7 Final Presentation

8/8/2019 7 Final Presentation

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Evolution, Concepts, Audit and Tax Aspects inINDIA

V Y Srinath Sharma


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Anatomy of TaxesMr A uses the resourcesavailable in his countrylike, men, material and

infrastructure tomanufacture the product.

Since the countrysresources are used byhim, Mr A will have to

compensate thegovernment.

This compensation is

called TAX

Mr A Mr B

ONE PERSONSEXPENSE ISANOTHERS

INCOME

Government


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Evolution


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Evolution


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Why is Transfer Pricing soImportant?

IndianParent

Company

USSubsidia

ryCompan

y

Purchases Goods

Transfer Price

Assume that the cost of manufacturing the goods by Indiancompany is Rs. 500

The price charged by the Indian company to its US Subsidiary isRs.1000 inclusive of Rs.500 profit.

The same goods are sold by US Subsidiary @ Rs.1100 [incl. ofRs.100 other exp.]

This shows that the US Subsidiary is making no profit/no loss.

The Indian Tax Administrators will not grumble as they havegot the tax at their end.


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Transfer Pricing inINDIA With the increasing participation of MNEs in economicWith the increasing participation of MNEs in economicactivities in the countryactivities in the country

Given rise to new and complex issues emerging fromGiven rise to new and complex issues emerging from

transactions entered into between two or more entities belongingtransactions entered into between two or more entities belonging

to the same group of MNEs.to the same group of MNEs.

The Profits Derived by such enterprises carrying businessThe Profits Derived by such enterprises carrying business

in INDIA can be controlled by the multinational Group.in INDIA can be controlled by the multinational Group.

By manipulating the prices charged and paid in such intraBy manipulating the prices charged and paid in such intra

group transactions, thereby, leading to erosion of tax revenues.group transactions, thereby, leading to erosion of tax revenues.

Prior Finance Act 2001Prior Finance Act 2001 SEC. 92SEC. 92 was the only sectionwas the only section

dealing specifically with cross border transactionsdealing specifically with cross border transactions where anwhere an

adjustment could be made to the profits of a resident arisingadjustment could be made to the profits of a resident arising

from a business carried on between the resident and a nonfrom a business carried on between the resident and a nonresident, if it appeared to the A O that owing to the closeresident, if it appeared to the A O that owing to the close


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TP under Income Tax Act1961Relevant extracts of the Statement of Objects and Reasons in theRelevant extracts of the Statement of Objects and Reasons in thespeech of the Finance Minister while introducing the Finance Bill,speech of the Finance Minister while introducing the Finance Bill,

2001:2001:

The presence of multinational enterprises in India and theirThe presence of multinational enterprises in India and their

ability to allocate profits in different jurisdictions by controllingability to allocate profits in different jurisdictions by controlling

prices in intra-group transactions has made the issue of transferprices in intra-group transactions has made the issue of transfer

pricing a matter of serious concern.pricing a matter of serious concern. Necessary legislativeNecessary legislative

changes are being made in the Finance Bill based on thesechanges are being made in the Finance Bill based on theseissues.issues.

The sections ofThe sections of92 to 92F92 to 92F under theunder the Income Tax Act, 1961Income Tax Act, 1961 relatingrelating

to the international transactions between associated enterprisesto the international transactions between associated enterprises

have been substituted by thehave been substituted by the finance act 2002finance act 2002 with thewith the effecteffect

from 1-4-2002from 1-4-2002..

Section 92 of the Income Tax Act 1961 provides for computationSection 92 of the Income Tax Act 1961 provides for computation

of income frof income from international transactionom international transaction betweenbetween associatedassociated

enterprisesenterprises should be with regards to theshould be with regards to the Arms Length Price.Arms Length Price.

Some of the important definitions :Some of the important definitions :International TransactionInternational Transaction - Sec. 92B- Sec. 92B


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International Transaction SEC.92B Transaction betweenTransaction between two or more associated enterprisestwo or more associated enterprises ,,

either or both of them areeither or both of them are non residents.non residents.

Transactions in nature of :Transactions in nature of :

Purchase, sale or lease of tangible or intangible propertyPurchase, sale or lease of tangible or intangible property

or provision of services lending or borrowing money or anyor provision of services lending or borrowing money or any

other transaction having a bearing on the profits income ,other transaction having a bearing on the profits income ,losses or assets of such enterprises.losses or assets of such enterprises.

Transaction in the nature of a mutual agreement orTransaction in the nature of a mutual agreement or

arrangement between two or morearrangement between two or more AEsAEs for apportionment offor apportionment of

any cost or benefit.any cost or benefit.

Any other transaction withAny other transaction with other than another than an AssociatedAssociated

Enterprise:Enterprise:

Transaction with any party with a prior agreement.Transaction with any party with a prior agreement.Transaction which is deemed to be so in relation.Transaction which is deemed to be so in relation.


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Associated Enterprise 92AAs per the Income Tax Act 1961, An AssociatedEnterprises are those which satisfy any of the conditions

specified Under Section 92A(2)(a) to 92A(2)(m). Theseconditions have been segregated with regards toManagement, Capital and Control are as follows:-


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Arms Length Price SEC.92F As per IT Act, 1961 ALP, means aAs per IT Act, 1961 ALP, means a price which is applied orprice which is applied orproposed to be applied in a transaction between persons otherproposed to be applied in a transaction between persons other

than associated enterprises, in uncontrolled conditions.than associated enterprises, in uncontrolled conditions.

Although there are discrepancies in the specifics of eachAlthough there are discrepancies in the specifics of each

country's laws concerning the application of the arm's lengthcountry's laws concerning the application of the arm's length

principle, most countries have based their transfer pricing lawsprinciple, most countries have based their transfer pricing laws

and regulations on the OECD Guidelines.and regulations on the OECD Guidelines.

The OECD Guidelines refer to the following methods:The OECD Guidelines refer to the following methods:

Comparable Uncontrolled Price method (CUP)Comparable Uncontrolled Price method (CUP)

Resale Price Method (RPM);Resale Price Method (RPM);

Cost Plus Method (CPM)Cost Plus Method (CPM)

Profit split method(PSM); andProfit split method(PSM); andTransactional Net Margin Method (TNMM)Transactional Net Margin Method (TNMM)

The Same methods are also adopted by the Indian IncomeThe Same methods are also adopted by the Indian Income

Tax Act.Tax Act.


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Steps involved in computingALP


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Comparable Uncontrolled Price MethodComparable Uncontrolled Price Method[CUP][CUP]

Identify an identicalIdentify an identical

international transaction withinternational transaction with

another unrelated entityanother unrelated entity

Sort out the price differencesSort out the price differences

occurring due to unrelatedoccurring due to unrelated

scenariosscenarios

The adjusted price to beThe adjusted price to be

compared with the relatedcompared with the relatedparty transactionparty transaction

IndianEntity

RelatedUS Entity

UnrelatedUS Entity

IndianEntity

RelatedUS Entity

UnrelatedEuropeEntity

No price

differences,comparethe pricesas it is

Adjust

pricedifferences,comparetheadjustedprice

CUP Method is adopted for transactions such as TransferCUP Method is adopted for transactions such as Transfer

of Goods, Intangibles, Interest on loans,of Goods, Intangibles, Interest on loans,

services, etc..services, etc..

This Method compares prices between controlled andThis Method compares prices between controlled and

uncontrolled transactions.uncontrolled transactions.


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Resale Price Method [RPM]

Identify the products purchasedfrom a related party.

Arrive at the price at which thesaid product is sold to an

unrelated party.

Deduct the industry GP Marginfor similar products from thesale price and work back to findout the cost price of the product

Compare the worked out pricewith that of the related partypurchase price.

Particulars Amount

Final Sale price XXXX

Less: Industry Average GPmargin

XXXX

Adjusted Cost price XXXX

Actual cost of product from

Related Party XXXX

This method is adopted for transactions where thedistribution of goods involves a little or no value additions.


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Cost Plus Method [CPM]

Accumulate the Direct andIndirect Costs of the product.

Arrive at the industry GP Marginfor similar products

Adjust the GP margin for therelated party specific transaction

Compare the worked out pricewith that of the related partypurchase price.

Particulars Amount

Direct Expenses XXXX

Indirect Expenses XXXX

Total cost of Sales XXXX

Add: Adjusted Gross Profit Margin XXXX

Total price from unrelatedtransaction

XXXX

Actual price of the product fromRelated Party XXXX

This method is adopted for transactions such as:Provision for services,

Joint facility agreements,

Transfer of Semi finished goods, andLong term Buying and selling arrangements.


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Profit Split Method [PSM]

Combined net profit of the

Whole group is ascertained.

Profits are split inproportionate to the AssetsEmployed, Functionsundertaken and Risks

assumed by every entity inthe group

Compare this with theActual profits

This method is adopted for transactions involvingintegrated services provided by more than one enterprise andtransfer of unique intangibles.

It is also adopted for those multiple internationaltransactions which are so closely interrelated that they cannotevaluated separately for determining ALP.

i i


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Transactional Net MarginMethod[TNMM]

Net profits of the respectiveentity to be computed

Net profits of the othercomparable entities in thesame nature of businessand of same stature has tobe computed.

Adjust for the economicdifferences

Compare the Net profits ofthe entity and comparableentities

Entity Industry Average

Particulars AmtParticulars Amt

Sales XXXXIndependent CoSales XXX

Less: DirectExpenses XXXX

Less: Ind Co.Direct Expenses XXX

Gross profit XXXXGross profit XXX

Less: Cost of

Sales & Admin XXXX

Less: Ind co.,

Cost of Sales &Admin XXX

Net Profit XXXXNet Profit XXX

Net Profit % %Less:Adjustments forthe specificcircumstances

XXX

Adjusted Netprofit

XXX

This method is adopted for transactions involvingProvisions for services, distribution of finished products whereRPM cant be applied, Transfer of Semi Finished Goods where

CPM cant be applied and Transfer of intangibles where PSM cantbe applied.

The Transaction Net Margin Method evaluates industryaverage of nearly independent companies and compares thosewith Assessee.


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What are the DocumentationRequirements?

Documentation requirement Rule 10DDocumentation to be retained for 9 years

N o Specific Documentation requirement if value ofInternational Transactions is less than one crore Rupees


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Why do you need a Transfer PricingDocumentation in INDIA?


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Assessment Procedure

AO with previous approval of Commissioner can refer

computation of ALP to TPO.

TPO will serve notice on the assessee to provide necessaryevidence to conclude the ALP and pass the Transfer PricingOrder.

On receipt of Transfer Pricing Order AO will further proceed to

d


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Recent Amendments as perFinance Act 2009

SECTION 92CWith Effect From 1 -4 -2009

Where more than one price is determined for adoptingthe MAM the ALP shall be arithmetical mean of suchprices.

However if the price so determined doesnt exceed 5% ofthe price at which the international takes place shall bedeemed to be ALP.

SECTION 92CBIntroduced with effect from 1 -4 -2009

Provides that the determination of ALP u/s. 92 C or 92CAshall be subject to SAFE HARBOUR rules prescribed theboard.

SAFE HARBOUR has been defined to mean circumstances

in which the income tax authorities shall accept thetransfer rice declared b the assessee.


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This makes us clearly understand that how importantTransfer Pricing is in the current Globalized environment with

Enterprises expanding and making the world a global village.

No country poor, emerging or wealthy wants its taxbase to suffer because of transfer pricing.

That is why the OECD has spent so much effort ondeveloping its Transfer Pricing Guidelines.

While they help corporations to avoid double taxation,they also help tax administrations to receive a fair share of the

tax base of multinational enterprises.

But abuse of transfer pricing may be a particularproblem for developing countries, as companies might takeadvantage of it to get round exchange controls and torepatriate profits in a tax free form.

The OECD rovides technical assistance to develo in


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Documents

7 Final Presentation