INSTITUTE OF CHARTERD
ACCOUNTANTS OF INDIA
WEBCAST –
“Overview of Transfer Pricing”
CA T. P. OSTWAL
TRANSFER PRICING
 Brief history Post World War I
 What is Transfer Pricing?
 Basic Issues Underlying Transfer Pricing
 Evolution of Transfer Pricing
 Concepts in Transfer Pricing
 Transfer Pricing Methods
 Special Issues Related to Transfer Pricing
 Transfer Pricing in Treaties
 Transfer Pricing in Domestic Law
 Global Transfer Pricing Regimes
 Transfer Pricing as a Current and Future Issue for Developing Countries
 Indian Regulation on Transfer Pricing
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October 2013
Where and why did the OECD/UN model treaty policy arise
as it has?
In 1920-1923, the ICC commenced a process to develop
a model income tax treaty in the immediate aftermath of
World War I. This was the period of conception for the
model treaties of today. This work has been lost as the
world has evolved. It is instructive with respect to the
current tax policies being espoused by Source Countries.
October 2013
The Post-World War I World (1920 – 1923)
Imagine a world, long ago, in which the paradigm of commerce and
international taxation was a developed country (let’s call it “England”)
and an under-developed country that was a colony of England (“India”).
A global war ended, with England having enormous war debt. There was
a material flow of commerce between England and India. For the most
part, England transferred to affiliates in India capital, technology, and
access to global markets. India responded with commodities and
produced goods. England was a creditor and India a debtor.
The policy issue for consideration was how income from these activities
should be shared between “Resident” and “Source” countries.
October 2013
ICC Proposal in 1923
In its interim report in 1923, the ICC proposed what we would call today
a profit split or formulary allocation methodology to address income
allocation between Residence (Creditor) and Source (Debtor) countries.
Rather close to the combined income methodologies that we typically
use today to resolve major CA cases between countries with an MNE
in the middle. Frankly, it is also similar to the methodologies for
evaluating intangibles in the 2012 OECD discussion draft.
League of Nations (1923 – 1928)
The ICC work was taken over by the League of Nations in 1923. The LofN
took an entirely different approach. It formulated 5 principles:
October 2013
League of Nations (1923 – 1928) cont…
1. Source Country (India) should tax local
operations, including property or other
pertinent matters.
2. Residual income should be earned by the
country of Residence, which provided the
knowledge and capital for the business.
3. Presence of an interim holding company
should be treated as a Residence Country.
Why was this assumed?: All countries would
adopt a common model!
4. Subsidiaries should not be treated as a PE.
5. TP is to be evaluated on a consistent basis.
The model treaties that eventually
became
the
OECD
Model,
and
subsequently the UN Model, are based on
these 5 principles.
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What was the net impact of these principles?
Answer: A system that allowed:
1.Source Country earns a routine return.
2.Residence Country receives the residual income.
3.Interim holding companies would be treated as Residence
Countries, even if located in a low tax country.
October 2013
MNE Tax Planning Strategies
Not surprisingly, the international tax and effective tax rate
(“ETR”) strategies of MNEs evolved based on this treaty model.
Common structures included what we today describe as:
1.Global/regional principal
2.Centralized risk-taker, intangibles owner
3.Limited risk activities in high tax countries
October 2013
Effective Tax Rates (‘ETR‘) strategies are often based on easily
applied one-sided TP methodologies, which typically test the
earnings of Source Country affiliates.
These strategies are precisely what was contemplated in the
work of the LofN, which is the model of OECD/UN model
treaties.
Today, MNEs are commonly pilloried for base stripping Source
Countries.
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Imperial Paradigm
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Present Day Scenario
Foreign Parents
Intermediate
Holding Company
Costa Rica
BVI
Supply Chain
Transaction
Cayman
Island
Interest transfer
payments
Developing
Countries
Bermuda
Luxembourg
Lease transfer
payments
Royalty transfer
payments
October 2013
ANATOMY OF INCOME SHIFTING
(BASE EROSION)
Tax
Havens
& many more…
October 2013
Is the criticism appropriate? Whether this answer is
“yes” or “no,” it is apparent to me that this is the
behavior that was encouraged by the LofN model. At
the time, it may have been intended to facilitate
repatriation of revenue to Residence countries to
repay war debts.
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October 2013
Introduction to Transfer Pricing
 Rise to a large number of multinational enterprises (MNEs)
 Rise of intra group trade – including highly complex
international transactions involving intangibles and multitiered services
 MNE transaction structure determined not only by open
market but also by group driven forces inclined towards the
common interests of the entities of a group
 Determination of transfer price becomes imperative
 Transfer price to be determined on arms length basis
 Transfer pricing therefore refers to the setting of prices (arms
length price) for transactions between associated enterprises
the transfer of property or services
October 2013
Concept of transfer pricing – Example 1
Purchase of
computer
from S Co
“Controlled
Transaction”
Purchase of
computer
from third party
“Uncontrolled
Transaction”
Country A
ABC
H Co
Country B
ABC
S Co
XYZ
Transfer price of controlled transaction to be equivalent to market price of a
comparable uncontrolled transaction; If lower, Country B loses revenue.
October 2013
Concept of transfer pricing – Example 2
Illustration:
PQR S Co is the distributor of PQR H Co’s
watches in Country B
PQR
H Co
Country A
 Manufacturing Cost to Hco.  $1400
 Distribution Cost to SCo.
 Transfer price
 Sale price in Country B
 H Co Profit
 S Co Profit
Country B
 $100
 $1500
 $1600
 $100
PQR
S Co
 NIL (Cost =Revenue)
 Tax authorities of Country B insists that S Co
should atleast report a profit of $100; thus
transfer price to be reduced to $1,400 – Leads to
economic double taxation.
Customers
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Transfer Pricing and Business Enterprises
 Pricing multiple transactions with associated entities in different tax
jurisdictions
 Measurement of performance of the individual entities in a MNE
 MNE intra-group transactions are undertaken only of its profitable
 Identifying and valuing intangibles transferred and services provided
 Transfer price of non-accounted intangibles
 Transfer price of intra department transactions
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Basic issues underlying Transfer Pricing
 Cross border tax situations involve issues related to jurisdiction, allocation
of income and valuation.
 A MNE Group may exploit the opportunity to shrink the overall tax burden
of the group through either under-charging or over-charging the associated
entity for intra-group trade:
 Illustration:
 Tax rate in the resident country A of HCo.  30%
 Tax rate in the resident country B of SCo.  20%
 HCo shifts profits from Country A to Country B through HCo. being over-charged for
the acquisition of property and services from SCo.
 A group may transfer the tax loss of an associated enterprise in a jurisdiction
where losses cannot be carried forward beyond the prescribed time limit to a
jurisdiction without such restrictions so as to fully utilize the same.
 In some cases loss may be transferred to take the benefit of deductions as quickly
as possible.
 Evidently profits may sometimes be shifted to certain countries in order to obtain
specific tax benefits.
 Reduction of taxation not the only factor contributing to the transfer pricing
policies and practices of a MNE Group
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Basic issues underlying Transfer Pricing
 The key issues in jurisdiction:
 Which country should tax the income of the group entities engaged in the
transaction?
 What happens if both countries claim the right to tax the same income?
 If the tax base arises in more than one country, should one of the country’s
give tax relief to prevent double taxation of the relevant entities’ income, and
if so, which one?
 What needs to be done to minimise profit shifting from one country to
another?
 The key issues in valuation:
 Valuation of intra-group transfers that are prone to manipulations
 With the MNE being an integrated structure with the ability to exploit
international differentials and to utilise economies of integration not
available to a stand- alone entity, transfer prices within the group are unlikely
to be the same prices that unrelated parties would negotiate
October 2013
Basic issues underlying Transfer Pricing
 The key issues in allocation of income:
 MNE’s
 Optimal allocation of common resources and overheads and achieve
competitive advantage
 Reduction of transaction cost
 Government
 Expand tax base
Transfer pricing rules are essential for countries (for Tax administration and Tax
Payers) in order to
- Protect their tax base;
- Eliminate double taxation ; and
- Enhance cross border trade
October 2013
Evolution of Transfer Pricing
• US
• First country to adopt a comprehensive transfer pricing legislation in 1968.
• OECD
• Reports on transfer pricing in 1979 and 1984
• issued the TP Guidelines in 1995 as amended by 2010 version
•United Nations (UN)
•Report on “International Income Taxation and Developing Countries” in 1988.
• The UN Conference on Trade and Development (UNCTAD) also issued a major
report on Transfer Pricing in 1999.
• The United Nations (UN) is again taking a leadership role, through its Transfer
Pricing Manual, in trying to arrive at updated global transfer pricing guidance
which can be used by countries all over the world in developing (or calibrating)
their transfer pricing regulations.
•European Commission (EC)
• Proposals on income allocation to EC members of MNEs
October 2013
Concepts in Transfer Pricing
• Transactions with related parties must be based on the “arm’s length principle” (ALP)
• Arm’s length principle” (ALP)
• Origins in Contract law
• to arrange an equitable agreement that will stand up to legal scrutiny, even
though the parties involved may have shared interests.
• Not specifically used in Article 9 of both OECD MTC and UN MTC. However it is
well accepted by countries as encapsulating the approach taken in Article 9 with
some differing interpretations.
October 2013
Concepts in Transfer Pricing
(contd)...
• Using the arm's length principle
• Argument in favour
• Geographically neutral, as it treats profits from investments in a similar
manner
• An alternative to the arm’s length principle
• Global Formulary Apportionment method
• Currently used by
• Some states of USA,
• Cantons of Switzerland and
• Provinces of Canada.
• EU is also considering a formulary approach - Common Consolidated
Corporate Tax Base (CCCTB) and home state taxation
October 2013
Special Issues Related to Transfer Pricing
1.
Intangibles
•
Trade intangibles
•
such as know-how relate to (production of goods and the provision of
services)
•
2.
Marketing intangibles (aid in the commercial exploitation of a product or service)
•
Trade names,
•
Trademarks and
•
Client lists
Intra-group services
- Financial Services (guarantee fees, etc.)
- Managerial,
- legal,
- accounting and finance,
- credit and collection,
- training and personnel management services.
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Special Issues Related to Transfer Pricing
3.
Cost – Contribution Agreements
•
Jointly develop, produce or obtain rights, assets or services.
4. Use of “secret comparables”
October 2013
Transfer Pricing in Domestic Law

Time limitations
 For TP adjustments possible India vis a vis other countries
 May lead to double taxation

Safe harbours

Dispute Prevention Measure
 Advance Pricing Agreements

Transfer Pricing and / or Controlled foreign corporation provisions
 If both applicable – Then first preference to be given to which provisions
 If only TP is applicable, whether bringingCFC is necessary – as both are anti
avoidance provisions.

Necessity of domestic transfer pricing rules.
October 2013
Transfer Pricing in Treaties
• Corresponding adjustments - To avoid economic double taxation
eg. Section 482 of Under Section 482 of the Internal Revenue Code (IRC) of U.S
• Transfer pricing dispute resolution mechanism
• Mutual Agreement Procedure (MAP) – in Article 25.
• Arbitration to resolve transfer pricing disputes.
• The EU Arbitration Convention
October 2013
Global Transfer Pricing Regimes
 By the end of 2011 there were around 100 countries with some form of
specific transfer pricing legislation as shown by the red shading in the
diagram below
October 2013
Global Transfer Pricing Regimes ….(contd)
Countries where Transfer Pricing Regulations are in existence
Argentina
Canada
Czech Republic
Estonia
Hungary
Italy
Latvia
Namibia
Panama
Romania
South Africa
Thailand
Venezuela
Australia
Chile
Denmark
Finland
India
Japan
Lithuania
Netherlands
Peru
Russia
Spain
Turkey
Vietnam
Austria
China
Dominican Republic
France
Indonesia
Kenya
Luxembourg
New Zealand
Philippines
Singapore
Sweden
United Kingdom
Belgium
Colombia
Ecuador
Germany
Ireland
Korea, North
Malaysia
Norway
Poland
Slovakia
Switzerland
United States
Brazil
Croatia
Egypt
Hong Kong
Israel
Korea, South
Mexico
Oman
Portugal
Slovenia
Taiwan
Uruguay
Countries where Transfer Pricing Regulations is still emerging
Algeria
Belarus
Cambodia
Gambia
Kazakhstan
Malawi
Morocco
Pakistan
Angola
Bolivia
Cote d'Ivoire
Georgia
Kuwait
Mali
Mozambique
Papua New Guniea
Armenia
Botswana
Cyprus
Ghana
Liberia
Mauritania
Netherlands Antilles
Qatar
Aruba
Bulgaria
El Salvador
Greenland
Libya
Mauritius
Nicargua
Senegal
Bangladesh
Burkina Faso
Ethiopia
Iceland
Macedonia
Mongolia
Nigeria
Sierra Leone
Sri lanka
Trinidad and Tobago
Ukraine
Uzbekistan
Zambia
Zimbabwe
October 2013
Specific challenges – Developing Countries face in dealing
effectively with Transfer Pricing Issues
• Lack of comparables
• Lack of knowledge and requisite skill-sets
• Complexity to administer
• Growth of the “E-commerce economy”- various ways in which
transactions can be done
• Location savings
October 2013
Part II. The Indian TP Regime
Indian TP provisions
• Indian TP provisions were introduced under
“Chapter X : Special Provisions Relating to
Avoidance of Tax”
– Chapter X, Section 92 of the Income Tax Act (1961)
and Rule 10A-D of the Income Tax Rules (1962)
– TP regime was introduced via Finance Bill 2001 w.e.f
April 1st 2001.
– In other words, India is a relatively new entrant into
the TP vortex!
• Birds-eye, one-line overview of Indian TP:
– Run-of-the-mill TP provisions, OECD-lite and
delightfully vague (like most TP provisions)!
October 2013
Indian TP Provisions – Section 92
Section
& Rules
Provisions
92
Computation of income having regard to ALP
92A
Meaning of Associated Enterprise
92B
Meaning of International transaction
92BA
Meaning of specified domestic transactions
92C (1)
Methods of computation of ALP
(Rule 10B, 10C) *Rule 10AB – Any other method for determination of ALP
92CA
Reference to Transfer Pricing Officer (TPO)
92CB
Safe harbour rules
92CC
Advance Pricing agreement
92CD
Effect of advance pricing agreement
92D
(Rule 10D)
Maintenance of information and documents by persons entering into an
international transaction or specified domestic transaction
92E
(Rule 10E,
Form 3CEB)
Accountant’s Report entering into an international transaction or specified
domestic transaction
92F (Rule 10A) Definitions: Accountant, ALP, Enterprise, PE, Specified date, Transaction *
* Sec 92F – Definitions does not define terms relevant for domestic TP transactions
October 2013
Transfer Pricing Penal provisions
(a.k.a ‘rubbing salt into the wound’)
Sr.
No.
1
Type of penalty
Section
Penalty quantified
271AA
2% of transaction value
271G
2% of transaction value
271(1)(c)
100% to 300% of tax on
adjustment amount
a) Failure to maintain
prescribed information/
documents
(b) Failure to report any such
transaction or
(c) Furnish incorrect
information
2
Failure to furnish information/
documents during assessment
u/s 92D
3
Adjustment to taxpayer’s
income during assessment
4
Failure to furnish accountant’s
report u/s 92E
271BA
INR 100,000
October 2013
Indian TP vs. OECD Guidelines
Snapshot view*
Concepts
Indian regulations
OECD Guidelines
Associated Enterprises
Very wide definition
Restricted to controlled
entities
Comparable range
(FY 2013)Allows 3% range band on Allows for range of
avg. results of comparables
comparable data
Multiple year data
Only allows data for current year
(and earlier 2 years under limited
circumstances)
Permitted
Foreign comparables
Not permitted in practice
Permitted
Priority of methods
Most appropriate method rule
(Originally) preference for
traditional methods
Use of unspecified method
Now specified
Permitted
Documentation
Stringent
Prudent business principles
Intangibles
definition vegue and unclear No
guidelines
Defined and described but
progress still not full
achieved.
* Modified version of table in ‘Transfer pricing Law and Practice in India – a fine print analysis’
October 2013
Indian TP
Assessment &
Litigation
Assessment timeline
example
2011+
Supreme
Court
2011+
High Court
May 2011
Income Tax Appellate Tribunal
(ITAT)
Appeal against
CIT(A) order
Appeal against
Final Asst. Order
May 2010
Commissioner of Income Tax
(Appeals)
Set-aside /
Remanded back
to AO
Dispute Resolution panel (DRP)
Appeal against
Asst. order
Appeal against
Draft Asst. order
AO:Dec. 2009
TPO reference
Assessing
Officer (AO)
Form 3CEB
TPO Order
u/s 92CA(3)
Transfer Pricing
Officer (TPO)
Specified
transaction U/S
92BA
T.P.Ostwal & Associates
TPO: Dec. 2008
Sept.2006
FY 2005-06
Part III. Specified Domestic
Transactions
 TP was earlier limited to ‘International Transactions’
 The Finance Act 2012, extends the scope of TP provision to ‘Specified
Domestic Transactions’ between related parties w.e.f. 1 April 2012
 The Supreme Court in the case of CIT vs Glaxo Smithkline Asia Pvt
Ltd [2010-195Taxman 35 (SC)] recommended introduction of domestic
TP provisions
 SDT previously reported/certified but onus was on revenue
authorities
 Obligation now on taxpayer to report/ document and substantiate the
arm’s length nature of such SDT transactions
 Shift from generic FMV concept to focused ALP concept
 These new provisions would have ramifications across industries
which benefit from the preferential tax policies such as SEZ units,
infrastructure developers or operators, telecom services, industrial
park developers, power generation or transmission etc.
 Apart from this, business conglomerates having significant domestic intra-group
transactions would be largely impacted
October 2013
Overview of Provisions of Section 92BA
Inter unit transfer of goods & services by
undertakings to which profit-linked deductions
apply
Expenditure
incurred
between
related
parties
defined under
section 40A
SDT
Transactions between undertakings, to which
profit-linked deductions apply, having close
connection
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Any other
transaction
that may be
specified
THANK YOU
October 2013