Pune Camp CPE Study Circle
Transfer Pricing: Legislation, Experiences and
Recent Developments
Presented by : Dinesh Supekar
April 24, 2010
PwC
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Brief legislative framework
Background : Why TP
•
Increasing participation of MNCs in world economic activities
•
General tendency to control profits and transfer the same to low tax
heavens
•
Legislation felt essential by Governments for protection of their respective
tax base
•
OECD issued TP guidelines for MNEs and Tax Administrations in 1979
(amended in 1995 and onwards)
•
India is an observer of OECD guidelines: not a member, yet
PricewaterhouseCoopers
April 2010
Slide 3
Brief legislative framework
Arm’s length principle
Associated
enterprise
Independent
entity
International transactions
- goods
- services
- intangibles
Resident
Transfer
price
PricewaterhouseCoopers
Resident
Arm’s length
price
April 2010
Slide 4
Brief legislative framework
TP in India : Background
•
Sections 92 to 92F of the Act read with rules 10A to 10E referred to as
framework of Indian TP legislation
•
Various circulars, notifications and administrative instructions issued by
CBDT
PricewaterhouseCoopers
April 2010
Slide 5
Brief legislative framework
Compliance requirements
•
Any income arising from international transaction : to be computed having
regard to Arm’s Length Price (also covers cost allocation & cost sharing
arrangements)
•
Tax payers required to maintain prescribed information & documentation
[Section 92D read with Rule 10D]
•
Accountant’s Report on international transactions to be filed along with the
return of income : irrespective of value of international transactions
PricewaterhouseCoopers
April 2010
Slide 6
Brief legislative framework
Penalties
The Indian TP legislation prescribes stringent penalties for not maintaining /
furnishing annual documentation and Accountant’s Report:
Sr. No.
Type of penalty
1
Failure to maintain prescribed information/ documents
2
Failure to furnish information/ documents during
assessment
3
Adjustment to taxpayer’s income during assessment
4
Failure to furnish accountant’s report
Penalty
quantified
2% of
271AA
transaction
value
2% of
271G
transaction
value
100% to 300%
of tax on
271 (1) (c)
adjustment
amount
Section
271BA
INR 100,000
No deduction available for TP adjustments after scrutiny by the AO under
Sec. 10A, 10AA, 10B or Chapter VI-A
PricewaterhouseCoopers
April 2010
Slide 7
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Brief on Assessment Procedures
Timelines and selection of cases
•
The Assessing Officer may make reference to the Transfer Pricing Officer
(‘TPO’) if he considers it necessary or expedient to do so [Sec. 92CA (1)]
with previous approval of the Commissioner
•
CBDT had issued internal guidelines for selection of cases for TP scrutiny
in cases where the aggregate value of international transactions exceeds
Rs. 5 crores [Circular 3/2001]
•
The threshold limit for selection of cases for scrutiny : Rs. 15 Crores
•
Irrespective of the threshold limit instructed by CBDT : the cases may be
picked up for scrutiny if the AO deems it fit or the AO may undertake the
scrutiny on his own
Reference to TPO if value of international transactions exceed Rs. 5 Crores
but the case selected for scrutiny due to norms other than filter of International
transactions?
PricewaterhouseCoopers
April 2010
Slide 9
Brief on Assessment Procedures
TP Audits : framework
AO to compute total income
in conformity with the ALP
determined by TPO
Commissioner
Approval for
Reference
Draft Assessment Order
AO
Assessee
TPO’s order
Reference
Notice u/s 92CA (2)
TPO
Show cause notice
Reply to SCN
Determination of ALP
By TPO after hearing
PricewaterhouseCoopers
Can AO change the
order by TPO?
April 2010
Slide 10
Brief on Assessment Procedures
Appeals : Framework
Draft Order by AO adjusting
Taxable Income of Assessee
Rectification application can be
made against the order of TPO
for apparent mistakes
Appeal can be made against the
Draft order of AO as order of
TPO included within
the order of the AO
Appeal to DRP
Appeal to CIT(A)
ITAT
High Court
Supreme Court
Constitutional Bench
PricewaterhouseCoopers
April 2010
Slide 11
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
The Charging Section & International Transactions
The Charging Section
•
Any income arising from an international transaction shall be computed
having regard to the arm’s length price [Section 92 (1)]
•
Arm’s Length Price is price applied or proposed to be applied by unrelated
enterprises under uncontrolled conditions
•
Following transactions also require compliance with Arm’s Length
Principle:
-
allowance for any expense or interest arising from an international
transaction [Explanation to Section 92 (1)]
-
costs or expenses allocated/apportioned under mutual
agreement/arrangement for provision of benefit or service or facility by
one enterprise to other [Section 92 (2)]
Base erosion is the important principle for attraction of TP provisions
PricewaterhouseCoopers
April 2010
Slide 13
The Charging Section & International Transactions
Case studies on Charging Section
Parent P
•
Whether it would be required for S to comply with TP provisions for
issuance of share capital?
•
Would it make difference
Issue of
Share Capital
Subsidiary S
•
if the shares are Preference Shares : entitled to fixed rate of
dividend?
-
if S issues convertible debentures bearing fixed rate of interest to
P?
-
if S avails loan from P, bearing interest?
-
if the loan is interest-free loan?
Whether dividends paid by S to P would require compliance with TP
provisions?
•
Whether S would be required to comply with TP provisions for
purchase of fixed assets?
•
Would it make difference
Parent P
Sale of fixed Assets
-
-
if S did not start manufacturing activities and carried the cost of
fixed assets as CWIP?
-
If S purchased raw material and carried it as stock in trade, since
it did not start its manufacturing activities?
Subsidiary S
PricewaterhouseCoopers
April 2010
Slide 14
The Charging Section & International Transactions
International Transaction [Section 92B]
•
•
•
International transaction is
- Transaction between the Group companies : either or both of whom
are non-residents
- for purchase, sale, lease of : tangible property or intangible property
- for provision of services or lending or borrowing money
- other transactions having bearing on profits / income / losses or
assets of an enterprise
- also to include cost allocations/apportionments for benefits/ services or
facility provided by one to other
Transaction includes arrangement, understanding or action in concert:
- whether formal or in writing
- whether intended to be enforceable with legal proceedings or not
[Section 92F (v)]
Transaction also includes number of closely linked transactions
[Rule 10A (d)]
PricewaterhouseCoopers
April 2010
Slide 15
The Charging Section & International Transactions
Deemed International Transaction
Transaction between subsidiary & third party may also be subject to TP:
Prior agreement
Parent Company
Third party
Prior agreement exists between
parent company and third party
Subsidiary
Determination of terms
Terms of transaction are
determined in substance by parent
company and third party
Global sourcing?
PricewaterhouseCoopers
Parent Company
Third party
Subsidiary
April 2010
Slide 16
The Charging Section & International Transactions
Case studies on International Transactions
Group Co : ABC
Claim for
reimbursement
Sale
Group Co : PQR
Sale
Customer of PQR
Settlement of warranty claims
•
Are the warranty claims settled by
PQR – claimed for reimbursements the
International Transactions?
•
Whether the provisions for warranties
are International Transactions:
-
If PQR had to bear warranty costs?
-
If ABC was Indian enterprise?
PQR uses the IT infrastructure of ABC for maintenance of its accounting
records, mails, sales tracking data, etc. ABC proposes to charge PQR an
allocation for the IT infrastructure costs based on an agreed allocation key :
Would the IT Cost allocations qualify to be International Transactions?
PricewaterhouseCoopers
April 2010
Slide 17
The Charging Section & International Transactions
… Case studies on International Transactions
Parent P
Assignment of
contract
Sale under contract
Customer of P
Subsidiary S
Sale at prices
as per contract
Whether sales by S to the Indian customer would qualify as International
Transactions : though S and Indian customer are both residents of India?
Transactions not taxable under DTAA?
Transactions taxable under presumptive basis under law?
PricewaterhouseCoopers
April 2010
Slide 18
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Associated Enterprises
Enterprises
•
•
Section 92F (iii) defines enterprise as any person (including PE) engaged
in:
-
any activity relating to production, storage, supply, acquisition or control
of articles, goods or specified intangibles.
-
any activity pertaining to provision of services or carrying out any work
in pursuance of a contract
-
any investment or financing activity
The term PE has been defined to be an inclusive term to include a fixed
place of business through which the business of the enterprise if wholly or
partly carried on [S.92F(iiia)]
PricewaterhouseCoopers
April 2010
Slide 20
Associated Enterprises
Associated Enterprises
Associated Enterprises have been defined to include:
•
Participation in Management / Control or Capital [Section 92A(1)(a)]
•
Common persons in Management/Control or Capital [Section 92A(1)(b)]
•
13 Categories of deeming fictions for enterprises to qualify as Associated
Enterprises [Section 92 (2)]
PricewaterhouseCoopers
April 2010
Slide 21
Associated Enterprises
… Associated Enterprises : participation criterion
Associated Enterprise for an enterprise means an enterprise which
participates :
• Directly or indirectly or
• Through one or more intermediaries
in management or control or capital of other enterprise [Section 92A (1) (a)]
Management/
Control/
Capital
B
C
Participation in management/control/capital:
by A INDIRECTLY and
by B DIRECTLY
Thus both A and B are AEs of C
PricewaterhouseCoopers
A
A
Management/
Control/
Capital
Management/
Control/
Capital
B
D
E
Management/
Control/
Capital
C
Participation in management/control/capital:
by A INDIRECTLY
by B DIRECTLY
By D and E DIRECTLY
Thus all A, B, D and E are AEs of C
April 2010
Slide 22
Associated Enterprises
… Associated Enterprises : Common control criterion
Associated Enterprise for an enterprise
means an enterprise in respect of
which :
One ore more persons who participate
• directly or indirectly or
• through one or more intermediaries
in its management or control or capital
ARE THE SAME PERSONS
WHO PARTICIPATE
• directly or indirectly or
• through one or more intermediaries
in its management or control or capital
of the other enterprise
PricewaterhouseCoopers
Company A
A & B are
AEs
Mr. X is a
Director
Company B
April 2010
Slide 23
Associated Enterprises
… Associated Enterprises : deeming fictions
Enterprises deemed to be AEs [Section 92 A (2)]:
a)
one has direct or indirect share holding carrying not less than 26% voting power in the other
b)
common parent / person holds 26% of voting power in both enterprises
c)
one advances loan constituting not less than 51% of book value of total assets of the other enterprise
d)
one provides guarantees of not less than 10% of total borrowings of the other enterprise
e)
more than half of board of directors of one enterprise are appointed by the other enterprise
f)
more than half of the board of directors of both enterprises are appointed by the same person or persons
g)
one enterprise is wholly dependent on use of IPRs of the other enterprise
h)
At least 90% of raw materials and consumables required by a enterprise are supplied by the other
enterprise, or by persons specified by the other enterprise, and prices and conditions relating to supply are
influenced by such other enterprise
i)
Goods or articles manufactured or processed by one enterprise, are sold to the other enterprise or to
persons specified by the other enterprise, and prices and conditions relating thereto are influenced by such
other enterprise
j)
Both enterprises controlled by same the same individual singly or jointly with relatives
k)
One enterprise controlled by HUF and other controlled by member of HUF or his relative or jointly
l)
One enterprise being a firm, association of persons or body of individuals, the other enterprise holds not
less than 10% interest therein
m) There exists between the two enterprises, any relationship of mutual interest, as may be prescribed
PricewaterhouseCoopers
April 2010
Slide 24
Associated Enterprises
… Associated Enterprises : deeming fictions
The deeming fictions may cover genuine third party transactions:
• Joint Ventures [Section 92 A (2) (a)]
• Extensive financing by Bank to an enterprise [Section 92 A (2) (c)]
• Global arrangements for supply of bulk material [Section 92 A (2) (h)]
• Use of exclusive technology by an enterprise on which it is fully dependent
[Section 92 A (2) (g)]
There may still be loopholes in catching the enterprises as AEs
Acceptance of influence in anticipation of proposed takeover
and takeover occurs after the financial year?
PricewaterhouseCoopers
April 2010
Slide 25
Associated Enterprises
Case study on AEs and International Transactions
•
Whether A & B would be treated as
AEs for the transactions entered into
before takeover, i.e. during April 1,
2008 till November 30, 2008?
•
Whether the transactions for sale of
goods by A to B during the period
before takeover would qualify as
International Transactions?
•
Which amount should be reported
by the CA of B in his report in Form
3CEB?
A
A acquires B
on December
1, 2008
Sales
B
PricewaterhouseCoopers
April 2010
Slide 26
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Principles of comparability
Let’s look at principles of comparability before understanding the
methods
Whether
=
Apple to apple comparability !!!
PricewaterhouseCoopers
April 2010
Slide 28
Principles of comparability
Factors to be used to judge comparability [Rule 10B(2)]
•
Characteristics of the property transferred (service provided)
•
FAR by the respective entity
•
Contractual terms
•
Conditions prevailing in the market
-
geographical location
-
size of the market
-
laws and regulations
-
capital invested
-
level of competition, etc.
Can related party transactions be considered?
PricewaterhouseCoopers
April 2010
Slide 29
Principles of comparability
Criteria for uncontrolled transaction to be comparable [Rule 10B(3)]
•
None of the differences between the transactions being compared are
likely to materially affect the price or cost or profit in the open market
OR
•
Reasonably accurate adjustments can be made to eliminate the material
differences
A Inc.
Export of
Product ‘X’
B Ltd.
(AE)
Rs. 2500 per
Kg, CIF
PricewaterhouseCoopers
Export of
Product ‘X’
The transactions can comparable
after adjustments for to Freight &
Insurance
Third Party
Rs. 2000 per
Kg FOB
Expenses incurred
Freight Rs. 500/Kg
Insurance Rs 100/Kg
April 2010
Slide 30
Principles of comparability
Use of data for comparability [Rule 10B(4)]
The data for analysis of comparability shall pertain to the financial year in
which the international transaction has been entered into
However data for previous 2 years to financial year may be used
• if such data could have an influence on the determination of TP
Use of multiple year data also recommended by OECD to consider
• Losses,
• business or product life cycle,
• economic conditions, etc.
Availability of data at the time of entering into transactions?
PricewaterhouseCoopers
April 2010
Slide 31
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Computation of ALP
How to determine ALP [Section 92C (1)]
By use of any of the prescribed methods being
the most appropriate method
having regard to :
• nature of transaction or
• class of transaction or
• class of associated persons or
• functions performed by such persons
Factors to consider for selection of Most Appropriate Method (MAM) (Rule 10C) :
• Nature and class of the international transactions
• Class of enterprise and FAR
• Availability, coverage and reliability of necessary data
• Degree of comparability between international transaction & uncontrolled
transaction
• Extent of reliable and accurate adjustment
PricewaterhouseCoopers
April 2010
Slide 33
Computation of Arm’s Length Price
Section 92C : Computation of arm’s length price
Methods for computation of ALP
Traditional Transaction
Comparable
Uncontrolled
Price
(“CUP”)
Resale
Price
Method
(“RPM”)
Transactional Profit based
Cost
Plus
Method
(“CPM”)
Profit
Split
Method
(“PSM”)
Transactional
Net Margin
Method
(“TNMM”)
No hierarchy of methods suggested by Indian TP legislation
PricewaterhouseCoopers
April 2010
Slide 34
Computation of Arm’s Length Price
Comparable Uncontrolled Method (“CUP”)
Steps :
• Identify price charged in comparable uncontrolled transaction;
• Adjust for differences materially affecting the price;
• The adjusted price is the ALP
Types of CUP
Outside
India
Parent
Company
India
Internal
CUP
Subsidiary
PricewaterhouseCoopers
Third Party
External CUP
Third Party
April 2010
Slide 35
Computation of Arm’s Length Price
Resale Price Method (“RPM”)
Steps
• Identify the third party selling (service) price (fee) for products (services)
purchased (procured) from Group Companies
• Reduce the comparable uncontrolled GP 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
Particulars
Ultimate Selling price
Less: Comparable GP Margin
Cost of Sales
Less: Expenses incurred for procurement
ALP
Amount (Rs.)
1,000
300
700
200
500
GP margin should recover operating costs and
ALP profit based on the FAR
PricewaterhouseCoopers
April 2010
Slide 36
Computation of Arm’s Length Price
Cost Plus Method (“CPM”)
Steps
• Identify direct and indirect costs of production for property (services)
• Add uncontrolled normal GP mark-up
• Adjust for functional and other differences, if any
• The adjusted price is ALP
Particulars
Cost of production (Direct & Indirect Costs)
Add: Comparable Gross Profit Margin
ALP
Amount (Rs.)
1,000
250
1,250
Whether Cost Plus Pricing mechanism = CPM for computation of ALP?
PricewaterhouseCoopers
April 2010
Slide 37
Computation of Arm’s Length Price
Profit Split Method (“PSM”)
Steps
• Determine combined NP for Group from international transactions
• Evaluate relative contribution by each of the AEs based on the FAR
• Split the combined NP amongst the AEs proportionate to relative
contributions
• The apportioned portion of the profit is taken to compute ALP
Applicability :
• Transactions involving transfer of unique intangibles or interrelated multiple
transactions
Detailed guidance about PSM in Proposed OECD Guidelines
PricewaterhouseCoopers
April 2010
Slide 38
Computation of Arm’s Length Price
Transactional Net Margin Method (“TNMM”)
Steps
• Compute NP margin for
- costs incurred
- sales effected
- assets employed or
- any other relevant base
• Compare NP margin realised from comparable uncontrolled transaction
• Adjust for functional and other differences, if any
• The NP is to be taken to compute ALP
Popular amongst tax payers
Favoured by Revenue Authorities
since protects tax base erosion
PricewaterhouseCoopers
April 2010
Slide 39
Computation of Arm’s Length Price
… TNMM
Points to be considered:
• Use of databases : Indian databases : PROWESS, CAPITALINE, etc.
• Selection of tested party?
• Use of foreign databases : PAN European : AMADEUS, North American :
Compustat, etc.
• Issues encountered in selection of comparables
- Availability of data in public domain,
- Computation of GP?,
- FAR of comparables, etc.
• Possible adjustments for comparability:
- Working capital adjustment,
- Risk adjustments, etc.
PricewaterhouseCoopers
April 2010
Slide 40
Computation of Arm’s Length Price
… TNMM
Profit Level Indicator (PLI)
PLI
Operating Margin
Formula
OP/Sales
Return on sales
Return on Costs
Typical Applicability
Manufacturers
Distributors
OP/TC
Service providers
Contract manufacturers
Return on Assets
Berry Ratio
OP/Operating Assets
GP/Operating Expenses
Capital Intensive Manufacturers
Distributors
Return on Operating
Expenses
PricewaterhouseCoopers
April 2010
Slide 41
Computation of Arm’s Length Price
Choice of MAM : General categorisation
Method
Transaction Type
CUP
Loans, Royalties, Service fee, transfer of tangibles, etc.
RPM
Marketing operations of finished products, where distributor not
performing significant value addition to product
CPM
Raw material or semi-finished goods are sold, long term buy-andsell agreement
PSM
Transaction involve provision of integrated services by more than
one enterprise or involve unique intangibles
TNMM
PricewaterhouseCoopers
Provision of services, transfer of semi-finished goods, distribution of
finished goods where applicability of RPM appears to be
inappropriate
April 2010
Slide 42
Computation of Arm’s Length Price
Peculiarities in computation of ALP
Options under proviso to Section 92 C (2)
where more than one price is determined by the most appropriate method
the ALP shall be taken to be the arithmetical mean of such prices
OR
if the variation between the ALP so determined and price at which the
international transaction has actually been undertaken does not exceed
five per cent of the latter, the price at which the international transaction has
actually been undertaken shall be deemed to be the arm’s length price.
(Amended by the Finance (No. 2) Act, 2009)
Whether +/- 5% benefit can be availed if only one ALP computed ?
PricewaterhouseCoopers
April 2010
Slide 43
Computation of Arm’s Length Price
Case studies on computation of ALP
More than one price determined by MAM:
Subsidiary S purchases article A from Parent P at Rs. 104. Parent P also sells the
article A to the third party Indian companies at negotiated prices.
Following would be illustration of computation of ALP:
Company
Comparable
ABC Ltd
114
XYZ Ltd
106
LMN Ltd
95
Arithmetic Mean
105
Therefore, the transaction of purchase of article A would be at arm’s length.
What if S purchased article A at Rs. 107?
PricewaterhouseCoopers
April 2010
Slide 44
Computation of Arm’s Length Price
… Case studies on computation of ALP
S can opt for availing benefit under proviso to Section 92C (2) and compute
the ALP with +/-5% range
Situation before 2009 amendment
Particulars
Arithmetic mean of uncontrolled purchase
prices
+ 5%
-5%
Rs.
105.00
110.25
99.75
The purchase price by S (Rs. 107) is lower than the +5% amount, i.e. Rs. 110.25.
Therefore the purchase transaction would be considered to be at arm’s length.
Situation after 2009 amendment
Particulars
Price at which the international transaction
has actually been undertaken
(100%-5%) = 95% of above
Rs.
107.00
101.65
The variation between ALP determined (Rs. 105) and actual price (Rs. 107) does not exceed
5% of actual price, thus fits within arm’s length.
PricewaterhouseCoopers
April 2010
Slide 45
Computation of Arm’s Length Price
… Case studies on computation of ALP
Application of +/-5% under TNMM
Particulars
Operating Income
Total Costs (TC)
Operating Profit (OP)
OP/TC
Average OP/TC of comparables
ALP based on OP/TC of Comparables
105% of price at which the international transaction
has actually been undertaken
Rs.
110.00
100.00
10.00
10.00%
13.00%
113.00
115.50
The ALP so determined (Rs. 113) does not exceed 105% of the operating income (Rs.
115.50). Therefore the transactions would be considered to be at arm’s length.
Important to note that +/-5% can be applied on arithmetical mean of ALP
and NOT the margins
PricewaterhouseCoopers
April 2010
Slide 46
Computation of ALP
When can AO compute ALP himself???
Mandatory satisfaction of any ONE of the following conditions for AO to
compute ALP [Section 92C (3)]:
• Price not determined under Section 92C
• Information & document have not been maintained under Section 92D
• Use of incorrect/unreliable data
• Failure to furnish information & document under notice
PricewaterhouseCoopers
April 2010
Slide 47
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
What is it that the taxpayer should do
Documentation Requirements
Mandatory documentation
Mandatory maintenance of prescribed information and documents by every
person entering into an international transaction [Section 92D read with
Rule 10D]
Entity Related
Price Related
Transaction Related
• Profile
• Profile
• Profile
• Profile
• Transaction terms
• Functional Analysis
• Agreement
• Invoices
• Price related correspondence
of the Group
of the Indian entity
of AE
of Industry
PricewaterhouseCoopers
(Functions, Assets, Risks)
• Economic Analysis
(Method selected,
Benchmarking analysis)
• Forecasts, budgets,
estimates, etc.
April 2010
Slide 49
Documentation Requirements
… Mandatory documentation
Supporting Documents [Rule 10D(3)]
• Official publications, reports, studies from Government
• Reports of market research studies, technical publications
• Price publications
• Published accounts and financial statements
• Agreements & contracts related to international transaction
• Letters and other correspondences
The information and documents should be contemporaneous and shall be
kept for a period of eight years from the end of the relevant assessment year
[Rule 10D (5)]
PricewaterhouseCoopers
April 2010
Slide 50
Documentation Requirements
Relaxations???
Relaxation from mandatory maintenance of documentation offered by
Rule 10D(2) in respect of value of international transactions not exceeding
Rs. One Crore
However the taxpayer would need to substantiate ALP on the basis of
material available with him
Filing of Accountants Report is necessary irrespective of
value of International Transaction
• Certification in Form 3CEB without documentation?
• Relaxation : Truth or Myth?
• What if the documentation was maintained for last year and there is no change in
business?
PricewaterhouseCoopers
April 2010
Slide 51
Part I
Transfer Pricing Legislation
Brief Legislative framework
Brief on Assessment Procedures
The charging Section and international transactions
Associated Enterprises
Principles of Comparability
Computation of Arm’s Length Price
Documentation requirements
Accountant’s Report
What is it that the taxpayer should do
What is it that the taxpayer should do?
Submit the
Accountant’s
Report
Conduct
Functional
Analysis and
Industry
Analysis
PricewaterhouseCoopers
Execute
Comparability /
Benchmarking
analysis
Maintain the
required
Documentation
April 2010
Slide 53
Part II
Transfer Pricing Experiences
Transfer Pricing Audit Environment in India
Issues and case studies
Transfer Pricing Audit Environment in India
Experiences till now…
• Eight Years of TP Documentation
• Fifth round of TP audits completed in October 2009
• High volume of cases handled per Transfer Pricing Officer (“TPO”)
• Aggressive positions adopted
• Service companies – high mark-ups expected
• Transaction wise TP analysis expected
• Exchange of information between TP and customs authorities
• Introduction of Safe Harbour and Dispute Resolution Panel (“DRP”)
• Advance Pricing Arrangements expected soon
PricewaterhouseCoopers
April 2010
Slide 55
Transfer Pricing Audit Environment in India
Development of
a matured
market
TP Journey
Effort to
adopt global
best
practices
Guidance to
the taxpayers
Introduction
of safe
harbour
provisions
2010
Introduction of
APA
2011
Introduction
of
TP Rules
Providing
certainty
Learning
Process
2001
2009
Eight years of TP
documentation, and
Five rounds of TP
Audit completed
PricewaterhouseCoopers
April 2010
Slide 56
Part II
Transfer Pricing Experiences
Transfer Pricing Audit Environment in India
Issues and case studies
Issues and Case Studies
Issues and Case Studies – Issue 1 : Pricing Policy
What is Pricing Policy / TP policy ?
• A pricing policy means a document that lays down and describes the different
nature of transactions which take place between the affiliated companies and
provides guidance to determine the prices for these transactions ensuring that the
arrangements
- Are in line with the arm’s length principle
- Ensure tax optimization for the group
- Reward each entity based on its characterization and as per group’s objective
• Case Study 1 :
- ABC India (manufacturing company) earns a margin of 15% (OP/Sales)
- International transaction of purchase of goods
- Benchmark at 10% (assuming overall TNMM adopted)
PricewaterhouseCoopers
April 2010
Slide 58
Issues and Case Studies
Issues and Case Studies – Issue 1 : Pricing Policy
• Questions asked by TPO ?
- Existence of Global TP policy ?
- How are the imports priced ?
- Whether Contemporaneous Data maintained ?
• Importance of pricing policy
- In the course of assessment, TPO’s often require the assessee to explain how
prices were set/ negotiated in respect of AE transactions
- Where the assessee’s have a well documented TP policy, it has been easier to
demonstrate the basis of pricing
PricewaterhouseCoopers
April 2010
Slide 59
Issues and Case Studies
Issues and Case Studies – Issue 1 : Pricing Policy
• Best Practices
- Detailed pricing policy governing the prices of products exported to different
countries / regions to be maintained
- Adequate back-up documentation to be maintained, which justifies
the
basis on which price setting has been done (e.g. budgets)
- Transfer pricing documentation to adequately bring out the facts mentioned in
such pricing policy and highlight reasons for differences in prices
- To have a global pricing policy in advance
- Pricing policy to be followed across the group
PricewaterhouseCoopers
April 2010
Slide 60
Issues and Case Studies
Issues and Case Studies – Issue 2 : Multiple year data
• TP Regulations
• Case Study : 2
- Documentation maintained for 2007
- Data used for benchmarking purposes 2007, 2006, 2005
- PLI (OP/Sales) Weighted Average used
- TPO adopts the case for scrutiny in 2010 and uses 2007 data
• What should be the defense strategy ?
- Non- availability of data at the time of filing return
- Pricing policy & price setting process
- OECD guidelines
PricewaterhouseCoopers
April 2010
Slide 61
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
Use of CUP method
• General preference of the Revenue authorities to use CUPs
• Inexact CUPs sometimes preferred over TNMM
• Typical approaches used by the Revenue authorities:
- Comparing price at which other AEs sell/ buy in the group to/ from third parties
- Comparing export prices with domestic prices and vice versa
- Comparing price of imported raw material with import prices reported in Customs
databases/ price paid by Competitors for similar materials
- In case of management fees/royalties, information on management fees/royalty
paid by other AEs in the region is also called for
- Existence of CUPs generally examined in detail when an assessee having
adequate net operating margins seeks to rely on the TNMM
PricewaterhouseCoopers
April 2010
Slide 62
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
• Other Points
- Whether generic charge out rates reported by industry associations / trade
journals can be used as a CUP to benchmark the assessee’s billing rates to
associated enterprises
- Whether prices of original researched raw materials imported by the assessee
from AEs, can be compared with prices of generic materials obtained by TPO’s
from the customs database / issuing notices under S. 133(6)
- Whether export prices to AEs can be compared with the price of same or
similar goods in the domestic market
- Local third party purchases v/s imports from AEs
PricewaterhouseCoopers
April 2010
Slide 63
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
• Case Study : 3 - Export Profitability
- Assessee is engaged in the business of manufacture and sale of certain
automobile ancillaries, primarily sold in the domestic market
- The assessee has a monopoly in the market with a market share of
approximately 90%
- The operations of the assessee are profitable, but the domestic sales are
more profitable as compared to the export sales to AEs
- The relatively lower profits in the exports business are questioned by the
TPO
PricewaterhouseCoopers
April 2010
Slide 64
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
• Arguments advanced:
- Domestic Market for the assessee is saturated
- Assessee has to necessarily look at other markets for growth
- Unlike the domestic market, the assessee does not have a monopolistic
situation in then export market.
- AE is free to buy from third parties, including other AEs
- To gain a foothold in the export markets, competitive pricing is essential.
- Above business factors, including lower volumes in export markets,
make the export profitability non comparable with domestic profitability.
PricewaterhouseCoopers
April 2010
Slide 65
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
• Related issue while selecting comparables
- Persistent loss making companies
- Outliers
- Start ups etc.
Best Practice
OECD proposed 10 step process for
performing a comparability analysis
PricewaterhouseCoopers
April 2010
Slide 66
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
OECD proposed 10 step process for performing a comparability analysis
• Step 1: Analysis of the taxpayer’s circumstances
• Step 2: Determination of years to be covered
• Step 3: Understanding the controlled transaction(s) based on functional
analysis
• Step 4: Review of existing internal comparables, if any
• Step 5: Determination of sources of information on external comparables if
required
PricewaterhouseCoopers
April 2010
Slide 67
Issues and Case Studies
Issues and Case Studies – Issue 3 : Comparability Issues
• Step 6: Selection of the most appropriate transfer pricing method and PLI
(if appropriate)
• Step 7: Identification of potential comparables
• Step 8 : Determination of and making comparability adjustments where
appropriate
• Step 9: Interpretation and use of data collected, determination of the arm’s
length remuneration
• Step 10 : Implementing support processes. Installing review process to
ensure adjustment for material changes and documenting these processes
PricewaterhouseCoopers
April 2010
Slide 68
Issues and Case Studies
Issues and Case Studies – Issue 4 : Risk and Other
Adjustments
• Capacity adjustments
- Account for difference in capacity utilisation between tested party and
uncontrolled comparable transactions
- Low profitability of tested party not always attributable to pricing of
international transactions
• Others
- Working capital
- Adjustment of business risk (entrepreneur v/s. captive) etc.
PricewaterhouseCoopers
April 2010
Slide 69
Part III
Recent Developments
Dispute Resolution Panel (‘DRP’)
Proposed revision of Chapters I-III of OECD TP Guidelines
Other proposed developments
Recent TP case laws
Recent Developments
Dispute Resolution Panel (‘DRP’)
• Introduced by Finance (No. 2) Act, 2009
• Speedier resolution of disputes – 9 months from the issuance of “Draft
Order” by the AO
• Period of 30 days given to the assessee for approaching DRP
• AO shall pass assessment order after receiving directions from DRP
• Appeal against such order lies with ITAT
• Constitution of DRP: 3 Commissioners of Income-tax
• Application in Form 35A in quadruplicate (3 copies to DRP members and 1
copy to AO)
• 51 DRP applications filed in Pune
• First round of DRP hearings in progress
PricewaterhouseCoopers
April 2010
Slide 71
Part III
Recent Developments
Dispute Resolution Panel (‘DRP’)
Proposed revision of Chapters I-III of OECD TP Guidelines
Other proposed developments
Recent TP case laws
Recent Developments
OECD proposed revision of chapters I – III of the TP guidelines
• Objective to update Chapters I – III of the TP guidelines
• Draft released for comment September 9, 2009
• Comment period closed January 9, 2010
• Likely to finalize model revisions in 2010
• No further public consultation likely
• Key Changes
- Most appropriate method
- Comparability analysis
- Application of the transactional profit methods
PricewaterhouseCoopers
April 2010
Slide 73
Part III
Recent Developments
Dispute Resolution Panel (‘DRP’)
Proposed revision of Chapters I-III of OECD TP Guidelines
Other proposed developments
Recent TP case laws
Recent Developments
Other proposed developments
• Safe Harbour Rules proposed to be introduced by Finance (No. 2) Act,
2009
• Advance Pricing Arrangements (APA) expected to be introduced by
Direct Tax Code (‘DTC’)
• Thin Capitalisation Rules expected to be introduced after implementation
of the DTC
• Other regulatory changes having impact on Transfer Pricing:
• Removal of upper limit on payment of Royalty
• Introduction of IFRS
PricewaterhouseCoopers
April 2010
Slide 75
Part III
Recent Developments
Dispute Resolution Panel (‘DRP’)
Proposed revision of Chapters I-III of OECD TP Guidelines
Other proposed developments
Recent TP case laws
Recent Developments
Recent TP Case Laws – Pune ITAT
Decision
Honeywell Automation
India Limited
Key points



E-Gain Communication
Private Limited




PricewaterhouseCoopers
Comparable financial data of subsequent years cannot
be considered
Data for earlier financial years can be considered only
in circumstances prescribed under Rule 10B(4)
Under TNMM, only those items of income or
expenditure having nexus with the operating profit / loss
of the enterprise can be considered
Appropriate adjustments have to be performed on
comparable for material differences
The comparables’ margins should be adjusted to
remove the income attributable to non-operating assets
Risk adjustments have to be made for comparability
analysis
In the case of companies earning extraordinary profits,
it is necessary for the tax authorities to evaluate
whether the said companies ought to be taken as
comparables
April 2010
Slide 77
Recent Developments
Recent TP Case Laws – Pune ITAT
Decision
Key points
Skoda Auto India Private 
Limited


MSS India Private
Limited



PricewaterhouseCoopers
Transactions between AEs, being controlled
transactions, cannot be considered for determining
internal CUP.
It is permissible to make economic adjustments in fit
cases.
For purpose of making comparison and economic
adjustment, when information available in public
domain is not sufficient, reasonable approximations and
assumptions can be made.
For Transfer Pricing purposes, it is immaterial as to
whether or not the income of assessee is exempt from
Income-tax.
When the assessee’s method of determination of ALP
is not accepted by the Revenue Authorities, the onus
shifts to the Revenue for proposing an alternative
method.
Reference to OECD principles can be made to seek
clarity on application of Indian Transfer Pricing
provisions.
April 2010
Slide 78
Recent Developments
Recent TP Case Laws
Decision
Perot Systems TSI (India)
Ltd
Authority
Delhi ITAT


VVF Limited
Global Vantedge
PricewaterhouseCoopers
Mumbai ITAT

Delhi ITAT

Key points
Granting of interest-free loans to
the AEs is an “international
transaction”
Interest-free loans given to AEs
are not at arm's length,
irrespective of commercial
expediency.
Such transactions should be
benchmarked by considering
comparable transactions of
foreign currency lending, by the
Parent Company itself (internal
comparable transaction) or
unrelated parties
Transfer pricing adjustments
along with the Arm’s length price
cannot exceed total profits in
value chain
April 2010
Slide 79
Recent Developments
Recent TP Case Laws
Decision
Vertex Customer Services
India Private Limited
BBC Worldwide
Quark Systems
PricewaterhouseCoopers
Authority
Key points

Nature of ‘Provision for bad and
doubtful debts’ for transactions
with AE: Operating expense or
extraordinary item – debatable
issue
 Penalty u/s 271 (1)(c) cannot be
imposed where there is merely a
difference of opinion between the
assessee and the revenue
Delhi ITAT
No further attribution of profits is
required if the Dependent agent (i.e.
the Indian subsidiary) is paid arm’s
length commission
Chandigarh ITAT  Merely because a comparable is
making a loss, it cannot be
excluded
 Importance of Functional (FAR)
Analysis was stressed by the
Tribunal
April 2010
Delhi ITAT
Slide 80
Concluding Remarks
 Emerging Practice Area
 Good understanding of business and Knowledge of economics is
necessary (not just knowledge of taxation)
 Focus area for Revenue Authorities
 Very relevant for all Large Corporates
 Not just about TNMM, Comparables and Margins!
 Not mere compliance (involves exhaustive exercise)
 Robust Documentation is a must
Thank You !!!
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of member firms of PricewaterhouseCoopers International Limited, each of which is a separate and independent
legal entity. *connectedthinking is a trademark of PricewaterhouseCoopers LLP (US).
PwC
Issues and Case Studies – Issue 2 : Multiple year data
1.Contemporaneous documentation – Rule 10D(4)
• “The information and documents specified under sub-rules (1) and (2), should, as
far as possible, be contemporaneous and should exist latest by the specified date
referred to in clause (iv) of section 92F”
2. Use of current year data and the proviso – Rule 10B(4)
• “The data to be used in analysing the comparability of an uncontrolled transaction
with an international transaction shall be the data relating to the financial year in
which the international transaction has been entered into :
Provided that data relating to a period not being more than two years prior to such
financial year may also be considered if such data reveals facts which could have
an influence on the determination of transfer prices in relation to the transactions
being compared.”
April 2010
PricewaterhouseCoopers