Method of Computation – Resale Price Method
(RPM), Cost Plus Method (CPM), Transactional
Net Margin Method (TNMM) and Profit Split
Method (PSM)
“INTENSIVE WORKSHOP ON TRANSFER PRICING “
Organized by J.B. Nagar CPE Study Circle jointly with WIRC
Prakash Kotadia
26 October 2012
CONTENTS
Overview
Resale Price Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method
Most Appropriate Method
Method of Computation – RPM, CPM, TNMM and PSM
Page 2
BACKGROUND
•
Any income arising from an international transaction between the AEs should be
computed having regard to the ALP
•
ALP is the price applied or proposed to be applied in a transaction between persons
other than AEs in uncontrolled transactions
•
Due to special relationship between AEs, transfer price may be different than the
price that would have been agreed between unrelated parties and hence, TP
Regulations
Method of Computation – RPM, CPM, TNMM and PSM
Page 3
COMPARABILITY
•
All the prescribed methods require comparables
•
Transfer Price is set or defended using data from comparable companies
•
Comparables should be independent and operate in uncontrolled environment
•
Factors used in judging comparability
Nature of transactions
Functions performed
Assets employed
Risks Assumed
Contractual terms
Economic and market conditions
Method of Computation – RPM, CPM, TNMM and PSM
Page 4
PRESCRIBED METHODS
Methods for
computing ALP
Profit Based
Traditional
CUP
RPM
CPM
Method of Computation – RPM, CPM, TNMM and PSM
Page 5
PSM
TNMM
New Method – CBDT
Notification 18/2012
OECD GUIDELINES 2010
•
Where traditional method and profit based method can be applied in an equally
reliable manner, the traditional method is preferable to the profit based method
•
Traditional methods cannot be applied to every possible situation
•
Mere difficulty in obtaining data for application of traditional methods should not be
the sole criteria for adopting profit based methods in determining ALP
•
Profit based methods are more appropriate in situations
- where each of the parties make valuable and unique contribution in relation to
the controlled transaction or when the transactions are highly inter-related;
- where reliable data for application of traditional methods is not available
Method of Computation – RPM, CPM, TNMM and PSM
Page 6
TRANSACTIONAL
RESALE
PRICE METHOD
NET MARGIN METHOD
Method of Computation – RPM, CPM, TNMM and PSM
Page 7
RPM
•
Compares the resale gross margin earned by AE with the resale gross margin earned
by comparable independent entity
•
An arm’s length gross margin should be sufficient for a reseller to cover its operating
expenses and make an appropriate operating profit considering its functions and risks
•
RPM can be applied only in cases where the tested party has purchased goods/services
from AE and resold to non-AE. If goods/services are purchased from non-AE and sold
to AE by the tested party, then RPM cannot be applied
Gharda Chemical Ltd Vs. DCIT (Mumbai ITAT) - 2009-TIOL-790-ITAT-MUM
RPM generally applied to marketing operations (distributor not adding significant value
to the product)
Method of Computation – RPM, CPM, TNMM and PSM
Page 8
RPM
Steps
•
Identify the third party selling price/fee for products/services purchased /procured
from AEs
•
Reduce the comparable uncontrolled Gross Profit Margin in similar products /services
•
Reduce the expenses incurred for procuring products/services
•
Adjust for functional and other differences, if any
•
The adjusted price is the ALP
Method of Computation – RPM, CPM, TNMM and PSM
Page 9
RPM
Foreign
Manufacturer
Product - A
Indian WOS –
AE Distributor
Resale Price
= 600
End Customer
in India
Product - B
Third Party
Distributor
COGS = 350
Sales = 500
End Customer
in India
GP Margin = 30%
Method of Computation – RPM, CPM, TNMM and PSM
Page 10
• Foreign manufacturer has WOS in India as
its distributor for Product A in India
• Foreign manufacturer has also appointed
third party distributor for Product B in
India
• GP Margin of third party distributor from
sale of Product B – 30%
• Market price of Product A in India – 600
• Transfer Price for sale of Product A by the
foreign manufacturer to its AE in India =
Resale Price x (1 – 30%)
600 x 70% = 420
RPM
Applicability of RPM when foreign AE is a distributor
and selected as tested party
•
Foreign benchmarking is required to be done treating AE as tested party
•
Even though the tax department has recently started accepting foreign benchmarking
but insist on providing robust documentation to prove functional similarity and
reliability of data
•
Assessee should be able to prove the close functional comparability between the AE
and comparables and should be able to prove the reliability of the data
Method of Computation – RPM, CPM, TNMM and PSM
Page 11
RPM
Strengths
•
Product differences are less significant, i.e. are less likely to have material effect on
profit margins than on price
•
Fewer comparability adjustments needed to account for product differences,
because focus is on functions performed
•
OECD Guidelines
“the facts may indicate that a distribution company performs the same functions
(taking into account assets used and risks assumed) selling toasters as it would
selling blenders and hence in a market economy there should be a similar level of
compensation for the two activities…”
Method of Computation – RPM, CPM, TNMM and PSM
Page 12
RPM
Weaknesses
•
Gross profit margins may be affected by management efficiency etc., which may
have an impact on profitability but not on the price of the goods or services
•
Accounting consistency important for comparability purposes
•
Resale price method difficult to use when
goods are further processed before resale, or
reseller contributes substantially to creation or maintenance of intangible
associated with the product (e.g. trademarks)
Method of Computation – RPM, CPM, TNMM and PSM
Page 13
RPM
Case Study
L Ltd. France
Purchase of finished
goods and raw
materials
L India
Manufacturing
of cosmetics
Distribution of
cosmetics
Method of Computation – RPM, CPM, TNMM and PSM
Page 14
• L India is 100% subsidiary of L Ltd., France
• L India engaged in manufacturing and
distribution of cosmetics
• L India’s business was accordingly
segregated between manufacturing and
distribution
• L Ltd. benchmarked manufacturing and
distribution segments separately
• For distribution segment i.e. international
transaction of purchase of finished goods,
L India applied RPM benchmarking the
gross margin at 40.80% against
comparables’ margin of 14.85%
• The TPO rejected RPM and applied TNMM.
An adjustment was made on the basis of
operating margin of comparables at 0.36%
against L India’s loss of (-) 19.84%
RPM
Case Study
L Ltd. France
Purchase of finished
goods and raw
materials
L India
Manufacturing
of cosmetics
Distribution of
cosmetics
Method of Computation – RPM, CPM, TNMM and PSM
Page 15
• L India’s contentions
– As per OECD guidelines and guidance
note issued by ICAI, RPM is the MAM in
case of distribution and marketing
activities especially when goods are
purchased from AE and resold to
unrelated parties
– Net losses in the distribution segment
incurred only for 3 years and
thereafter L India started earning
profits
– Certificates from AE confirming profit
margin only at 2%
• Ruling
– RPM is appropriate for distribution
– Losses on account of business strategy
– No motive to shift profits in view of
low margin earned by AE
RPM
Practical Issues
• Minor functional difference affect gross profit margins
- In RPM, the comparability is at the Gross margin level and hence, RPM requires a
high degree of functional comparability rather than product comparability. Hence,
a detailed analysis showing the close functional comparability and risk profile of
the tested party and comparables should be clearly brought out in the TP Study to
justify comparability at gross profit level under RPM
- Axalto Cards & Terminals India Ltd (2010-TII-37-ITAT-DEL-TP)
• Difficulties in determination of costs
-
Finding correct data of gross margin in the public domain
Categorization of expenses as COGS or operating expenses
Adjustments on account of economies of scale, operational efficiencies, accounting policies
etc.
Benchmarking limited risk distributor
Method of Computation – RPM, CPM, TNMM and PSM
Page 16
COST
PLUS
TRANSACTIONAL
COST
PLUS METHOD
METHOD
NET MARGIN METHOD
Method of Computation – RPM, CPM, TNMM and PSM
Page 17
CPM
•
Compares the gross profit on costs earned by the tested party with the gross profit on
costs earned by comparable independent entity
•
“Cost Plus method” is different from “Cost Plus Pricing mechanism”
For instance: A captive service provider in India may charge Cost plus 15% mark up
from its AE but may use TNMM to justify its international transactions
CPM generally applied to Contract Manufacturer, in particular of semi-finished goods,
Contract R&D Service Provider, Captive Service Provider
Method of Computation – RPM, CPM, TNMM and PSM
Page 18
CPM
Steps
•
Identify the direct and indirect costs of production incurred in transactions
undertaken by the tested party
•
Identify the normal gross profit in comparable uncontrolled transactions
•
Adjust the normal gross profit (as computed above) to account for functional and
other differences
•
Add the adjusted gross profit (as computed above) to the costs identified in first step
•
The sum so arrived above is taken as ALP
Method of Computation – RPM, CPM, TNMM and PSM
Page 19
CPM
Strengths
• Product differences are less significant, i.e. are less likely to have material effect on
profit margins than on price
• Less product comparability required compared with CUP method
• Fewer comparability adjustments needed compared with the CUP method to account
for product differences, because focus is on functions performed
Method of Computation – RPM, CPM, TNMM and PSM
Page 20
CPM
Weaknesses
• In practice, often difficult to determine appropriate cost basis
• Costs incurred may not always be determinant of profit level
• Not always discernible link between level of costs incurred and a market price
• Accounting consistency important for comparability purposes
Method of Computation – RPM, CPM, TNMM and PSM
Page 21
CPM VS TNMM
In the case of manufacturer, whether CPM should be selected as the Most Appropriate
Method instead of TNMM?
• Facts of various judicial precedents suggest that the assessees engaged in
manufacturing activity have been following CPM. However, they could not justify the
same before TPO due to functional differences, difference in terms and conditions,
inadequate documentation, etc and hence, the TPO rejected CPM and followed TNMM
• Diamond Dye Chem Ltd. vs. DCIT (2010-TII-20-ITAT-MUM-TP)
Where reliable cost data for the product manufactured is available, CPM must be
followed
•
It may be advisable that in case of manufacturer, CPM should be preferred over TNMM
subject to availability of the reliable data necessary for the application of CPM and a
close degree of comparability of the functions performed, assets employed and risks
assumed by the tested party and the comparables.
Method of Computation – RPM, CPM, TNMM and PSM
Page 22
CPM
Case Study
Foreign AE
• Foreign manufacturer has WOS in India
• Indian WOS manufactures and supplies semi finished
goods to its foreign AE
• Comparable companies in India selling similar products
earn an average mark-up on cost of 20%
ALP of international transaction of Indian WOS
Particulars
Supply of semi
finished goods
Indian WOS –
Manufacturer
Amount
Cost of raw materials
200
Other direct and indirect production costs
100
Total cost base
300
Mark-up on costs (20% - tested in CPM –
determined from uncontrolled comparables
Transfer Price
60
360
Overheads and other operating expenses
40
Operating Profit
20
Method of Computation – RPM, CPM, TNMM and PSM
Page 23
PROFIT
SPLIT METHOD
METHOD
TRANSACTIONAL
PROFIT
SPLIT
NET MARGIN METHOD
Method of Computation – RPM, CPM, TNMM and PSM
Page 24
PSM
•
PSM calculates the combined operating profits resulting from all intercompany
transactions based on the relative value of each AE’s contribution to the operating
profits
•
The contribution made by each party is ascertained on the basis of FAR of each AE
•
PSM may be applicable mainly in international transactions involving
- transfer of unique intangibles; or
- in multiple inter-related international transactions which cannot be evaluated
separately
•
It works on an assumption that independent parties would split the combined profits
in proportion to the value of their relative contributions
Method of Computation – RPM, CPM, TNMM and PSM
Page 25
PSM
Steps
•
Determine the combined net profit of AEs arising out of international transactions
•
Evaluate relative contributions by each AE on the basis of FAR of each AE
•
Split the combined net profit amongst AEs in proportion to their relative
contributions
•
Profit thus apportioned to the tested party is used to arrive at ALP
Method of Computation – RPM, CPM, TNMM and PSM
Page 26
PSM
Strengths
• Offers solution for highly integrated operations for which one-sided method would not
be appropriate
• Offers solutions where both the parties to the transaction contribute unique
intangibles
• Offers flexibility since it takes into account specific, possibly unique, facts and
circumstances of the AEs which are absent in the case of independent third parties by
adopting arm’s length approach
• The two-sided approach in PSM ensures that neither party to the controlled
transaction is left with an extreme and improbable profit result
Method of Computation – RPM, CPM, TNMM and PSM
Page 27
PSM
Weaknesses
• Difficult to apply in practice
• AEs and Tax authorities face difficulties in accessing information from foreign
affiliates
• It may be difficult to measure combined costs and revenue for all AEs, as it may
require stating of books and records on common basis as regards
- Accounting practices
- Different currencies, etc.
• It may be difficult to identify the operating expenses associated with the international
transactions and AE’s other activities
PSM is not widely used in practice
Method of Computation – RPM, CPM, TNMM and PSM
Page 28
PSM
Determination of ALP
Allocation of the combined profit can be done by any one of the following ways
• Contribution Approach / Analysis
- Capital Investment Approach / Analysis
- Compensation Approach
- Bargaining Theory Approach
- Survey Approach
• Residual Approach / Analysis
Method of Computation – RPM, CPM, TNMM and PSM
Page 29
PSM
Determination of ALP
Contribution Approach / Analysis
• The combined profit i.e. the total profit from the controlled transactions would be
divided between the AEs based on
- the reasonable approximation of the division of the profits under the arm’s length
condition prevailing in similar transactions and
- the relative value of the functions performed after taking into account assets
employed and risks assumed by each AE, i.e. FAR analysis of each AE
Determination of contribution of each AE should be
economically justified and not on Global Apportionment Formula
Method of Computation – RPM, CPM, TNMM and PSM
Page 30
PSM
Determination of ALP
Residual Approach / Analysis
• Under the residual approach, the combined profits of the controlled transactions are
allocated in two stages
- Towards the basic return appropriate for the type of transactions (which would be
without considering the contribution of intangibles or unique product)
- The residual profit must be split between enterprises in their relative contribution
(which is generally based on contribution of intangibles possessed by AEs)
Method of Computation – RPM, CPM, TNMM and PSM
Page 31
PSM
Determination of ALP
Factors to be kept in mind
• The combined profit to be split (including losses) should be only that profit arising
from controlled transactions under review
• Allocation of combined profit between AEs should be consistent with the FAR Analysis
of each AE and should be based on the factors agreeable between the third parties
• Criteria or allocation keys used to split the profit should be reasonably independent of
the transfer pricing policy formulation and should be reasonably supported by reliable
comparable data
• In practice, common allocation keys used are assets (operating assets, fixed assets,
intangible assets, etc.) or capital employed or costs (relative spending and/or
investment in key areas such as research and development, engineering, marketing,
etc.)
Method of Computation – RPM, CPM, TNMM and PSM
Page 32
PSM
Determination of ALP
Factors to be kept in mind
• Asset based or capital based allocation keys can be used where there is a strong
correlation between tangible or intangible assets or capital employed and creation of
value in the context of the controlled transaction
• Cost based allocation keys can be used where there is a strong correlation between
relative expenses incurred and relative value added
• Other allocation keys can be based on incremental sales, headcounts, time spent by
certain group of employees, number of servers, data storage, floor space, etc.
Method of Computation – RPM, CPM, TNMM and PSM
Page 33
PSM
Case Study
Sells the BTS Equipment
manufactured by XYZ India under
the brand name XYZ Germany
XYZ
Germany
Government
of Germany
Sells Manufactured BTS
Equipment for Mobile GSM
Network
XYZ India
Method of Computation – RPM, CPM, TNMM and PSM
Page 34
• Government of Germany is the sole
telecom operator in Germany
• XYZ Germany, pursuant to its Agreement
with the German Government in 1997, was
to provide BTS Equipment to the
Government for the period of 25 years
• XYZ Germany enjoys the monopoly (due to
its early entry in German Market and
expertise in delivering BTS Equipment) in
the German Market - the sole customer
being the German Government
• XYZ Germany owns the brand name under
which the BTS Equipments are sold to the
German Government
• In view of the above, determination of the
ALP treating XYZ Germany as the tested
party is ruled out
PSM
Case Study
Sells the BTS Equipment
manufactured by XYZ India under
the brand name XYZ Germany
XYZ
Germany
Government
of Germany
Sells Manufactured BTS
Equipment for Mobile GSM
Network
XYZ India
Method of Computation – RPM, CPM, TNMM and PSM
Page 35
• XYZ India, WOS of XYZ Germany,
manufactures the BTS Equipments by
application of highly complicated technical
know-how developed by it in-house
• ABC India is the only company in India
which manufactures such BTS equipments,
but entire transaction of ABC India is with
its related party (Uncontrolled comparable
is not available)
• CUP method, CPM and TNMM cannot be
selected as the MAM due to lack of
availability of comparable data; and RPM is
not applicable based on the facts of the
case
• On account of presence of valuable
intangibles with XYZ India (viz. technical
knowhow) and XYZ Germany (viz. Product
Brand name), PSM was considered as the
MAM
PSM
Case Study
Financial Results of XYZ India and XYZ Germany
XYZ India
Particulars
Amount
Particulars
Amount
Particulars
Amount
Particulars
Purchases
460 Sales
150
Other Op.
Expenses
140
60
Net Profit
100
Total
700 Total
COGS
250 Sales
Other Op.
Expenses
Net Profit
Total
XYZ Germany
460 Total
Method of Computation – RPM, CPM, TNMM and PSM
Page 36
460
460
Amount
700
700
PSM
Case Study
Allocation of Profits to Routine Contributions
• The total profits of 160 is required to be allocated between XYZ India and XYZ
Germany on the basis of their manufacturing and distribution functions respectively
• Based on the benchmarking study conducted from the data available in public domain
in India in relation to manufacturing of Communication Equipments, a profit margin of
8% on total cost was considered to be at arm’s length
• Based on the benchmarking study conducted from the data available in public domain
in Germany in relation to distribution of communication equipments, a profit margin
of 4% on sales was considered to be at arm’s length
• Accordingly, 32 (8% of 400) and 28 (4% of 700) was attributed to manufacturing and
distribution functions performed by XYZ India and XYZ Germany respectively
Method of Computation – RPM, CPM, TNMM and PSM
Page 37
PSM
Case Study
Allocation of Residual Profits
• The residual consolidated profit of 100 (160-32-28) will have to be allocated between
XYZ India and XYZ Germany on the basis of their relative value of intangibles
• Valuation of intangible was conducted for the technical know-how owned by XYZ India
based on income approach and was valued at 250 with expected life of the know-how
to last for 10 years
• Valuation of intangible was conducted for the brand name owned by XYZ Germany
based on income approach and was valued at 1,000 with expected life of the brand
name to last for residual 10 years (i.e. till the expiry of the contract with the German
Government)
• Hence, the consolidated residual value of profits was allocated between XYZ India and
XYZ Germany in the ratio of 1:4
• Accordingly, the balance profit of 100 was allocated between XYZ India and XYZ
Germany in the proportion of 20 and 80 respectively
Method of Computation – RPM, CPM, TNMM and PSM
Page 38
PSM
Case Study
Summary of Distribution of Consolidated Profits
Profit Attribution
XYZ India
Consolidated Net Profit
(a)
Less: Attributed towards
respective Routine Contributions
(b)
Residual Profits
Attribution towards relative
intangibles
Total Profit Attribution
XYZ
Germany
Total
160
32
28
(c = a – b)
60
100
(d) (1:4)
20
80
100
(e = b + d)
52
108
160
Since actual profit earned by XYZ India is more than the Attributed Profit (60 > 52),
the transactions entered into by XYZ India with XYZ Germany are at arm’s length
Method of Computation – RPM, CPM, TNMM and PSM
Page 39
TRANSACTIONAL NET MARGIN METHOD
Method of Computation – RPM, CPM, TNMM and PSM
Page 40
TNMM
• Under TNMM, ALP is determined by comparing
-
the net profit margin of the tested party
from controlled transaction
with net profit margin earned from comparable uncontrolled transactions (Internal TNMM) or
with net profit margin of an unrelated party engaged in a comparable uncontrolled transaction (External
TNMM)
• TNMM compares net margins by using certain ratios (PLIs) to express net profit as a %
of a given base which commonly include operating cost, operating income, total
assets, value added expenses, etc.
• TNMM is similar to RPM and CPM to the extent that it involves a comparison of margins
earned in a controlled situation with margins earned from comparable uncontrolled
situations
• However, TNMM differs from RPM and CPM to the extent that it involves comparison of
margins at net profit level as against at gross profit level
Method of Computation – RPM, CPM, TNMM and PSM
Page 41
TNMM
Steps
Perform FAR Analysis
of all entities engaged in
controlled transactions
Determine arm’s Length
Operating Margin after
Making Adjustments, if any
Compare adjusted margin
of comparables with
tested party’s margin
Method of Computation – RPM, CPM, TNMM and PSM
Page 42
Choose a Tested Party
(generally, the simpler
Entity)
Select PLI and
determine operating Margin
of comparables
Determine whether controlled
transactions are at ALP
Characterize the Tested
Party (based on FAR
Analysis)
Indentify uncontrolled
Transactions or
comparables
TNMM
Strengths
• Requires comparability at a Broad functional level - Product differences are
acceptable provided such difference does not materially affect the margin
• Operating profit margins are less affected by transactional differences as is the case
with price in case of application of CUP Method
• Need to examine a financial indicator of only one of the AE (i.e. the tested party)
• No need to restate the books and records for all participants on a common basis or to
allocate costs as is the case with PSM
• The differences in functions performed between enterprises are often reflected in
variation in operating expenses. Consequently enterprises may have wide range of
gross profit margins but it may still earn broadly similar level of net profits
Method of Computation – RPM, CPM, TNMM and PSM
Page 43
TNMM
Weaknesses
• Requires information on uncontrolled transaction which may not be available at the
time of entering into controlled transaction
• Difficulty in ascertaining revenue and operating expenses (i.e. segmental results)
related to the controlled transactions to establish the net profit indicator
• Difficulty in making reasonable accurate adjustments in cases where factors like
difference in working capital, risk assumed, etc. have influence on the net margins of
the taxpayers vis-à-vis third parties
• Difficulty in determining the corresponding adjustment, particularly where the
controlled transactions are both on the purchase as well as sales side
Method of Computation – RPM, CPM, TNMM and PSM
Page 44
TNMM
Tested Party
• The following parameters are used for selection of the tested party
- Should be least complex (functionally) entity
- Availability of reliable comparable data that requires fewest and most reliable
adjustments
- Should ideally not own any intangibles
The reasons for selection of tested party should be adequately documented in
the TP Study
Method of Computation – RPM, CPM, TNMM and PSM
Page 45
TNMM
PLI
• PLIs are the ratios that measure the relationship between the profits and other
attributes like costs or sales or resources like capital employed or assets employed to
establish ALP
• Most commonly used PLIs in TNMM are:
- Operating Margin (Operating Profit to Operating Cost or Operating Income)
- Return on Assets or Capital Employed (Operating Profit to Operating Assets or
Capital Employed)
• Operating Margin is calculated by eliminating extra-ordinary income or expenses and
non operating income and expenses like interest, loss on sale of fixed assets, etc.
from the net profit
Method of Computation – RPM, CPM, TNMM and PSM
Page 46
TNMM
PLI
PLI
Formula
Typical Applicability
Operating Margin
on Operating
Income
OP/OI
When amount payable to AE for
purchase from AE or services
received from AE
Operating Margin
on Operating Cost
OP/OC
When amount receivable from
AE for exports to AE or services
rendered to AE
OP/Operating Assets
Capital Intensive Manufacturers
Return on Assets
Berry Ratio
GP/VAE
Method of Computation – RPM, CPM, TNMM and PSM
Page 47
Intermediary activities
TNMM
PLI
Indian TP regulations
• Net profit margin realized by an enterprise from an international transaction entered
into with its AEs has to be compared with the net profit margin realized by an
enterprise from a comparable uncontrolled transaction or by an unrelated enterprise
from a comparable uncontrolled transaction
• In the absence of any clarification on what constitutes the net margin, it is normally
understood as “NPBT / Sales” or “NPBT / Cost” as the case may be
Method of Computation – RPM, CPM, TNMM and PSM
Page 48
TNMM
PLI
OECD Guidelines
• TNMM examines the net profit relative to an appropriate base (for example costs,
sales, assets) that a taxpayer realizes from a controlled transaction
• Net profit from a controlled transaction (i.e. international transaction) should
constitute only those items, which are
- Directly or indirectly related to international transaction; and
- Operating in nature
• Accordingly, net profit margin is understood as Operating Profit
Method of Computation – RPM, CPM, TNMM and PSM
Page 49
TNMM
PLI
Judicial Precedents
• One View:
TNMM requires comparison of Net Profit Margin and not operating margins
-
Addl. CIT vs. M/s Tej Diam (2010-TII-27-ITAT-MUM-TP);
UCB India Pvt. Ltd. vs. ACIT (121 ITD 131)(Mum);
ACIT vs. M/s Twinkle Diamond (2010-TII-09-ITAT-MUM-TP)
Symantec Software Solutions Pvt. Ltd. vs. ACIT (2011-TII-60-ITAT-MUM-TP)
• Contrary View:
Net Margin i.e. only operating income and operating expenses for relevant business
activity to be considered
-
TNT India Private Ltd. vs. ACIT [ITA No. 1442(BNG) / 08]
M/s Marubeni India Pvt. Ltd. vs. Addl. CIT (2011-TII-36-ITAT-DEL-TP)
M/s DHL Express (India) Pvt. Ltd. vs. ACIT (2011-TII-59-ITAT-MUM-TP)
Method of Computation – RPM, CPM, TNMM and PSM
Page 50
TNMM
Case Study
G Ltd. USA and its
group companies
Cost plus
15%
Sourcing
Services
G India
Sale of
goods
Third party
vendors
Method of Computation – RPM, CPM, TNMM and PSM
Page 51
• G India was engaged in facilitating sourcing of
apparel from India for its AEs
• The primary activity of G Ltd comprised of
assistance in identifying vendors, assistance
to vendors in procurement of apparel,
inspection and quality control and
coordination with vendors to ensure delivery
of goods to AEs
• The technical and intellectual inputs for
discharge of above services were provided by
AEs
• G India adopted TNMM to benchmark the
service fee determined at cost plus 15% mark
up from AE
• TPO disregarded FAR of G India, observed
that G India was not limited risk support
provider and held that G India ought to have
earned a commission of 5% on FOB of goods
procured for AEs
TNMM
Case Study
G Ltd. USA and its
group companies
Cost plus
15%
Sourcing
Services
G India
Sale of
goods
Third party
vendors
Method of Computation – RPM, CPM, TNMM and PSM
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Ruling
• G India is a limited risk procurement service
provider, no intangibles were developed by G
India
• G India’s roles and responsibilities were well
defined by its agreement with AEs
• G India had no role to play in the end
customer pricing and therefore there was no
question of location savings. The intent of
sourcing from India was to provide lower cost
to end customers
• The application of PLI on the basis of
commission of FOB value would give absurd
results. The PLI should be in consonance to
FAR of G India. Accordingly application of
cost plus was the most appropriate PLI
TRANSACTIONAL
MOST
APPROPRIATE
NETMETHOD
MARGIN METHOD
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MOST APPROPRIATE METHOD
• Indian TPR does not provide any hierarchy or priority for selection of MAM
• MAM is that method which, under the facts and circumstances of the transaction
under review, provides the most reliable measure of an arm’s length result
• Each method needs to be tested on its merits depending on the nature of international
transaction, availability of reliable comparable data, extent to which reasonable
adjustments can be made, etc.
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MOST APPROPRIATE METHOD
Method
PLI
Degree of
comparabil
ity
required is
With respect to
CUP
Price
Very High
Similar products & surrounding conditions
RPM
GP/Sales
High
Similar FAR and engaged in distribution of
products
CPM
GP/Direct and
Indirect Cost of
Production
High
Similar FAR and engaged in manufacture,
assembly or production of tangible products
or provision of services
PSM
OP/Assets or
Capital Employed
or Cost
Moderate
Similar FAR and involving transfer of unique
intangible or multiple inter related
international transactions
TNMM
OP/OC or OI or
operating assets
or capital
employed
Moderate
Similar FAR and applied when other
methods fail to be applied
Method of Computation – RPM, CPM, TNMM and PSM
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ISSUES IN SELECTING THE MOST APPROPRIATE METHOD
• Can ALP be determined without following any method as MAM
- It is mandatory for the assessee to follow one of the prescribed method and
demonstrate the arm’s length nature of the international transaction
- DCIT vs. M/s Starlite (2010-TII-28-ITAT-MUM-TP)
- TPO can not follow the method which is not authorized under the IT Act or Rules
- CA Computer Associates Pvt. Ltd. vs DCIT (2010-TIOL-68-ITAT-MUM)
- Nimbus Communications Ltd. vs. ACIT (2010-TII-21-ITAT-MUM-TP)
- However, in view of New Method prescribed by CBDT Notification 18/2012 , it
would be possible to apply a method other than the prescribed ones
Method of Computation – RPM, CPM, TNMM and PSM
Page 56
GLOSSARY
Abbreviation
Term
Abbreviation
Term
AE(s)
Associated Enterprise(s)
PSM
Profit Split Method
ALP
Arm’s Length Price
RPM
Resale Price Method
BTS
Base Transceiver Station
TNMM
Transactional Net Margin Method
COGS
Cost of Goods Sold
TPO
Transfer Pricing Officer
CPM
Cost Plus Method
TPR
Transfer Pricing Regulations
CUP Method
Comparable Uncontrolled Price Method
VAE
Value Added Expenses
FAR Analysis
Functions, Assets and Risk Analysis
ICAI
The Institute of Chartered Accountants of India
IT Act
The Income Tax Act, 1961
MAM
Most Appropriate Method
NPBT
Net Profit Before Tax
OECD
Organisation for Economic Co-operation and
Development
OECD
Guidelines
Transfer Pricing Guidelines issued by OECD in July
2010
PLI
Profit Level Indicator
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Method of Computation – RPM, CPM, TNMM and PSM
Page 58
PRAKASH KOTADIA
Partner, Tax & Regulatory Services
BDO Consulting Pvt. Ltd.
Direct +91 22 6672 9790
Mobile+ 91 98213 48261
prakash.kotadia@bdoindia.co.in
Method of Computation – RPM, CPM, TNMM and PSM
Page 59
DISCLAIMER
This document has been carefully prepared, but it has been written in general terms and should be seen as broad guidance only. This publication
cannot be relied upon to cover specific situations and you should not act, or refrain from acting, upon the information contained therein without
obtaining specific professional advice. Please contact BDO Consulting Pvt. Ltd. to discuss these matters in the context of your particular
circumstances. BDO Consulting Pvt. Ltd., its partners, employees and agents do not accept or assume any liability or duty of care for any loss
arising from any action taken or not taken by anyone in reliance on the information in this document or for any decision based on it.
BDO Consulting Private Limited, a private limited company incorporated in India, is a member of BDO International Limited, a UK company limited
by guarantee, and forms part of the international BDO network of independent member firms.
BDO is the brand name for the BDO network and for each of the BDO Member Firms.
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