorities will never understand your business as well as you, therefore…
Effective communication of your TP policy is critical!
The tax authorities will never understand your business as well as you, therefore…
Effective communication of your TP policy is critical!
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Documentation- fixing the jigsaw puzzle!
Documentation
Benchmarking
Accountant’s Report
FunctionalAnalysis Industry Analysis
Agreements
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Primary Documentation required under Indian Regulations
Associated Enterprise related documentsTransaction related documents
Description of functions performed, risks assumed and assets utilised
ALP computation related documentsRecord of transactions considered for determining price of international transactionsAnalysis performed to evaluate comparabilityDescription of all methods considered and reasons for selection of the most appropriate methodRecord of actual working for determining arm’s length priceDetails of comparable data used in applying most appropriate method
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Government publications, reports, studies, databases
Market research studies and technical publications of recognized national or international institutions
Price publications including stock exchange and commodity market quotations
Secondary Documentation required under Indian Regulations
Relevant agreements and contracts entered into with associated enterprises or with unrelated enterprises
Letters and correspondence documenting terms negotiated with the associated enterprise
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Indian Documentation
No need for fresh documentation every year
Requirement for filing of CA’s report
31st Oct/31st July
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Summing Up
Indian Income-tax Act, 1961Transfer Pricing Regulations
Arm’s length price
Arm’s length price DocumentationDocumentation Accountant’s
Report
Accountant’s Report
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Compliance and Certification Timeline
April 1st ’05 March 31st ’06
Oct 31st ’06
Oct 31st ’07
March 31st ’09
March 31st ’15
Beginning of tax year
Beginning of tax year
End of tax year
End of tax year
Deadline for maintaining
documentation
Filing tax return
Filing Accountant’s
Report
Deadline for maintaining
documentation
Filing tax return
Filing Accountant’s
Report
Limitation for initiation
of assessment
Limitation for initiation
of assessment
Limitation for completion of assessment
Limitation for completion of assessment
Date till which docn. is
required to be maintained
Date till which docn. is
required to be maintained
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Contact Narayan MehtaTel: +91 22 22821141Fax: +91 22 22024193Mobile: +91 9820544495E-Mail: [email protected]
Queries?
Thank You
