Transfer Pricing

Transfer Pricing

--An Analysis

An Analysis

By

By

Dr. Ravi Gupta

Dr. Ravi Gupta

CA. Avinash Gupta

CA. Avinash Gupta

Contents

Contents

��Concept

Concept

��Transfer Pricing Regulations

Transfer Pricing Regulations

��Recent Change in TP Assessment

Recent Change in TP Assessment

��Arm

Arm

’’ s length price

s length price

��Prescribed m

ethods

Prescribed m

ethods

��Recent Case Laws

Recent Case Laws

A Typical Global Supply Chain

A Typical Global Supply Chain

Global HQ

Manufacturing

Unit

Warehouse

Global

Marketing &

Advertising

Centre

Sales

Representatives

Customers

US

Korea

Japan

Singapore

India

Product Planning

&

Technical Designs

Shifting of

Manufactured Goods

from Factory to an

APAC Warehouse

Marketing

Strategy

Marketing &

Business

Development

Product Supply Agreement

Delivery of Products

Payment for products

Concept

Concept

International transactions

-goods

-services

-intangibles

-loans

Independent

entity

Resident

Associated

enterprise

Resident

Transfer

price

Arm

’s length

price

Associated Enterprises (AEs)

Associated Enterprises (AEs)

��Direct or indirect participation (through one or more

Direct or indirect participation (through one or more

interm

ediaries) in m

anagement control or capital

interm

ediaries) in m

anagement control or capital ––

Sec

Sec

92A(1

)92A(1

)

��The above section is further supplemented by 13 clauses

The above section is further supplemented by 13 clauses

which enlist

various

conditions

under

which two

which enlist

various

conditions

under

which two

enterprises

shall

be deemed to be AE

enterprises

shall

be deemed to be AE’’ s under

s under

Sec

Sec

92A(2

)92A(2

)

Associated Enterprises (AEs)

Associated Enterprises (AEs)

A B

C

D

E

Outs

ide I

ndia

India

Associated Enterprises (AEs)

Associated Enterprises (AEs)

Deemed

Deemed

Pow

er to

appoin

t m

ore

than h

alf o

fdirecto

rs

Loans in

excess o

f 51%

of to

tal assets

Com

mon

executive

directo

r(s)

Guara

nte

es

in e

xcess o

f10%

of to

tal

borr

ow

ings

Supply

of

raw

mate

rials

(90%

or m

ore

)Rela

tionship

sof m

utu

al

inte

rest

Com

ple

tedependence

on I

PRs

Exis

tence

of com

mon

contr

ol

Deemed

AEs

Arm

Arm

’’ s length price

s length price

Arm

Arm

’’ s length price

s length price

Determination of arm’s length prices using one of the Prescribed m

ethods

Whether

you arrive at

a single

price ?

The price thus determined is

the arm’s length price

The arithmetic mean of such

prices or a price is the arm’s

length price (92C(2))

Yes

Price applied or proposed to be applied in a transaction betweenpersons

other than associated enterprises, in uncontrolled conditions

No

The Arm

The Arm

’’ s Length Range

s Length Range --How it works

How it works

��Mostly not possible to identify a single arm

Mostly not possible to identify a single arm

’’ s s

length price

length price

��Overall range m

ay contain extremes

Overall range m

ay contain extremes

��Indian legislation recognizes only arithmetic

Indian legislation recognizes only arithmetic

mean

mean

��If Arm

If Arm

’’ s Length Price falls within +/

s Length Price falls within +/ --5% range

5% range

of transfer price, pricing should be defendable

of transfer price, pricing should be defendable

as arm

as arm

’’ s length

s length

Prescribed m

ethods

Prescribed m

ethods

OECD T

ransfe

r Pricin

g M

eth

ods

OECD T

ransfe

r Pricin

g M

eth

ods

��OECD prefers traditional methods over transactional methods

OECD prefers traditional methods over transactional methods

��Indian rules prescribe no guidance

Indian rules prescribe no guidance ––

legal view it to follow

legal view it to follow

chronological order of the m

ethods in the Act

chronological order of the m

ethods in the Act

��Any other method prescribed by the Central Board of Direct

Any other method prescribed by the Central Board of Direct

Taxes

Taxes --

None as of now

None as of now

Transactional

Net Margin

Method

Profit Split

Method

Cost Plus

Method

Resale

Price

Method

Comparable

Uncontrolled

Price

Traditional Transaction Methods

Transactional Profit Methods

��All methods require comparables.

All methods require comparables.

��Transfer price is set/ defended using data from comparable

Transfer price is set/ defended using data from comparable

companies which should be independent and similar to the

companies which should be independent and similar to the

entity.

entity.

��Following factors are generally used in judging comparability

Following factors are generally used in judging comparability

(Rule 10C(2)):

(Rule 10C(2)):

��nature of transactions undertaken (i.e type of good, service etc

nature of transactions undertaken (i.e type of good, service etc.).)

��company functions

company functions

��risks assumed

risks assumed

��contractual term

s (i.e similar credit term

s)contractual term

s (i.e similar credit term

s)

��economic and m

arket conditions

economic and m

arket conditions

Comparables

Comparables

��Comparable Uncontrolled Price (

Comparable Uncontrolled Price ( ““CUP

CUP”” ) method is

) method is

considered as

the most appropriate method, for

all

considered as

the most appropriate method, for

all

transactions, if inform

ation is available.

transactions, if inform

ation is available.

��CUP m

ethod compares the price charged in a controlled

CUP m

ethod compares the price charged in a controlled

transaction with the price in an uncontrolled transaction.

transaction with the price in an uncontrolled transaction.

��It requires strict comparability in products, contractual

It requires strict comparability in products, contractual

term

s, economic term

s, etc.

term

s, economic term

s, etc.

Comparable Uncontrolled Price Method

Comparable Uncontrolled Price Method --Rule

Rule

10B(1)(a)

10B(1)(a)

Comparable Uncontrolled Price Method

Comparable Uncontrolled Price Method

Identification of price charged or paid in comparable transaction(s)

Such price adjusted to account for differences if any between

international transaction and uncontrolled transaction(s)

Adjusted price arrived above taken to be arm

’s length price

Manufacturer A

Related party -Manufacturer B

Non-related party

Non-related party B

�External CUP

Non-related party A

Comparable Uncontrolled Price Method

Comparable Uncontrolled Price Method

�Internal CUP

Resale Price Method

Resale Price Method--Rule 10B(1)(b)

Rule 10B(1)(b)

�Resale Price Method (“RPM”) compares the resale gross m

argin earned

by AEs with the resale gross m

argin earned by comparable independent

distributors.

�An arm

s’length gross m

argin should be sufficient for a reseller to cover

its operating expenses and m

ake an appropriate operating profit (in light

of its functions and risks).

�Preferred m

ethod for a distributor buying purely finished goods from a

group entity (if no CUP available).

Group Manufacturer

(Outside India)

Related Distributor

(India)

Unrelated

Wholesalers

$75

$100

Resale Price Method

Resale Price Method

Identification of resale price by tested party

Such price reduced by expenses incurred (customs duty etc.) in

purchase of the product/ services.

This price m

ay be adjusted to account for functional and

other differences if any

Resale price reduced by norm

al gross profit with reference

to uncontrolled transaction(s)

Adjusted price arrived above taken to be arm

’s length price

�Cost Plus Method (“CPM”) compares the gross profit on costs the AEs

earns with the gross profit on costs earned by comparable

independent companies.

�Preferred m

ethod for:

�manufacturer supplying semi-finished goods

�entity providing services

Cost Plus Method Rule 10B(1)(c)

Cost Plus Method Rule 10B(1)(c)

Manufacturer A

(Indian)

Related

Manufacturer B

(Outside India,

say US)

Cost + 40%

US Market

Cost Plus Method

Cost Plus Method

Identification of direct and indirect costs of production incurred

in tested party transactions

Norm

al gross profit adjusted to account for functional and

other differences if any

Adjusted gross profit added to total costs identified in step 1

Identification of norm

al gross profit with reference to

uncontrolled transaction(s)

Sum arrived above is taken to be arm

’s length price

Profit Split Method

Profit Split Method-- Rule 10B(1)(d)

Rule 10B(1)(d)

�Profit Split Method (“PSM”) is appropriate for transactions which are not

capable of being evaluated separately.

�Calculates the combined operating profit resulting from the whole

inter-company transaction based on the relative value of each AE's

contribution to the operating profit.

�The contribution m

ade by each party is determ

ined on the basis of a

division of functions perform

ed, valued, if possible using external

comparable data.

�Applicable for analysing tangible, intangible or services issues.

Profit Split Method

Profit Split Method

Determ

ination of combined net profit of the AEs

arising out of international transaction

Splitting of combined net profit amongst enterprises in

proportion to their relative contributions

Profit thus apportioned to the tested party is used to

arrive at the arm

’s length price

Evaluation of relative contributions by each enterprise on the basis

of functions perform

ed, risks assumed and assets employed

Transactional Net Margin Method

Transactional Net Margin Method-- Rule 10B(1)(e)

Rule 10B(1)(e)

�Transactional Net Margin Method (“TNMM”) examines net operating

profit from transactions as a percentage of a certain base (can use

different bases i.e. costs, turnover, etc) in respect of similarparties, as

the profit level indicator.

�Ideally, operating m

argin should be compared to operating m

argin

earned by same enterprise on uncontrolled transaction –

Internal TNMM

�TNMM can also be used to compare the “comparable transactions”

between independent parties –External TNMM.

�It is applicable for any type of transaction and can also be used to

supplement analysis under other methods.

�It is the m

ost frequently used m

ethod in India, due to:

�lack of availability of data to apply other methods.

�evens out business cycles, product dissimilarities.

Transactional Net Margin Method

Transactional Net Margin Method

Net profit from uncontrolled transaction adjusted to account for

differences if any

The net profit thus established is taken into account to arrive at

an arm

’s length price for the international transaction

Computation of net profit as a percentage of a certain base

realised from theinternational transaction.

Computation of net profit realised by the tested party or an

unrelated enterprise in a comparable uncontrolled transaction

TP Study Layout

TP Study Layout

[Nam

e o

f th

e c

om

pany]

Transfer Pricing Study

Fin

ancia

l Year __________

Assessm

ent Year _______

Privileged and Confidential

Draft Report Dated ____________

_____________________

Chart

ere

d A

ccounta

nts

TP Study Layout

TP Study Layout

CO

NTEN

TS

S. No.

S. No.Particulars

Particulars

Page No.

Page No.

11Executive Summary

1.1 Introduction & Scope

1.2 Brief on INC

1.3 Brief on AE Group

1.4 Use of Comparables

1.5 Economic Analysis

22Overview

2.1 General

2.2 Profile of AE Group

2.3 Profile of the company

2.4 Relationship structure between INC & AE

TP Study Layout

TP Study Layout

S. No.

S. No.Particulars

Particulars

Page No.

Page No.

33Industry Overview

44Applicability of Transfer Pricing

Regulations

55Functional Analysis

5.1 Objective

5.2 Analysis of Transactions

5.3 Risk Analysis

66Economic Analysis

6.1 Selection of most appropriate m

ethod

6.2 Search process for comparables

6.3 Conclusions

TP Study Layout

TP Study Layout

Lis

t of Appendic

es

Appendix

A : Scope and Limitation

Appendix

B : Indian Transfer Pricing Regulations

Appendix

C : Accept Reject Matrix

Appendix

D : Results of Selected Comparable Companies

Appendix

E : Brief about the selected companies

Appendix

F :Financial Inform

ation of the company to compute its m

argins

Documentation

Documentation-- Rule 10D

Rule 10D

��Profile of

Profile of

industry

industry

��Profile of group

Profile of group

��Profile of Indian

Profile of Indian

entity

entity

��Profile of

Profile of

associated

associated

enterprises

enterprises

��Transaction term

sTransaction term

s

��Functional analysis

Functional analysis

(functions, assets and risks)

(functions, assets and risks)

��Economic analysis (m

ethod

Economic analysis (m

ethod

selection, comparable

selection, comparable

benchmarking)

benchmarking)

��Forecasts, budgets,

Forecasts, budgets,

estimates

estimates

��Agreements

Agreements

��Invoices

Invoices

��Pricing related

Pricing related

correspondence

correspondence

(letters, emails

(letters, emails

etc)

etc)

Entity related

Price related

Transaction related

•Documentation to be retained for 9 years from financial year

•Documentation is not required to be maintained if the aggregate value of all

international transactions does not exceed one crore rupees

Fact

gathering

Functional

analysis

Economic analysis

Documentation/ Accountants

report

13 24

Mapping of international

transaction

Analysis of Functions, Risks, Assets and

Intangibles

Industry Analysis

Selection of Most

Appropriate

Method

Selection of

Comparables

Calculation of arm

’s length result

TP Study Report

and Accountant’s

Report

The approach for TP documentation m

ay be summarised in the

following phases of work:

Documentation –

Rule 10D

Documentation

Documentation ––

Rule 10D

Rule 10D

Accountant

Accountant ’’s report (Form

3CEB)

s report (Form

3CEB)

--Rule 10E

Rule 10E

��Essentially comments :

Essentially comments :

��whether the tax payer has maintained the transfer

whether the tax payer has maintained the transfer

pricing documentation as required by the legislation,

pricing documentation as required by the legislation,

��whether as per the transfer pricing documentation

whether as per the transfer pricing documentation

the prices of international transactions are at arm

the prices of international transactions are at arm

’’ s s

length, and

length, and

��certifies the value of the international transactions as

certifies the value of the international transactions as

per the books of account and as per the transfer

per the books of account and as per the transfer

pricing documentation are

pricing documentation are ““true and correct

true and correct””

TP Penalties

TP Penalties-- Section 271

Section 271

Defa

ult

Defa

ult

Penalty

Penalty

Post

Post-- inquiry adjustment

inquiry adjustment

(deemed concealment of

(deemed concealment of

income)

income)

100

100-- 300% of tax on the

300% of tax on the

adjusted amount

adjusted amount

Failure to m

aintain

Failure to m

aintain

documents

documents

2% of the transaction value

2% of the transaction value

Failure to furnish

Failure to furnish

documents

documents

2% of the transaction value

2% of the transaction value

Failure to furnish

Failure to furnish

accountants report

accountants report

Rs 100,000

Rs 100,000

Recent Case Laws

Recent Case Laws

��Skoda Auto India

Skoda Auto India ––

Pune ITAT

Pune ITAT

2009

2009-- TIOL

TIOL-- 214

214-- ITAT

ITAT-- PUNE

PUNE

��Transactions between Associated Enterprises (

Transactions between Associated Enterprises ( ‘‘AEs

AEs ’’) )

cannot be considered for determ

ining the existence of

cannot be considered for determ

ining the existence of

an internal Comparable Uncontrolled Price (

an internal Comparable Uncontrolled Price (‘‘ CUP

CUP’’ ))

��Assessee cannot be expected to get details and

Assessee cannot be expected to get details and

particulars, which are not available in public domain

particulars, which are not available in public domain

��SDRC India

SDRC India ––

Delhi ITAT

Delhi ITAT

2009

2009-- TIOL

TIOL-- 185

185-- ITAT

ITAT-- DEL

DEL

��If Assessing Officer (

If Assessing Officer ( ‘‘AO

AO’’ ) was convinced that there

) was convinced that there

was an arrangement to avoid tax, he should have

was an arrangement to avoid tax, he should have

referred the case to TPO under section 92(C)

referred the case to TPO under section 92(C)

Recent Case Laws

Recent Case Laws

��Honeywell Automation

Honeywell Automation ––

Pune ITAT

Pune ITAT

2009

2009-- TIOL

TIOL-- 104

104-- ITAT

ITAT-- PUNE

PUNE

��Only current year data to be used, if the Appellant is not

Only current year data to be used, if the Appellant is not

be able to reveal any facts to bring the case to the

be able to reveal any facts to bring the case to the

proviso to Rule10B(4)

proviso to Rule10B(4)

��UCB India

UCB India ––

Mumbai ITAT

Mumbai ITAT

2009

2009-- TIOL

TIOL-- 184

184-- ITAT

ITAT-- M

UM

MUM

��Penalty not leviable for non

Penalty not leviable for non-- provision of documents

provision of documents

beyond taxpayer

beyond taxpayer ’’s control

s control

��Detailed Functions, Assets & Risks (

Detailed Functions, Assets & Risks ( ‘‘FAR

FAR’’ ) analysis

) analysis

required for application of CUP m

ethod

required for application of CUP m

ethod

Recent Case Laws

Recent Case Laws

��Moser Baer India & Others

Moser Baer India & Others ––

Delhi High Court

Delhi High Court

2008

2008-- TIOL

TIOL-- 647

647-- HC

HC-- DEL

DEL

��Provisions of section 92CA(3) casts an obligation on the TPO to

Provisions of section 92CA(3) casts an obligation on the TPO to

afford a personal hearing to the Appellant before proceeding to

afford a personal hearing to the Appellant before proceeding to

pass an order determ

ining the Arm

pass an order determ

ining the Arm’’ s Length Price (

s Length Price (‘‘ ALP

ALP’’ ))

��Coca Cola India

Coca Cola India ––

Punjab & Haryana High Court

Punjab & Haryana High Court

2008

2008-- TIOL

TIOL-- 656

656-- HC

HC-- P&H

P&H

��Perm

ission granted by the Reserve Bank of India (

Perm

ission granted by the Reserve Bank of India (‘‘ RBI

RBI ’’) under

) under

the Foreign Exchange Regulation Act (

the Foreign Exchange Regulation Act (‘‘ FERA

FERA’’ ) cannot control the

) cannot control the

provisions of the Income

provisions of the Income-- tax Act, 1961 (

tax Act, 1961 (‘‘ the Act

the Act’’ ))

Recent Case Laws

Recent Case Laws

��Philips Software

Philips Software ––

Bangalore ITAT / Karnataka

Bangalore ITAT / Karnataka

High Court

High Court

2009

2009-- TIOL

TIOL-- 123

123-- HC

HC-- KAR

KAR

��AO / TPO required to demonstrate tax avoidance

AO / TPO required to demonstrate tax avoidance

before / during assessment proceedings

before / during assessment proceedings

��TPO cannot reject taxpayer analysis without due

TPO cannot reject taxpayer analysis without due

reasons

reasons

��Recognized importance of economic adjustments

Recognized importance of economic adjustments

��Karnataka High Court has admitted revenue

Karnataka High Court has admitted revenue’’ s appeal

s appeal

against the ITAT order and stayed the order of ITAT

against the ITAT order and stayed the order of ITAT

Recent Case Laws

Recent Case Laws

��Development Consultants

Development Consultants ––

Kolkata ITAT

Kolkata ITAT

2008

2008-- TIOL

TIOL-- 150

150-- ITAT

ITAT-- KOL

KOL

��Taxpayer analysis to be accepted if not controverted by the TPO

Taxpayer analysis to be accepted if not controverted by the TPO

��Cargill India

Cargill India ––

Delhi ITAT

Delhi ITAT

2008

2008-- TIOL

TIOL-- 94

94-- ITAT

ITAT-- DEL

DEL

��Penalty not leviable for non

Penalty not leviable for non-- provision of documents beyond

provision of documents beyond

taxpayer

taxpayer ’’s control

s control

Recent Case Laws

Recent Case Laws

��Ranbaxy Laboratories

Ranbaxy Laboratories ––Delhi ITAT

Delhi ITAT

2008

2008-- TIOL

TIOL-- 75

75-- ITAT

ITAT-- DEL

DEL

��Powers to Commissioner to re

Powers to Commissioner to re-- open case if not examined

open case if not examined

properly by TPO

properly by TPO

��I Gate Global

I Gate Global ––Bangalore ITAT

Bangalore ITAT

112 TTJ 1002

112 TTJ 1002

��Voluntary TP adjustment eligible for Section 10A benefit

Voluntary TP adjustment eligible for Section 10A benefit

��Aztec Software & Technology Services Ltd.

Aztec Software & Technology Services Ltd.

--Bangalore ITAT Special Bench

Bangalore ITAT Special Bench

��AO should use current year data for comparability analysis even

AO should use current year data for comparability analysis even

if such data was not available to the assessee in public databas

if such data was not available to the assessee in public databas e

e

at the time of preparation of TP Study

at the time of preparation of TP Study

Thanks

Thanks