By CA. Deepender Kumar
Deepender Anil & Associates
Chartered Accountants
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Backdrop
Transfer Price and Transfer Pricing
Indian TPR
Associated/Deemed Enterprises
International Transactions
Arm’s Length Price
Various Methods To Compute ALP
FAR Analysis
Transfer Pricing Process
Penalties
Safe Harbor Rules
Recent Circulars and Notifications
2
• Liberalization of trade and foreign exchange policy started in India in the
year 1991
• This created huge increase in interest of MNEs in India
• The Standing Committee in March 1991 observed that provisions of
Income Tax Act, 1961(Act) were inadequate to curb transfer pricing among
MNEs
• The Expert Group constituted by Central Board Of Direct Taxes (CBDT)
recommended complete revision of existing section 92 of the Act
• The Finance Act, 2001 introduced TPR in India by substituting existing
Section 92 of the Act and introducing new sections 92A to 92F w.e.f April,
2001
3
• When evaluations are based on profit, etc. we need to establish price for
internal transfers
• “Transfer price is the price one subunit (department or division) charges
for a product or service supplied to another subunit of the same
organization.”
• Transfer prices can have a dramatic effect on the reported profitability of a
division but not on overall profit
• Transfer Pricing is a mechanism for the pricing of goods and services
between related entities,
 Tangible Goods
 Intangible Goods – trademarks, trade-names, patents
 Services – management, engineering, after-sales services
• Transfer pricing mechanism provide the conceptual framework for pricing
intercompany transactions and ensuring an appropriate allocation of income
between the various tax jurisdictions in which a multinational company
operates.
4
• OECD TP Guidelines lays the foundation of the Transfer Pricing Regulation
in India
• Section 92 - Income arising to “Associated Enterprises” from
“International Transactions” (or Specified Domestic Transactions w.e.f
AY 2013-14) shall be computed having regard to the “Arm’s Length Price”
• Preconditions:
 Two or more associated enterprises
 Enter into an international transactions
 Specified Domestic Transaction (w.e.f. AY 2013-14)
• Consequence:
 Income to be computed having regard to the arm’s length price
5
Section 92A
• AE means direct or indirect participation in management control or
capital:
 by one enterprise into another enterprise; or
 by the same person in both the enterprises
• Equity holding, Control of Board of Directors/ Appointment of one or more
Executive Director, mutual interest will also constitute Associated
Enterprise
• Either or both of Associated Enterprises should be non-residents
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” includes:
– Holding of 26% of voting power
 by one enterprise into another enterprise; or
 by the same person in both the enterprises
– Dependence on intangible assets
– Sale of goods
 influence on price and conditions of supply by buyer
– Control by individual or his relative
– Financial transaction
 Loan - 51% or more of book value of total assets of the borrowing
enterprise
 Guarantee - 10 % or more of the total borrowings of an enterprise
8
Section 92B
• Means “transaction” between 2 or more Associated Enterprises:
 Transaction between two or more associated enterprises (at least one
of which will be non-resident) of purchase, sale or lease of tangible
and intangible property, provision of services, capital financing, cost
sharing/cost contribution arrangements , or
 affecting profits, losses, income, assets or liability of the enterprise
• The expression “International Transaction” has been amended by Finance
Act, 2012 w.e.f 1.04.2002 and specifically includes:
 Inter-company Guarantees,
 Advance payments, deferred payments, receivables,
 Business restructuring / reorganisation,
 Purchase / sale/ use of intangibles such as customer lists, customer
contracts, customer relationships,
 Transfer / secondment of trained employees, etc.
10
Section 92F(ii)
• Arm’s Length Price means a “price which is applied or proposed to be
applied in a transaction between persons other than associated
enterprises, in uncontrolled conditions”
• Arm’s length price can be determined by selection of most appropriate
method from any of the following methods (Sec. 92C):
– Comparable Uncontrolled Price Method
– Resale Price Method
– Cost Plus Method
– Profit Split Method
– Transactional Net Margin Method
– Other Method as prescribed under Rule 10AB
• Where arms length price is within 3% range of the transaction price, no
adjustment is warranted and the transaction price will be deemed to be
the Arm’s Length Price. (5% range was applicable till A.Y.2012-13).
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Transfer
Pricing
Methods
Traditional
Transaction
Methods
Comparable
Uncontrolled
Price
Resale Price
Method
Transactional
Profit
Methods
Cost Plus
Method
Profit Split
Method
Other
Method
Transactional
Net Margin
Method
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• CUP method can be applied where reliable data of similar uncontrolled
transaction between two unrelated parties or between related party and
third party is available. Here, Prices are to be compared.
• Internal CUP
Sale to related party B
Manufacturer
A
Sale to non-related
party C
• External CUP
Non-related
party P
Non-related
party Q
• Adjustments permitted for volume discount, geographical differences, etc.
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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 at arm’s length
price
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• Compares the resale gross margin earned by AE, with gross margin of
comparable independent distributors
Group
Manufacturer
(Eligible Unit)
INR 75
Related Distributor
(India)
INR 100
Unrelated
Wholesalers
• Comparable need not be in very same product
• Software distributor compared with FMCG distributor
• Difficult to use when processing is carried out before resale
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Identification of resale price by tested party
Resale price reduced by normal gross profit with
reference to uncontrolled transaction(s)
Such price reduced by expenses incurred (customs duty
etc.) in purchase of the product/services.
This price may be adjusted to account for functional and
other differences, if any. Adjusted price arrived above
taken to be arm’s length price
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• Used predominantly when AE works for another AE as contract
manufactures
ALP =
Direct & Indirect
Cost of Production
/ service
+
Comparable
Margin
• Typically applied to a contract manufacturer who:
 Does not bear risk of marketing
 Does not “normally” undertake high skill work
• May apply to contract manufacture, BPO, call centre, software developers,
etc
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Identification of direct and indirect costs production
incurred in tested party transactions
Identification of normal gross profit with reference to
uncontrolled transaction(s)
Normal gross profit adjusted to account for functional
and other differences if any
Adjusted gross profit added to total costs identified in
step 1. Sum arrived above is taken to be at arm’s length
price
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• Generally applicable in case of transaction involving
 Transfer of unique intangibles
OR
 Multiple transactions which are interrelated not permitting separate
evaluation
Outside India
US Co A –
Technology
intangibles
India
Mfg. Co B
Mkt Co C
Marketing
intangibles
• Split global profit according to contribution of each AE.
• There are two approaches to this method
 Total Profits Split
 Residual Profit Split
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Determination of combined net profit of the associated
enterprises arising out of international transaction
Evaluation of relative contributions by each enterprise
on the basis of functions performed, risks assumed and
assets employed
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
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• Comparable Net profit adopted in relation to :
 Costs incurred, or
Parent A
 Sales effected, or
 Assets employed, or
 Any other relevant base.
Unrelated Cos.
Outside India
India
Subsidiary B
Unrelated Cos.
Net margin 5%
Net margin 3%
• Ideally, operating margin should be compared to operating margin earned
by same enterprise on uncontrolled transaction – Internal TNMM
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Computation of net profit as a percentage of a certain
base realized from the international transaction
Computation of net profit realized by the tested party or
an unrelated enterprise in a comparable uncontrolled
transaction
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
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Selection of the tested party
Period of Comparison
Aggregation of Transactions
Identification of Comparable entities
Profit Level Indicators
Adjustment Calculations
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 An entity for which net profitability of the controlled transactions is to be
tested – may not necessarily be the taxpayer
 An entity for which the reliable data on closely comparable transactions
can be identified
 Generally a least complex entity without its own intangibles or unique
assets and which only performs the routine functions For e.g., a
distributor, sales agent, contract manufacturer
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As per the IT Rules, multiple year data can also be used for
comparability, in order to eliminate the accounting differences,
product life cycles, varying businesses and discrepancies in shorttem economic conditions
The averages for the multiple year data can be simple
average or weighted average depending upon the facts of
each case.
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 Multiple transactions entered into by the enterprise which are so
interlinked that they cannot be evaluated separately.
 TNMM is applied by aggregating the such transactions with respect to
closely linked products, similarity of functions, long- term arrangements,
and intangible rights.
 If aggregation using this criteria is not possible, then aggregation is done
on entity wide basis. However, it is preferred to aggregate the transactions
at the most micro level to the extent it can reliably be analyzed
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 Internal or External comparison
 External Comparison involves selection of comparable independent
enterprise having similar FAR.
 For external comparison the information which are available in public
domain can only be used
• Two databases are basically considered to be reliable for selection of such
comparable i.e. Prowess and Capitaline Plus
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All of the profit-level indicators used in TNMM are based on operating
income, which is gross profit less operating expenses
Overview of Various Profit Level Indicators
Return on Assets (ROA)
Operating profit divided by the operating assets
(normally only tangible assets)
Return on Capital Employed
(ROCE)
Operating profit divided by capital employed which
is usually computed as the total assets minus cash
and investments
Operating margin (OM)
Operating profit divided by sales
Return on Total Costs (ROTC)
Operating profit divided by total costs
Return on Cost of Goods Sold
Gross profit divided by cost of goods sold
Berry Ratio
Gross profit divided by operating expenses
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 Adjustment to comparable margin should be made to improve
comparability. It shall be based on commercial practices, economic
principles or statistical analyses.
 Some familiar adjustments:
• Working Capital
• Depreciation
• Custom Duty
• Location Savings
• Foreign Exchange
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• As the name of method suggest, “transactional net margin method”
calculate net margin of only “international transactions” and not of whole
enterprise unless all transactions are with AEs only
• Therefore, operating, non operating and extraordinary items are
considered from the point view of international transactions only and
from the point of view of enterprise
• Non-operating income and expenses does not form part of the cost or
revenue for calculating segmental PLI even they are of normal and
recurring nature
• Revenue and expenses which does not affect the earning of margin of the
relevant segment relating to international transactions of which the
comparison have to be made, have to be ignored.
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CALCULATION OF SEGMENTAL PLI
A. Segmental Revenue
Total revenue /sale
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Less non operative revenue/sale (As per nature of business)
Less non segmental revenue /sale (As per nature of international transactions)
Less extraordinary/abnormal revenue/sale (As per frequency and amount of transactions)
Less revenue/sale relating to other years
B. Segmental cost
Total Cost
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Less non operative cost (As per nature of business)
Less non segmental cost (As per nature of international transactions)
Less extraordinary/abnormal cost (As per frequency and amount of transactions)
Less cost relating income which does not form part of segmental normal revenue
C.
D.
Segmental Margin
Segmental Margin %
(a-b=c)
c/a% or c/b% (as the case may be)
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Strengths
Weaknesses
 Net margins are less affected by
transactional differences than
price
and
by
functional
differences than gross margins
 Less complex functional analysis
is needed
 Applicable to either side of the
controlled transaction (i.e.to
either
the
related
party
manufacturer or the distributor)
 The results resembles the results
of a modified RPM or CPM
analysis
 Net margins are affected by
factors (e.g. variability of
operating expenses) that do not
have or have a less significant
effect on price or gross margins
 Information challenges, including
the unavailability of information
on profits attributable to
uncontrolled transactions
 Applied to only one of the related
parties involved
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• CBDT has notified the “other method” vide a Notification and Rule 10AB has
now been inserted in the Income-tax Rules, 1962 (the Rules). Applicable
from FY 2011-12.
• Rule 10AB describes the other method as “any method which takes into
account the price which has been charged or paid, or would have been
charged or paid, for the same or similar uncontrolled transaction, with or
between non-associated enterprises, under similar circumstances,
considering all the relevant facts.“
• “Other Method” refers to “price which has been charged or paid, or
would have been charged or paid”. Effectively, this implies that under
this “other method” “quotations” rather than prices “actually” charged
or paid can also be used by the taxpayers.
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Possible Applicability
 Where the application of the five specific methods is not possible due to
difficulties in obtaining comparable data or due to uniqueness of
transactions
 Intangibles or business transfers, transfer of unlisted shares, sale of fixed
assets, revenue allocation/splitting, guarantees provided and received,
etc.
Possible third party references
 Third party quotations
 Valuation reports
 Commercial, economic, financial models etc.
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Method
Comparability
Requirements
Approach
Application
CUP
Very High
Price Benchmarking
Very difficult but most
preferred method
RPM
High
GP based Price
Benchmarking
Distributor
CPM
High
GP based Price
Benchmarking
Manufacturer/Service
Provider
PSM
Medium
Net Margin
Benchmarking
Manufacturer/Distribu
tor/Service Providers
TNMM
Medium
Net Margin
Benchmarking
Manufacturer/Distribu
tor/Service Providers
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•
Functions Performed: Analysis of critical functions performed in controlled
environment with function performed in uncontrolled transactions that add
value to transactions hence fetch higher returns.
• Assets Employed: Analyzing assets employed in transaction in controlled
environment by identifying the assets.
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–
–
–
•
Type of assets
Capital
Tangibles
Intangibles
Risks Assumed: Analysis involve identification of various risk assumed by each
party in controlled transaction.
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—
—
—
—
Nature of Risk
Market Risk
Manpower Risk
Credit Risk
Technology Risk
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Identification
of intragroup
Documentation
Tax return filing
TP Adjustments
TP Assessment
transactions
FAR Analysis
Identification
of comparable
transactions
Establishing comparability,
adjustment for material differences
Determination of
ALP
Selection of most
appropriate
method
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Sections
Default
Penalty
271(1)(c )
In case of a post-inquiry adjustment, 100-300% of tax
there is deemed to be a concealment adjusted amount
of income
271AA
Failure to
documents
271BA
Failure to furnish accountant’s report
271AA
Failure to report a transaction in 2% of the value of transaction
accountant’s report
271G
Maintaining or furnishing incorrect 2% of the value of transaction
information or documents under 92D
maintain
and
on
the
furnish 2% of the value of transaction
INR 100,000
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• Safe Harbor (“SH”) Rules shall be applicable for a period of five fiscal years
(i.e., tax AY 2013-14 onwards) and SH do not apply to specified domestic
transactions
• Safe Harbour Rules are the circumstances under which tax authorities
automatically accept the transfer prices declared by the taxpayer
• Provides certainty and compliance relief
• Could be in the form margin threshold or exclusion of certain classes of
transactions from TP regulations
• Safe Harbour and Presumptive Taxation provisions (Similar in nature)
• Taxpayer would still be required to maintain TP documentation and Form
3CEB
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S. No. International Transaction
Condition
1
ITS and ITeS – Max INR 500 crores (Insignificant risk bearer)
OP/ OC >= 20%
2
ITS and ITeS – Above INR 500 crores (Insignificant risk bearer)
OP/ OC >= 22%
3
ITES – KPO services - Max INR 100 crores (Insignificant risk
bearer)
OP/ OC >= 25%
4
Intra Group Loan to WOS <= INR 50 crores
Base rate on 30 June of
PY (SBI) + 150 bsp
5
Intra Group Loan to WOS > INR 50 crores
Base rate on 30 June of
PY (SBI) + 300 bsp
6
Explicit Corporate Guarantee to WOS <= INR 100 crores
2% or more P.A on
amount guaranteed
7
Explicit Corporate Guarantee to WOS > INR 100 crores (WOS
rated to be of adequate to highest safety)
1.75% or more P.A on
amount guaranteed
8
Contract R&D for software development (Insignificant risk bearer)
OP/ OC >= 30%
9
Contract R&D for generic pharmaceutical drugs (Insignificant risk
bearer)
OP/ OC >= 29%
10
Manufacture and export of core auto components
OP/ OC >= 12%
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Revised and Updated Guidance for
Implementation of Transfer Pricing Provisions
CBDT issues instruction No. 15/2015 replacing Instruction No. 3 dated
May 20, 2003 to give guidance to AO and TPO regarding transfer
pricing assessments
1.
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Reference to Transfer Pricing Officer (TPO)
AO must record his satisfaction as jurisdictional requirement, that there
is income/potential income arising from international transaction
before proceeding to determine ALP on his own or making a
reference to TPO, in following circumstances –
(i) No accountant's report filed by assessee, but international
transactions entered by assessee have come to the notice of AO;
(ii) Taxpayer has not declared one or more international transaction in
Form 3CEB which has come to AO's notice;
(iii) where transaction is declared in Form 3CEB with qualifying remarks
to the effect that such transaction is not international transaction or it
does not have impact on taxpayers income
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 In case no objection is raised by the taxpayer to the applicability of
Chapter X [Sections 92 to 92F] of the Act, then the prima-facie view
of the AO would be sufficient before referring the international
transaction to the TPO for determining the ALP.
However, where the applicability of Chapter X [Sections 92 to 92F] of
the Act to the facts of the taxpayer's case is objected to, the
assessee's objection should be considered and specifically dealt with
so as to make sufficient compliance with the principles of natural
justice.
 Making a reference to TPOs on the basis of value of international
transactions is no more necessary as selection of TP cases for scrutiny is
to be based on risk assessment, consequently when a case is selected for
scrutiny for non-TP issues, no reference to TPO is necessary irrespective
of value of international transactions
Only exception to above would be a situation where AO notices
undisclosed international transaction during assessment proceedings due
to non-filing of Form 3CEB/ non-reporting of such transaction in Form
3CEB
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2. Role of Transfer Pricing officer
 The TPO, being an Additional/Joint CIT, shall obtain the approval of the
jurisdictional CIT (TP) before passing the order. On the other hand, the
TPO, being a Deputy/Assistant CIT, shall obtain the approval of the
jurisdictional Additional/Joint CIT before passing the order
The jurisdictional CIT (TP) should assign a limited number of important and
complex cases, not exceeding 50, to the Additional/Joint CslT [TPOs]
working in the same jurisdiction
 TPO's order being subject to judicial scrutiny, must contain adequate
reasons/data regarding selection of most appropriate method, data
used for computation of ALP and copies of all relevant documents in
this respect to be made available to AO for his record and use at
subsequent stage of appellate and penal proceedings
 Instruction also highlights role of TPO in compliance audit in pursuance to
APA signed and regarding safe harbour provisions
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3.
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4.
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Maintenance of Database
References received from the AOs by the TPOs in his jurisdiction are
dealt with expeditiously and accurate record of all events connected
with the whole process of determination of ALP is maintained in the
format enclosed as Annexure-I to this Instruction.
The ClT (TP)must ensure that the separate data maintained
by all
TPOs under their jurisdiction are consolidated into one report for
the entire charge after the completion of each transfer pricing
audit cycle.
Applicability
Guidance provided in instruction applicable only to scrutiny of
'international transactions' and CBDT is considering issue of separate
guidance for specified domestic transactions
However, guidance regarding cases selected for scrutiny on non-TP
parameters also applicable to specified domestic transactions
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1.
2.
3.
CBDT notifies transfer pricing (TP) rules to incorporate “range concept”
and “use of multiple year data”
Applicablity
Amended Rules applicable to international transactions and specified
domestic transactions undertaken on or after April 1, 2014
Range Concept
Range concept to be applicable in certain cases and data points lying
between 35th and 65th percentile of comparable prices to be
considered as arm’s length price
Clarifies that the transaction price shown by taxpayers falling within the
range will be accepted and no adjustment will be made
Weighted Average PLI
Notification proposes use of weighted average of PLI for 3 years and
gives illustrations on computation of weighted average PLI & arm's
length range
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4. Multiple Year Data
CBDT states that use of multiple year data allows for yearly variations to
be averaged out and would therefore add value to the TP analysis
Stresses that amended rules would provide clarity in determination of
price in TP cases and reduce disputes on TP issues and further, that it is a
part of continuing initiative of providing a stable and certain direct tax
regime
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