Deva Project (1)

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DAYANANDA SAGAR BUSINESS SCHOOL

PROJECT REPORT

ON

TRANSFER PRICING

Submitted for partial fulfillment of award ofMASTER`S DEGREE IN

BUSINESS ADMINISTRATION

BY

DEBASHISH ROY

MBAl Year, 3rd

trimesters

2/5/2011 To 31/7/2011


Shavige Malleshwara Hills, kumaraswamy layout Bangalore-560078


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ACKNOWLEDGEMENT

I take this as an opportunity to thank with bottom of my hear all those without whom the

journey of doing my project would not have been as pleasant as it has been to me. Working

on my project was a constant learning experience with all sweat and tear which was its due

but not without being richly stimulating experience of life time.

I am very thankful to Dr. PARUL TANDON for giving me their valuable advice and

guidance towards fulfillment of the project

Finally I would like to convey my heartiest thanks to all my well wishers for their blessing

and co-operation throughout my study. They boosted me up every day to work with a new

and high spirit.

Debashish Roy


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DECLARATION

I hereby declare that this Research Project entitled, A Study on TRANSFER PRICING

written and submitted by me, under the guidance of Mr. MANISH KUMAR KOTHARI is

my original work and that has not been submitted to any other University / Institute

previously.

DEBASHISH ROY

PGDM-3RD

TRIMESTER


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CERTIFICATE

This is to certify that the Research Project Report entitled, TRANSFER PRICINGfor the award of POST GRADUATES DIPLOMAIN MANAGEMENT from DAYANANDA SAGAR BUSINESS SCHOOL,

BANGALORE, has been carried out by DEBASHISH ROY. The Report

embodies result of original work and studies carried out by the student himself

and the contents of the Report do not form the basis for award of any other

Degree to the candidate or to anybody else.

Dr. PARUL TANDON

DEPT. PGDM (AICTE)


DATE:-

PLACE:-


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CONTENT

CHAPTER-I

,,

i) Introduction

ii) Objectives of the study

iii) Scope of the study

iv) Importance of study

v) Research Methodology

CHAPTER-2

vi) Theoretical perspective

vii) Objectives of transfer pricing

viii) Methods to calculate transfer pricing

ix) Checking transfer pricing manipulation

x) Penalties

xi) Changes in transfer pricing

CHAPTER-3

xii) Data

xiii) Problem solved

xiv) Recommendation

xv) Conclusion

xvi) Limitation of the study

xvii) Bibliography


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CHAPTERI

i) INTRODUCTION

ii)OBJECTIVE OF THE STUDY

iii)SCOPE OF THE STUDY


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INTRODUCTION

Over the course of past few years. Transfer pricing

become an increasingly important- and often complex issue facing by chief

financial officer (CFO) of the companies in India which provide service to theirparent or affiliated organization overseas. This is not just because of the

increase in such transaction as a result of the hectic pace of globalization, but

also importantly, due of the lack of the clarity in the minds of both tax payer as

well as revenue official on what the effective and optimal pricing mechanism

should be, the area of transfer pricing is still a relatively new field and bothcorporation and tax authorities are on a learning curve. Further, what is the right

margin for a business at a point of time is somewhat is subjective issue open to

different interpretation and hence disputes.

The price of a service, and therefore the margin of thatbusiness, is that function of the type of activity that the service provider is

engaged in. Ideally the margin charged by the provider should be directlyproportionate to the value addition undertaken software design and architecture

(higher value adding activities), or just code-writing (lower value addition).

Similarly, in the of a transaction involving manufacture of a component,

margins would be lower if design and tools were provided by the buyer and the

provider undertook only conversion or assemblingEqually, the risk borne by the taxpayer is an important

determinant of the margin-again both are directly proportionate; the greater therisk, the higher the margin. Risks, often considered for the purpose of

determination of margin, include market risk; human capital risk; credit risk;

foreign exchange fluctuation risk; product/service price risk and product

development risk.Captive units generally bear lower risks than other types

of Associated Enterprises (AE), For example, parent organization can afford

higher bench strength than an independent service provider. They will also carry

lower product development risk because they have much greater access to the

company information. However, they do carry foreign exchange fluctuation riskas much as any export organization. Since they carry lower risk, they can,

theoretically, operate at lower margins. Whether this logic is accepted by

transfer pricing auditors however, is a separate issue.


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What is transfer pricing and its method?

Transfer pricing is simply the act of pricing of goods and services or intangibles

when the same is given for use or consumption to a related party (e.g.

Subsidiary). There can be either Market-based, i.e. equivalent to what is being

charged in the outside market for similar goods, or it can be non-market based.

Importantly, two-thirds of the managers say their transfer pricing is non-marketbased. There can be internal and external reasons for transfer pricing. Internal

include motivating managers and monitoring performance, e.g. by putting a cost

to imported inputs. External would be taxes and tariffs.

Different method to calculate transfer pricing

1. Best rule method of transfer pricing

2. Multiple method if transfer pricing

3. Comparable uncontrolled price method

4. Resale price method of transfer pricing

5. Cost plus method of transfer pricing6. Profit split method of transfer pricing

7. Transactional net margin method (TNNM) of transfer pricing

.


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OBJECTIVE OF THE STUDY

1. To study about transfer pricing

2. To evaluate the various application of transfer pricing

3. To analyze the various method of transfer pricing


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Scope of study

The scope of this study is to identify the methods of the Client ofM.K.kothari

& Associates. This study is based on secondary data only because of the rules

of Indian government that a CHARTERED ACCOUNTANT cannot publish

their clients accounting details. Due to time constraint only limited number of

Clients was contacted. This study only focuses on the clients ofM.K. Kothari

& Associates because the study conducted with the clients of M.K. Kothari The

study does not say anything about the other firms which are not the clients of

M.K.kothari & Associates. The scope of study is limited for clients of

M.K.kothari & Associates in Kolkata. It provides help to further study for

transfer pricing in corporate sector.


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Research Methodology

Research Methodology is a set of various methods to be followed to find out

various informations regarding transfer pricing of different company.

Research Methodology is required in every industry for acquiring knowledge of

their method of calculating transfer pricing.

Area of study:

The study is exclusively done in the area of finance. It is a process

requiring care, sophistication, experience, judgment, and knowledge for which

there can be no mechanical substitutes.

Information Collection: -

Information is collected from various clients through personal interaction.

Information is collected with mere interaction and formal discussion with

different clients. Some other relevant information collected through secondary

data

Tools of Analysis : -

The survey about the techniques of marketing and nature of expenditure

is carried out by personally interacting with the potential clients in Kolkata.


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Theoretical Perspective

Transfer price refers to the amount used in accounting for transfer of goods or

services from one responsibility centre to another or from one company toanother which belongs to the same group. Transfer pricing is a mechanism for

distributing revenue between different divisions which jointly develop,manufacture and market products and services.

Transfer pricing systems are designed to accomplish the following objectives: to

provide each division with relevant information required to make optimaldecisions for the organization as a whole; to promote goal congruencethat is,

actions by divisional managers to optimize divisional performance should

automatically optimize the firm's performance; and to facilitate measuringdivisional performances.

The fundamental principle is that the transfer price should be similar to the price

that would be charged if the product were sold to outside customers orpurchased from outside vendors.

Market-based transfer pricing system provides optimal results when the market

for the intermediate product is perfectly competitive and the selling division can

sell its output either to insiders or outsiders and as long as the buying divisioncan obtain all its requirements from either outsiders or insiders.

In such a situation the company as a whole has no additional cost of providing

autonomy to divisions. For example, if division A decides to sell its product atthe market price of Rs. 100 per unit and division B decides to buy the same

product from market at the market price, net cash flow to the firm will be zero

If the market for the intermediate product is imperfect, this system may lead to

sub-optimal utilization of production capacity by the buying division. The

transfer price will form an element of the total marginal cost and the buyingdivision will restrict its output at the level where marginal cost = marginal

revenue. Thus the firm as a whole will lose an opportunity to improve its profitbecause actual marginal cost is lower than the transfer price.

For instance, the intermediate product that the sub-unit A of the firm uses is

produced by the sub-unit B of the firm and another firm. The market price of theproduct is Rs 100 per unit, while the variable cost of production in division B is

Rs 40 per unit. If, the transfer price is fixed at Rs 100 per unit (the market price)

the sub-unit A will consider Rs 100 per unit as a part of its marginal cost. It will

restrict the output at the level where marginal cost = marginal revenue. If the


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sub-unit B has excess capacity, the decision of the sub-unit A is sub-optimal for

the firm as a whole. Even in a situation where the sub-unit B has no excess

capacity, that is, it can sell its total output to outsiders at Rs 100 per unit, the

decision of the sub-unit A to restrict its output at a level lower than its

achievable capacity might be sub-optimal for the firm as a whole.

Assume that the firm earns a contribution of Rs 100 per unit on the final

product, the output of the sub-unit A. The contribution is higher than the

contribution of Rs 60 per unit on the intermediate product. The firm loses the

opportunity to earn higher profit by using the intermediate product internally inthe sub-unit A instead of selling the same to outsiders.

If competitive prices are not available or it is too costly to obtain market prices,

transfer prices may be determined based on the cost plus a profit. Cost-based

transfer prices should be used only as a second option to market-based transferprices because it involves complex calculations and results are less than

satisfactory

Companies use variations of market-based and cost-based transfer pricing

mechanisms to achieve the objective of goal congruence. Transfer-pricing

system must have in-built mechanisms for smooth negotiation and conflictresolution.

Although there is sound economic theory behind the selection of transferpricing methods, companies use transfer price methods to achieve certain other

objectives even at the cost of goal congruence. Often in family run businesses,decisions are taken at the group level.

Therefore, decisions aim to optimize group performance. When group

companies produce products that are used within the group, transfer price is

established with an aim to optimize the group performance, although it may hurtthe selling or the buying company within the group.

An issue that is often ignored is that whether this practice undermines theinterest of minority shareholders. If there is no minority shareholder in thecompany that is hurt, the ethical/corporate governance issue does not arise.

Otherwise, this is an important issue and need to be addressed by the board ofdirectors of individual companies.

For multinational corporations, it may be advantageous to arbitrarily select

prices such that most of the profit is made in a country with low taxes, thus

shifting the profits to reduce overall taxes paid by a multinational group.


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However, most countries enforce tax laws based on the arm's length principle as

defined in the OECD (Organization for Economic Co-operation and

Development) Transfer Pricing Guidelines for Multinational Enterprises and

Tax Administrations, limiting how transfer prices can be set and ensuring that

that country gets to tax its "fair" share. In India, the OECD principle wasadopted in 2001.

Applying transfer pricing rules based on the arm's length principle is not easy,

even with the help of the OECD's guidelines. It is not always possibleand

certainly takes valuable timeto find comparable market transactions to set anacceptable transfer price.

The revenue authority and the MNCs should work together in good faith to

implement regulations effectively. The question of ethics cannot be ignored

even in tax planning.

Objective of transfer pricing

The main objective is to take advantage of different tax rates between countries.Transfer pricing also is used to evaluate performance of divisions within acompany.

Tax Savings

Imagine a company with two branches, where one makes semi-finished goodsin a low-tax country and exports them to a branch in a high-tax country, where

they are finished and sold. By increasing the transfer price and declaring moreof its profits in the low-tax country, the company can reduce its global tax bill.

Boost Profits

By undercharging for goods crossing national borders, a company can save

money on customs duties paid by the branch in the importing country.

Conversely, by overcharging, a company can extract more money from a

country with tighter currency outflow restrictions.

Measure Performance

Companies need to know how their individual divisions are performing. A way

of measuring that is through transfer pricing. By setting a price for goods in

each stage of the production process, a company can measure the profitability ofeach division and decide where to make organizational adjustments.


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Arm's Length Standard

The basic principle of this standard used by most developed countries is that for

transactions between branches a company should use market prices. However,

enforcement of this rule is complicated, especially when a company hasbranches in numerous countries.

Method to calculate transfer pricing

Best rule method of transfer pricing

The best method rule is intended to avoid the rigidity of the priority of methods

that formerly had been required. The rule guides taxpayers and the IRS (internalrevenue service) as to which method is most appropriate in a particular case.

The temporary regulations no longer provided for an ordering rule to select themethod that provides for an arms-length result. Rather, in choosing a method,

the arms-length result must be determined under the method which providesthe most accurate measure of an arms-length result.

The best method rule appears to be somewhat subjective and, because of itstechnical nature, may require special expertise. Certainly, the rule does not

appear to eliminate the potential for controversy between the IRS and taxpayers.The rule will likely require taxpayers to expend more energy developingintercompany transfer prices and reviewing data.

The best method rule had three limitations:

1. Tangible property rules normally do not adequately consider the effect of

no routine intangibles in determining which method is the best method. Inthese cases, adjustments may be required under the intangible property

rules.

2. Tangible property comparable methods may be superseded, especially asthey effect significant no routine intangibles that are not defined.

3. A taxpayer can request an advance pricing agreement to determine itsbest method.


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Multiple Methods of Transfer Pricing

The temporary regulations encouraged the taxpayer to use more than one

transfer pricing method. When two or more methods produce inconsistent

results, the best method rule should be applied to determine which methodproduces the most accurate measure. Presumably, if the results are consistent, itmay not be necessary to invoke the best method rule.

If the best method rule does not clearly indicate the most accurate method,

consistency between results should be considered as an additional factor. Using

this approach, the taxpayer should ascertain whether any of the methods, or

separate applications of a method, yields a result consistent with any othermethod.

Comparable Uncontrolled Price Method

The CUP method provides the best evidence of an arm's length price. A CUPmay arise where:

the taxpayer or another member of the group sells the particular product,in similar quantities and under similar terms to arm's length parties in

similar markets (an internal comparable);

an arm's length party sellsthe particular product, in similar quantities and

under similar terms to another arm's length party in similar markets (anexternal comparable); the taxpayer or another member of the group buys the particular product,

in similar quantities and under similar terms from arm's length parties in

similar markets (an internal comparable); or

an arm's length party buys the particular product, in similar quantities and

under similar terms from another arm's length party in similar markets (anexternal comparable).

Incidental sales of a product by a taxpayer to arm's length parties may not be

indicative of an arm's length price for the same product transferred betweennon-arm's length parties, unless the non-arm's length sales are also incidental.

Transactions may serve as comparables despite the existence of differencesbetween those transactions and non-arm's length transactions, if:

the differences can be measured on a reasonable basis; and

Appropriate adjustments can be made to eliminate the effects of thosedifferences.


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Where differences exist between controlled and uncontrolled transactions, it

may be difficult to determine the adjustments necessary to eliminate the effect

on transfer prices. However, the difficulties that arise in making adjustments

should not routinely preclude the potential application of the CUP method.

Therefore, taxpayers should make reasonable efforts to adjust for differences.

The use of the CUP method precludes an additional allocation of related product

development costs or overhead unless such charges are also made to arm's

length parties. This prevents the double deduction of those costs-once as an

element of the transfer price and once as an allocation.

Resale price method of Transfer Pricing

The resale price method begins with the resale price to arm's length parties (of a

product purchased from an non-arm's length enterprise), reduced by acomparable gross margin. This comparable gross margin is determined byreference to either:

the resale price margin earned by a member of the group in comparable

uncontrolled transactions (internal comparable); or The resale price margin earned by an arm's length enterprise in

comparable uncontrolled transactions (external comparable).

Under this method, the arm's length price of goods acquired by a taxpayer in anon-arm's length transaction is determined by reducing the price realized on the

resale of the goods by the taxpayer to an arm's length party, by an appropriate

gross margin. This gross margin, the resale margin, should allow the seller to:

recover its operating costs; and

Earn an arm's length profit based on the functions performed, assets used,and the risks assumed.

Where the transactions are not comparable in all ways and the differences have

a material effect on price, the taxpayer must make adjustments to eliminate theeffect of those differences. The more comparable the functions, risks and assets,

the more likely that the resale price method will produce an appropriate estimateof an arm's length result.

An exclusive right to resell goods will usually be reflected in the resale margin.

The resale price method is most appropriate in a situation where the seller adds

relatively little value to the goods. The greater the value-added to the goods by

the functions performed by the seller, the more difficult it will be to determinean appropriate resale margin. This is especially true in a situation where the


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seller contributes to the creation or maintenance of an intangible property, suchas a marketing intangible, in its activities

Cost plus method of Transfer Pricing

The cost plus method begins with the costs incurred by a supplier of a product

or service provided to an non-arm's length enterprise, and a comparable gross

mark-up is then added to those costs. This comparable gross mark-up isdetermined in two ways, by reference to:

the cost plus mark-up earned by a member of the group in comparable

uncontrolled transactions (internal comparable); or The cost plus mark-up earned by an arm's length enterprise in comparable

uncontrolled transactions (external comparable).

In either case, the returns used to determine an arm's length mark-up must be

those earned by persons performing similar functions and preferably sellingsimilar goods to arm's length parties.

Where the transactions are not comparable in all ways and the differences havea material effect on price, taxpayers must make adjustments to eliminate theeffect of those differences, such as differences in:

the relative efficiency of the supplier; and Any advantage that the activity creates for the group.

The more comparable the functions, risks and assets, the more likely it is thatthe cost plus method will produce an appropriate estimate of an arm's lengthresult.

In general, for purposes of applying a cost-based method, costs are divided intothree categories:

(1) Direct costs such as raw materials;

(2) Indirect costs such as repair and maintenance which may be allocatedamong several products; and

(3) Operating expenses such as selling, general, and administrative expenses.

The cost plus method uses margins calculated after direct and indirect costs of

production. In comparison, net margin methods-such as the transactional net

margin method (TNMM) discussed in Section B of this Part-use margins

calculated after direct, indirect, and operating expenses. For purposes of


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calculating the cost base for the net margin methods, operating expenses usuallyexclude interest expense and taxes.

Properly determining cost under the cost plus method is important. Cost is

usually calculated in accordance with accounting principles that are generallyaccepted for that particular industry in the country where the goods areproduced.

However, it is most important that the cost base of the transaction of the tested

party to which a mark-up is to be applied be calculated in the same manner as-

and reflects similar functions, risks, and assets as-the cost base of the

comparable transactions. Where cost is not accurately determined in the same

manner, both the mark-up (which is a percentage of cost) and the transfer price(which is the total of the cost and the mark-up) will be misstated.

Transactional Profit Methods of Transfer Pricing

Traditional transaction methods are the most reliable means of establishing

arm's length prices or allocations. However, the complexity of modern business

situations may make it difficult to apply these methods. Where the information

available on comparable transactions is not detailed enough to allow for

adjustments necessary to achieve comparability in the application of a

traditional transaction method, taxpayers may have to consider transactional

profit methods.

However, the transactional profit methods should not be applied simply because

of the difficulties in obtaining or adjusting information on comparable

transactions, for purposes of applying the traditional transaction methods. The

same factors that led to the conclusion that it is not possible to apply a

traditional transaction method must be considered when evaluating thereliability of a transactional profit method.

The OECD Guidelines endorse the use of two transactional profit methods:

the profit split method; and Transactional net margin method (TNMM).

The key difference between the profit split method and the TNMM is that the

profit split method is applied to all members involved in the controlledtransaction, whereas the TNMM is applied to only one member.

The more uncertainty associated with the comparability analysis, the more

likely it is that a one-sided analysis, such as the TNMM, will produce aninappropriate result. As with the cost plus and resale price methods, the TNMM


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is less likely to produce reliable results where the tested party contributes to

valuable or unique intangible assets. Where uncertainty exists with

comparability, it may be appropriate to use a profit split method to confirm theresults obtained.

Profit split method of Transfer Pricing

Under the profit split method:

The first step is to determine the total profit earned by the parties from

a controlled transaction. The profit split method allocates the total

integrated profits related to a controlled transaction, not the total profits

of the group as a whole. The profit to be split is generally the operating

profit, before the deduction of interest and taxes. In some cases, it may be

appropriate to split the gross profit. The second step is to split the profit between the parties based on the

relative value of their contributions to the non-arm's length transactions,

considering the functions performed, the assets used, and the risks

assumed by each non-arm's length party, in relation to what arm's lengthparties would have received.

The profit split method may be applied where:

the operations of two or more non-arm's length parties are highlyintegrated, making it difficult to evaluate their transactions on an

individual basis; and

the existence of valuable and unique intangibles makes it impossible to

establish the proper level of comparability with uncontrolled transactionsto apply a one-sided method.

Due to the complexity of multinational operations, one member of the

multinational group is seldom entitled to the total return attributable to thevaluable or unique assets, such as intangibles.

Also, arm's length parties would not usually incur additional costs and risks to

obtain the rights to use intangible properties unless they expected to share in the

potential profits. When intangibles are present and no quality comparable data

are available to apply the one-sided methods (i.e., cost plus method, resale pricemethod, the TNMM), taxpayers should consider the use of a profit split method.

The second step of the profit split method can be applied in numerous ways,including:

splitting profits based on a residual analysis; and


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relying entirely on a contribution analysis.

Following the determination of the total profit to be split in the first step of the

profit split, a residual profit split is performed in two stages. The stages can be

applied in numerous ways, for example:

Stage 1: The allocation of a return to each party for the readily

identifiable functions (e.g., manufacturing or distribution) is based on

routine returns established from comparable data. The returns to these

functions will, generally, not account for the return attributable to

valuable or unique intangible property used or developed by the parties.

The calculation of these routine returns is usually calculated by applying

the traditional transaction methods, although it may also involve the

application of the TNMM. Stage 2: The return attributable to the intangible property is established

by allocating the residual profit (or loss) between the parties based on the

relative contributions of the parties, giving consideration to any

information available that indicates how arm's length parties would dividethe profit or loss in similar circumstances.

Transactional net margin method (TNMM) of Transfer Pricing

The TNMM:

compares the net profit margin of a taxpayer arising from a non-arm's

length transaction with the net profit margins realized by arm's length

parties from similar transactions; and

Examines the net profit margin relative to an appropriate base such ascosts, sales or assets.

This differs from the cost plus and resale price methods that compare gross

profit margins. However, the TNMM requires a level of comparability similar

to that required for the application of the cost plus and resale price methods.

Where the relevant information exists at the gross margin level, taxpayersshould apply the cost plus or resale price method.

Because the TNMM is a one-sided method, it is usually applied to the least

complex party that does not contribute to valuable or unique intangible assets.

Since TNMM measures the relationship between net profit and an appropriate

base such as sales, costs, or assets employed, it is important to choose the

appropriate base taking into account the nature of the business activity. The

appropriate base that profits should be measured against will depend on the

facts and circumstances of each case


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CHECKING TRANSFER PRICING MANIPULATION

Having understood the implications and growing importance of Transfer

Pricing, more Precisely Transfer Pricing Manipulation, we look at what

regulations have been enacted to counter this by India.

The Finance Act 2001 introduced detailed Transfer Pricing regulations w.e.f.

1st April, 2001. The basic idea behind regulations is determining whetherInternational Transactions between associated parties are conducted at

arms length pricesArms Length Price (ALP) This is the price that would

be charged in uncontrollable transactions, i.e. when parties are unrelated. Two

most common methods of doing this are

1. Checking the price in a similar transaction between two totally different

parties and

A B vs. C D2. Checking the price in a similar transaction between one of the involved party

and one

Unrelated party .

A B vs. A C

The various methodsprescribed by Indian regulations to find out the arms

length price.

There is generally more than one Transfer Price which is defendable in any

transaction and hence most countries talk of a transfer pricing band rather than a

singular transfer price.There are clearly some roadblocks in implementation of ALP, like:

- Specialized nature of goods/ services and uniqueness of intangibles

- Independent entities might not undertake similar transactions, because of

Copyright issues. For e.g. Coke would only share its formula with a related

party where it has some stakes.- There is a huge administrative burden on part of tax authorities in determining

the true transfer price and this exercise might sometime take years, by when the

Situation changes dramatically

- Confidentiality issue may restrict availability of comparable information.Associated PartiesThose having 26% or more Equity holding, having loans or

Guarantees over a certain value, having power to appoint Board Members or

Managers or when there is dependence for license, copyrights or raw materials

for that matter.

International TransactionsInternational transaction has been defined as a

transaction between two or more associated enterprises, either or both of whom

are non-residents. The transactions intended to be covered are purchase, sale or

lease of tangible or intangible property, provision of services, lending and

borrowing of money cost sharing and any other transaction which have a


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bearing on the profits, income, losses or assets of an enterprise. As such,

virtually every conceivable transaction is proposed to be roped infor scrutiny. The regulations apart from filing of proper tax returns require

maintenance of a host of documentary and other evidence to substantiate

transfer prices adopted by MNEs and penalties have gotten stricter. Anorganization can be fined up to 2% of the transaction value for not just evasion

of tax but also for non-compliance with procedural requirements.

PENALTIES

Penalties have been provided as a disincentive for non-compliance with

procedural requirements is as follows.

(a) Penalty for Concealment of Income - 100 to 300 percent on tax evaded

(b) Failure to Maintain/Furnish Prescribed Documentation - 2 percent of the

value of the international transaction

(c) Penalty for non-furnishing of accountants report - INR 100,000 (fixed)

The above penalties can be avoided if the taxpayer proves that there was

reasonable cause for such failures.

Changes in transfer pricing

India has a relatively short history of transfer pricing (TP) legislation comparedto some countries where this law is well developed. The detailed TP regulation

in the country was introduced in the Finance Act, 2001, with a view to check

erosion of tax base in the country. The domestic TP regulation is designed for

an international transaction, which has been defined to mean a transactionbetween associated enterprises, either or both of whom are non-residents.

As per the domestic TP regulation, an international transaction between

associated enterprises is required to adhere to arm's-length standard. In order to

ensure that the international transaction between associated enterprises is at


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arm's length, there are reporting and detailed documentation requirements that ataxpayer must maintain to avoid stringent penalties.

A domestic transactiona transaction between two tax residents of India

may not be governed specifically by the domestic TP regulation. Generally

speaking, one may assume that the overall tax base of a country is unaffected by

manipulation in the prices of domestic transactions between related parties,since it will have nullifying effect as far as overall taxability of the transaction is

concerned. However, there may be situations where pricing of a domestictransaction could be manipulated for tax arbitrage opportunities.

For instance, price manipulation could result in shifting of profits between a

loss-making entity and a profit-making entity to achieve an overall reduced tax

rate. Similarly, profit shifting to an entity enjoying tax concessions under an

incentive scheme could also be achieved through pricing of transactions of suchentity with another related company.

The Income-Tax Act has provisions (sections 40 A (2) and 80IA10) thatempower the assessing officer to get into the aspect of pricing of the transaction

between a taxpayer and a related person, and adjust the expense or income as

per the market value of such transaction. However, a taxpayer is not required to

maintain specific and detailed documentation to support the pricing of suchtransactions.

Also, there is no guidance in the Act or rules governing such provisionspertaining to determination of fair market value of the transaction. This oftenresults in the tax officer exercising his best judgment in estimating the market

value of the transaction and disregarding the excessive expenditure and incomereported by the taxpayer.

In an interesting development, the Supreme Court in the recent case of

Commissioner of Income Tax IV, Delhi, vs. GlaxoSmithKline Asia (P) Ltd

(SLP (Civil) no 18121/2007) discussed the above-mentioned limitations in the

current provisions governing pricing of domestic transaction between relatedparties.

In this case, the court, on the facts of the case, declined to interfere and

dismissed the special leave petition filed by the tax department. However, sincethe issue involved concerned section 40A (2) of the Act, the court took up a

larger issue of the scope of domestic TP regulation being limited to cross-border

transactions. The apex court observed that in the case of a domestic transaction,

under invoicing of sales and over invoicing of expenses would ordinarily be tax

neutral.


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However, there could be situations where a tax arbitrage could be created. The

court expressed the view that certain provisions of the Act, such as sections

40(A)(2) and 80IA(10), need to be amended to empower the tax officer to make

adjustments to income having regard to the fair value of the transactions

between related parties.

Identifying the shortcomings of current provisions and with a view to reducelitigation, the court has suggested that the ministry of finance should consider

whether the law ought to be amended to provide for extensive documentation to

be maintained by the taxpayer even for domestic transactions with related

parties. This would align the provisions governing domestic transactionsbetween related parties with the provisions of the domestic TP regulation.

The amendment of law to introduce documentation requirements even for

domestic transactions between related parties would not be unique to India.There are many countries that mandate compliance requirements for domestic

transactions within their transfer-pricing regimes. The UK, for instance, is a

jurisdiction where TP provisions governing domestic transactions are fairlydeveloped.

The issue is whether the objective of reduced litigation would be achieved?

Considering that litigation surrounding TP issues has increased significantly, the

change might not result in the desired outcome. However, it would rule out

absolute discretion and bring out some objectivity in the application of theprovisions.

So, are we ready for domestic transfer-pricing legislation? Or, more

importantly, whether the increased burden on the taxpayer as well as the tax

officers is worth the effort? The answer may not be a simple 'aye' or 'nay'.

However, as the Supreme Court has suggested, this is a change that meritsconsideration by lawmakers.


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In the books of nilimara jute mills

Trading & Profit and loss account for the year ending 31st

of March 2009

PARTICULAR AMOUNT PARTICULAR AMOUNT

Opening stock

Purchase

Wages

Expenses

Impartment

Interest

Depreciation

Net profit (b/f)

231000

718800

744900

73900

37100

228100

37100

658200

2729100

Sales

Closing stock

2500000

266200

2729100


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Balance sheet as at 31st

march 2009

PARTICULAR AMOUNT PARTICULAR AMOUNT

SHARE CAPITAL

AUTHORISED CAPITAL@2

ISSUED AND SUBSCRIBED

2 2963478@2

RESERVES & SURPLUS

General reserves

Tea board subsidy as capital res

Housing subsides

Preference shares

Loans

Secured loans

W.B.govt sales tax loan

Others

Bonds

9% secured redeemable

convertible 12yrs bond

Scheduled banks

State banks of India

Bank of Baroda

Allahabad banks

United banks of India

7500

45926956

1073500

114000

406000

294500

1851300

15000

125700

500000

461000

256000

Fixed assets

Goodwill

Land & building

Tea Estate

Roads & culverts

Plant/ machinery

Drawing design &trading

Vehicles

Computers software

Investment

Equity

Tide wale oil

228390@10

New beblwon coal ltd

[email protected]

Others

Gloster jute mills

208@10

Exide industry

212714@1

1215000

1753900

1245800

5375000

5306000

749000

599000

332000

1410700

12703805

2080

212714

Contd...
mailto:[email protected]:[email protected]


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Particular Amount Particular Amount

Sundry creditor& liabilities

Advances and Deposits received

Customers and others

Micro Small and Medium

Enterprises

Unclaimed Redeemed

Preference Shares

Interest accrued but not due on

and deposits

544300

121660

640

260

80000

36096190

Unquoted

The statesman

9966@10

ABC tea worker service

750@10

Debentures

Bond (FULLY PAID)

305@10000

SUNDRY DEBTOR

Unsecured debt

Other debt

Cash

Closing stock

99660

7500

3050000

509614

229418

.

1291833

3166

36096190


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Problems Solved

Assumption completive and perfectly competitive and the manager are motivated to

maximize short-run profit. The production capacity of department A is 1000 denotes

the quantity transferred by X.

Maximize = ( -)(1000-x)+(--)X

= (200-120)-(1000-X) + (300+150+120)

= 8000 -50X

Two decentralized decision makers each maximizing her division profits:-

Profit A = (200-120) (1000-X) + (TP-120) x

= 8000 + (TP-200) x

Profit B = (300-150-TP) x

= (150-TP) x

(1)What is the minimum transfer pricing according to the course text?

ANSWERS

Variable cost + Opportunity

=120+80

=200


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(2)What are the transfer price according to the variable cost and full cost?

ANSWER

VARIABLE COST: 120

FULL COST: 120+31000/1000=151

From the above calculation we can understand that how to calculate the

transfer pricing of a firm. The above calculation is one of the methods of

calculating transfer pricing. It is merely the amount of price of the

product or service which should be charged by the firm on the parent

company. The problem was very simple and it has been drawn on certain

assumption. And through this we can understand the concept of transfer

pricing.


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RECOMMENDATION

The calculation of the transfer pricing is very complex for the normal

person and so he has to take help of the expert

There are many method for calculating transfer pricing so the normalpeople are not able to get which methods will project the best and fairvalue for their business line

The calculation for the multinational companies are very difficult becauseof the international transaction and the complexity of international taxesrates and rules and regulation

The day to day changes in the taxes rates by the government makes it toocomplex for the Officer to calculate the correct figure for the transferpricing.


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CONCLUSION

Transfer pricing is inherent in the way the global economy is structured with

sourcing and consuming destinations being different, with numerousorganizations operating in multiple countries and most importantly due to

varying tax and other laws in different nations.

Also nations have to achieve a fine balance between loss

of revenues in the form of outflow of tax and making their country an attractive

investment destination by giving flexibility in Transfer Pricing. One can choose

to go to extremes like Singapore would be doing especially when it is the low

tax country. Given that countries are not integrated into a global system, each of

them want increase in total inflow through tax or FDI and something like VATis not expected to remove this non-competitive method of attracting investment,

countries will need to enact legislations on their own. Thus, achieving the

mentioned balance, suiting their conditions and pattern of international

transactions, according to the stage of economic development they are in, are

some of the challenges companies are facing as they become a global economiccommunity.


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Limitation of the study

Certain limitations do creep in a research study due to constraints of the time,

money and human efforts, the present study is also not free from certain

limitation, which were unavoidable.

Although all effort were taken to make the result of the work as accurate aspossible as study but the study have following constraints

a. Some clients were calculating there transfer pricing from their ownmethods of calculation, which were not applicable according to Indiangovernment rules & regulation.

b. Due to large number of clients only few clients books were studiedc. Due to time constraint and other imperative work load during the period it

could not be made possible to explore more area of concern pertaining to

study.d. Also impossible for company to provide their confidential details for the

study

e. As per the rules of a chartered accountant they cannot disclose or publishtheir client details in any place.


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Bibliography

Prasan chandra 2009 TATA McGraw-Hill Taxation of international business transaction

http://en.wikipedia.org/wiki/Transfer_pricing

http://www.business-standard.com/india/news/transfer-pricing-explained/327373/

Books provided by the chartered account
http://en.wikipedia.org/wiki/Transfer_pricinghttp://www.business-standard.com/india/news/transfer-pricing-explained/327373/http://www.business-standard.com/india/news/transfer-pricing-explained/327373/http://en.wikipedia.org/wiki/Transfer_pricing

Documents

Deva Project (1)