 Conceptual background
 Transfer Pricing in India
 Brief Legislative framework
 Arms Length Principles
 scope f TP legislation
 How does TP functions
 SDT
 Advance Pricing Agreement
 Safe Harbour Rules
 Challenges to Audit
 What do we do in this audit
• Transfer pricing is the price at which related parties transfer
goods or services to each other, which may not be in
accordance with the market price charged by them to
unrelated parties.
• Transfer Pricing is best described as the price charged by
one enterprise to an associated or connected enterprise
for the supply of goods, services, know-how etc.
 Rise of large number of multinational enterprises (MNEs)
due to rapid advancement of the technology
 Rise of intra group trade – including highly complex
international transactions involving intangibles and multitiered services
 MNE transaction structure determined not only by open
market but also by group driven forces inclined towards
the common interests of the entities of a group
 At present the world economy is ruled by the MNEs
(Source: - World Trade Report 2014)
(Source: - World Trade Report 2014)
PRESENT DAY SCENARIO
Foreign
Parents
Costa Rica
Supply Chain
Transaction
Cayman
Island
Interest transfer
payments
Intermediate
Holding
Company
Developing
Countries
BVI
Bermuda
Luxembourg
Royalty transfer
payments
Lease transfer
payments
Purchase of computer
from S Co “Controlled
Transaction”
Purchase of
computer
from third party
“Uncontrolled
Transaction”
Country A
ABC
H Co
Country B
ABC
S Co
XYZ
Transfer price of controlled transaction to be equivalent to market price of a comparable uncontrolled
transaction; If lower, Country B loses revenue.
ABC S Co is the distributor of ABC H Co’s computer in
Country B
 Manufacturing Cost to H Co.  Rs1400
 Distribution Cost to S Co.  Rs100
 Transfer price
 Rs1500
 Sale price in Country B
 Rs1600
 H Co Profit
 Rs100
 S Co Profit
NIL(Cost =Revenue)
 Tax authorities of Country B insists that S Co should
atleast report a profit of Rs 100; thus transfer price to be
reduced to Rs 1,400 – Leads to economic double
taxation.
ABC
H Co
Country A
Country B
ABC
S Co
Customers
 Cross border tax situations involve issues related to
jurisdiction, allocation of income and valuation.
 A MNE Group may exploit the opportunity to shrink the
overall tax burden of the group through either undercharging or over-charging the associated entity for intragroup trade.
 Reduction of taxation not the only factor contributing to the
transfer pricing policies and practices of a MNE Group
• US
• First country to adopt a comprehensive transfer pricing legislation in 1968.
•
OECD
• Reports on transfer pricing in 1979 and 1984
• issued the TP Guidelines in 1995 as amended by 2010 version
• United Nations (UN)
• Report on “International Income Taxation and Developing Countries” in 1988.
• The UN Conference on Trade and Development (UNCTAD) also issued a major report on
Transfer Pricing in 1999.
• The United Nations (UN) is again taking a leadership role, through its Transfer Pricing
Manual, in trying to arrive at updated global transfer pricing guidance which can be used by
countries all over the world in developing (or calibrating) their transfer pricing regulations.
• European Commission (EC)
• Proposals on income allocation to EC members of MNEs
 By the end of 2011 there were around 100 countries with some form of specific transfer pricing
legislation as shown by the red shading in the diagram below
 India has introduced comprehensive Transfer Pricing legislation
w.e.f. April 1, 2001
 Prior to this amendment, a limited provision existed in the Indian
Income Tax Act
 Erstwhile section 92 mandated adjustment to the income of resident taxpayer
from a transaction with a non-resident
 With opening of the economy in 1991 and afterwards by entering into
DTAA with almost all major countries, India has become a major
economic player in the world.
 With the economic down-turn in the world, avoidance of Base Erosion
and Profit Shifting has become a new object of most Tax
Administrations including India.
 The Finance Minister's in his speech of 2001 on the rational for introducing
Transfer Pricing Regulations stated
"The presence of multinational enterprises in India and their ability to
allocate profits in different jurisdictions by controlling prices in intragroup transactions has made the issue of transfer pricing a matter of
serious concern. …. Necessary legislative changes are being made in the
Finance Bill based on these recommendations.”
 Intention of Legislature: Circular No. 12/2001
“The aforesaid provisions have been enacted with a view to provide a statutory
framework which can lead to computation of reasonable, fair and equitable
profit and tax in India so that the profits chargeable to tax in India do not get
diverted elsewhere by altering the prices charged and paid in intra-group
transactions leading to erosion of our tax revenues.”
 Intent behind introduction of TP provision in India is Growth of investments by multinationals in India
 Increase in cross border transactions of multinational
enterprises in India
 Potential risk of erosion of India's tax base
 Need for a statutory framework to examine intra-group
cross border transaction
 Sections 92 to 92F in the Income Tax Act, 1961 described various
provisions of the Transfer Pricing in India.
 Rules 10A, 10B, 10C, 10D and 10E of the Income Tax Rules, 1962
complementing the TP-Regulations with detailing the procedure.
 These provisions deal with computation of income arising from
"international transactions" with "associated enterprises".
 The regulations provide that any income arising from an international
transaction shall be computed having regard to the arm's length
price.
Associated
enterprise
Independent
entity
International transactions
- goods
- services
- intangibles
Resident
Transfer price
Resident
Arm’s length
price
Market forces
Profit motive
Seller
Profit motive
Price
Market forces
Purchaser
Seller
AE
Group
Profit motive
Price
Group
Profit motive
Purchaser
AE
Profit of X= 70
Tax=21
X Inc. US
Profit of Y=55
Tax=22
Independent
customer
Y India Ltd.
Independent
Cost=80
Price=150
Profit=70
Tax@30%=21
Cost=150+5
Price=210
Profit=55
Tax@40=22
Profit of X Group= 70+55=125
Tax=21+22=43
X Inc. US
AE
Independent
customer
X India Ltd.
AE
Cost=80
Price=150
Profit=70
Tax@30%=21
Cost=150+5
Price=210
Profit=55
Tax@40%=22
Profit of X Group=120+5=125
Tax=36+2=38
X Inc. US
AE
Cost=80
Price=200
Profit=120
Tax@30%=36
Independent
Customer
X Ltd. India
AE
Cost=200+5
Price=210
Profit=5
Tax@40%=2
Profit of X Group=20+100+5=125
Tax=6+2=8
X Inc. US
AE
Cost=80
Price=100
Profit=20
Tax@30%=6
Cost=100+5
Price=205
Profit=100
Tax@0%=0
X Mauritius
AE
Independent
Customer
X Ltd. India
AE
Cost=205+5
Price=215
Profit=5
Tax@40%=2
 Transaction at market rate:
 Profit of X group: 125
 Tax payable: 43
 Transaction at manipulated rates:
 Profit of X group: 125
 Tax payable: 38
 Transaction involving tax haven
 Profit of X group: 125
 Tax payable: 6
 To lower corporate taxes
 To lower customs duty
 For repatriation of profits
 Exchange risk
 Capitalization
 To maximize subsidies
 To support a subsidiary
 Inflating capital contribution
 To enlarge market
 Two types of transactions
 Uncontrolled
 Between independent parties
 Price determined by market forces
 Arms length price
 Controlled
 Between related parties
 Relationships determine the price
 The term "international transactions" has been defined in Section 92B of the Act as a
"transaction" between two or more AEs, either or both of whom are not residents.
 The definition of international transaction also covers the transaction entered into by an
enterprise with a person other than an associated enterprise, if there exists a prior agreement
in relation to the relevant transaction between such other person and the associated enterprise,
or the terms of the relevant transaction are determined in substance between such other
person and the associated enterprise.
 Further, Section 92F of the Act defines the term "transaction" as any arrangement,
understanding or action in concert whether formal or in writing and whether enforceable or
not.
 One enterprise participates directly or indirectly through
one or more intermediary into management, control or
capital of another enterprise.
 The ultimate holders in both the enterprises are same,
either directly or indirectly through intermediaries.
Management/
control/capital
Associate
Enterprise
Intermediary of
company 1
Management/
control/capital
AE1 and company 1
associate enterprise
AE 1
Intermediary of
company 1
Management/
control/capital
Management/
control/capital
AE 1
AE1 and AE2 are
associate enterprise
AE 2
Intermediary of
company 1
Management/
control/capital
Intermediary of
company 2
AE 2
Management/
control/capital
AE 1
AE1 and AE2 are
associate enterprise
Holding / Transaction
Associated
Enterprise (s)
1
A holds at least 26% of the voting power of B
A&B
2
A holds at least 26% of the voting power of B & C
B&C
3
A advances a loan to B, constituting at least 51% of the book value of total assets of B
A&B
4
A guarantees at least 10% of the total borrowings of B
A&B
5
A appoints, more than half the directors of B; or, one or more executive directors of B
A&B
6
A appoints, more than half the directors of B & C; or, one or more executive directors of B & C;
B&C
7
The manufacture or processing of goods or articles or business carried on by A is wholly dependant
on the use IPRs (know hows etc.) belonging to B or in respect of which B has exclusive rights
A&B
8
At least 90% of the raw materials and consumables required for the manufacturing or processing of
goods or articles carried out by A, are supplied by B or by persons specified by B, and the prices and
other conditions relating to the supply are influenced by B
A&B
9
The goods manufactured or processed by A are sold to B or persons specified by B, and the prices and
other conditions relating thereto are influenced by ‘B’
A&B
10
Where A is controlled by B (an individual) a transaction between A and C, if C is controlled by B or his
relative or jointly by B and his relative
A&C
11
Where A is controlled by B HUF, a transaction between A and C, if C is controlled by a member of B
HUF or by a relative of a member of B HUF or jointly by such member and his relative
A& C
12
Where A is a firm, AOP or BOI and B holds at least 10% interest in A
A&B
13
There exists any relationship of mutual interest between A and B as may be prescribed.
A&B
 Any
international transaction (as per Section 92B) with an associated
enterprise/deemed associate enterprises (as per Section 92A) must be computed
having regard to the arm’s length price.
 Also, costs or expenses allocated or apportioned between two or more associated enterprises
based on mutual agreement or arrangement, should be determined having regard to arm’s
length prices.
 The transfer pricing provisions are wide enough to cover transactions between a
foreign entity and its permanent establishment in India.
 The transfer pricing provisions would not however apply in cases where in the
application of the arm’s length price results in a downward revision in the income
chargeable to tax in India or results in an increase in the loss.
 Re-compute profit of AEs
 Treating them as independent concerns
 Substituting arms length price for TP
 To ensure
 Even distribution of taxes & profits between countries
Method
Procedure
Usage
Comparable
uncontrolled price
method
Comparison of price charged or paid for property
transferred or services provided in a comparable
uncontrolled transaction
Used mainly in respect of transfer of goods,
provision of services, intangibles, loans,
provision of finance.
Resale-price method
Considers the price at which property purchased or
services obtained by the enterprise from an AE is
resold or are provided to an unrelated enterprise
Used mainly in case of distribution of
finished goods or other goods involving no
or little value addition
Cost-price method
Considers direct and indirect costs of production
incurred by an enterprise in respect of property
transferred or services provided and an appropriate
mark-up
Used mainly in respect of provision of
services, joint
facility
arrangements,
transfer of semi finished goods, long-term
buying and selling arrangements
Method
Procedure
Usage
Profit-split method
Considers combined net profit of the
AEs arising from the international
transaction and its split amongst them.
Used mainly in report of transactions involving
integrated services provided by more than one
enterprise, transfer of unique intangibles, multiple
inter-related transactions, which cannot be separately
evaluated
Transactional net margin
method
Considers net profit margin realised by
the enterprise from an international
transaction entered into with an AE.
Used in respect of transactions for provision of
services, distribution of finished products where resale
price method cannot be adequately applied, transfer
of semi-finished goods
Any other method as
prescribed by the CBDT
Other method as prescribed by CBDT
under rule 10AB.
Where all the above five methods fail to apply.
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”)
No hierarchy of methods suggested by Indian TP legislation
Transactional
Net Margin
Method
(“TNMM”)
 The Assessing Officer (AO) may refer the case to a Transfer Pricing Officer (TPO) for the purpose
of computing the arm's-length price of the international transactions or specified domestic
transactions.
 In accordance with prevailing internal administrative guidelines of the Revenue, selection for
cases would be risk based.
 The TPO would then follow the assessment procedure with limited purpose to determine Arm’s
Length Price of the transaction and pass an order.
 A copy of the order would be sent to the AO and the taxpayer.
 On receipt of the TPO's order, the AO would compute the total income of the taxpayer by applying
the arm's-length prices determined by the TPO and pass a draft order within the time limit
prescribed for completion of scrutiny assessments.
 The Transfer Pricing Officer shall determine the arm's length price and send a copy of his written
order to the Assessing Officer and to the tax-payer.
 Wherever the Assessing Officer propose to make any variation in the income or loss returned of
the assessee as a consequence of the above order of the Transfer Pricing officer, the assessing
officer shall forward the draft order to assessee for his/her objections (if any).
 On receipt of draft order the assessee shall communicate either his acceptance or file objections
against such order with Dispute Resolution Panel (DRP) within 30 days.
 The DRP being a collegiums of three Commissioner of income tax shall issue binding directions
to assessing officer after due consideration of objections and evidences filed by assessee.
 The assessing officer shall pass appropriate order in conformity with the directions of DRP within
nine months from the end of the month in which the draft order is forwarded to the assessee.
 Orders of DRP is appealable to ITAT.
 If assessee opts not to go for DRP, AO proceeds to pass a Final Assessment Order which is
appealable at CIT (Appeals).
Assessing Officer
Transfer Pricing Officer
Draft Assessment order
No Reference To DRP
DRP
Final Assessment Order
Final Assessement Order
CIT (Appeal)
ITAT
High Court
Supreme Court
 With effect from 1 July 2012, with a view to solve the potential transfer
pricing disputes in a cooperative manner, APA provisions were introduced.
 It could be checked whether all the procedural aspects were followed
before APA was entered into.
 Whether the applicant furnished the requisite fees.
 Right now, since only 8 APA are either signed or on advance stage of
finalization and no APA file has been received, the check list would evolve
with time. The audit of APA needs to be done at APA under MoF.
 These Rules were notified on 18 September 2013 and hence the cases have
not been found in audit so far.
 The rule provides that if the margin declared by the assessee is within the
range provided in the Rules, then the margin declared by the assessee
would not be subjected to the TP proceedings.
 It may be checked whether the assessee is involved in the same functional
area which the Rules provide for and fulfills the eligibility given in the
Rules.
 Right now, since no file has been received, the check list would evolve with
time.
 These provisions shall come into force with effect from AY 2013-14 and
hence would be available to audit from 55th or 56th Cycles only.
 These provisions were brought on the specific recommendation of the
Apex Court to discourage excessive exempt profit margins being shown in
Exempt entities engaged in certain activities or for transactions with
related parties.
 The initial threshold limit was Rs.5 crore for reporting such cases which
have now been raised to Rs.20 crore (in current finance bill).
 Right now, since no file has been received, the check list would evolve with
time.
 The Transfer Pricing audit is a multi dimensional subject involving cross-skills
right from knowledge of costing, finance, Economics, International Polity etc.,
auditor needs to equipped with the specialized knowledge and understanding of
the subject.
 Department has very little scope of rectifying the mistake made during the TP
proceedings.
 Indian TP regime is considered to be second most aggressive regime, hence we
should focus on the system that is prevailing not only to “loss to revenue”
 Department has lost almost all the cases which went in appeal.
How are we doing it?
 Selection of the Audit Year/Cycle is important.
 If the audit of TP charges are provided during the
February or March, the cases available for audit
would be of that financial year while in case, the audit
is provided in any other month, the cases would most
probably be of previous year as TP year would be
open.
 The Audit program may be prepared based on this
criteria.
 Like in the case of normal audits, the foremost criteria is
to fill up the basic details like Name of the assessee,
normal assessment charge, PAN, Status, Assessment Year,
Date of reference to Transfer Pricing Officer, Date of issue
of TP notice etc. meticulously.
 The most important aspect of scrutiny is detailed analysis
of the nature of business of the assessee.
 The best source for the same is the FAR analysis done by
the assessee.
 The assessee represents a particular segment of
business and it is of utmost importance to understand
the exact nature of his business.
 After
all, the different business segments have
different risk and reward parameters. For instance,
the assessee involved in KPO cannot be compared
with BPO under normal circumstances.
 The start Point of audit is the Form 3CEB submitted by the assessee.
 It should be analysed to check whether it has been prepared and certified
before the due date of filing of return.
 If the Form 3CEB is prepared beyond due date, it would be worth scrutiny
from the assessment charge of the assessee to know whether the
Department has rejected the return filed as defective and other sections of
the Act applied or not.
 Whether all the transactions appearing in the Related party transactions
part of the Annual Accounts have been reported or not in the Form 3CEB. If
not, whether the TPO has noticed such transactions and brought them to
record.
 From the AY 2012-13, whether penalty at the rate of 2 per cent of the
International Transaction has been recommended for initiation for such
non-reporting under section 271AA.
 Further, whether the continuing transactions have been identified in Form
3CEB. For instance, loan provided during any previous year, though interest
charged, may not be reported in the current Form 3CEB. Though no penalty
till AY 2011-12, penalty leviable from AY 2012-13.
 The second most important document is the note submitted by
the TPOs to CIT (TP) for approval.
 It becomes far more important in case of Nil order as this note
is where the TPO discusses the grounds on which the ALP
determined by the assessee in Form 3CEB is accepted.
 Many a times, TP discuss only those issues in TP order where
adjustments are made. However, in all International
Transactions where adjustments are made or no adjustments
are made, are discussed in the note submitted to CIT (TP).
The most tricky part of the audit is the
extensive use of databases both by the
assessee and the Department notable
being Prowess, Capitaline and ACE TP.
 There are some other databases like TiPs (for
Pharma
Sector)
and
(databases for Royalty rates).
However,
RoyaltySource
the database subscriptions
being costly and not available so far, the
choice was to be made regarding the
databases.
Two choices possible:
Audit without databases
Audit with databases
Prowess, Capitaline and ACE TP are
only three broad based databases
relevant for almost every case of
Transfer Pricing Audit.
 The database being costly subscriptions, the audit
without them involved inherent risk factors. Audit in
such environment is carried out with the following
assumptions:
 The TPO and assessee have selected the right comparables.
 The
comparables selected are essentially functionally
similar and comparable on the basis of FAR criteria.
 Unless the individual P&L accounts and Balance Sheets are
available, the figures adopted by the TPO (and assessee) are
correct.
 In such cases, the audit has constraint to check whether the figures have
been adopted correctly (only in those cases where hard copies of
comparables’ accounts kept in file).
 For instance, even a small error in adoption of numbers may be magnified
several times. For instance, even omission to include Rs.1 crore figure in
comparable case may lead to short adjustment of Rs.3.51 crore (Thomas Cook
India Ltd).
 In most of the cases at Department level, the final computation (calculation)
is submitted by the assessee and is adopted by the TPO.
 This is one area for closer scrutiny as the assessee tries to adopt the figures
selectively for assessee and comparables in order to inflate the Margin of
the assessee and deflate the margin of the comparables so as to bring the
gap to +/- 5 percent.
 For instance, in case of Sitel India Limited (AY 2011-12), while in case of assessee,
the provisions were excluded from Operating Expenditure, the same were not
excluded from the comparables data.
 Whether the assessee or TPO has adopted the
publicly available data as only publicly available data
is admissible for comparison or comparable data is
faulty.
 For instance, in case of Serdia Pharmaceutials India Limited
(AY 2011-12), notices u/s 133(6) were issued to parties listed
in TIPs database. Thus, while the value was captured in the
database figure, the same was taken again u/s 133(6) and
average was taken. This had pushed the adjustment required
in downward direction.
 The averaging has a serious effect on the amount of
adjustments. Hence, the assessee tries to repeat the lower
value figures more often to suppress the average. For
instance, Suppose, there are five Bank Guarantee rates
available for few banks (say .5, 1, 1.5, 2, 2.5 percent pa).
While adopting the CUP method for benchmarking the
Corporate Guarantee Fees receivable, the assessee
should normally compute the average of 1.5 percent pa.
 However, the assessee would try to repeat the value of .5
percent transaction from the same bank to same assessee
for different tranches so that each additional entry
suppresses the overall average rate and hence, the
adjustment required.
 Whether the TPO is consistent in his premises and his
conclusion. For instance, certain TPOs consider the amount of
Compulsorily Non Convertible Preference Shares in AEs as
loans advanced at the rate of prescribed dividend. However,
while making adjustment, they ignore whether dividend was
received or whether the CNCPS was non-cumulative. This may
have huge bearing on adjustments. For instance, in case of
Reliance Communication Ltd., this violation led to short
adjustment of Rs.82 crore.
 Whether the TPO has correctly identified the Operating and
Non operating incomes and expenditures. For instance, the
TPO may wrongly consider the income transferred from
Reserve to Income as Operating resulting in enhanced margin
and hence short adjustment.
 Any of the database contains accounts of more than
25000 companies. Having database will create
another problem of temptation of redoing the AcceptReject Matrix by the Audit. Hence, a fine line is
required for what we can see and what not.
 If we redo the Accept Reject Matrix, it may be akin to
stepping into the shoes of TPO’s discretion. So,
database may be kept only for the purposes of
revalidation of data/ computation.
 Most of the time, the assessee submits Accept-Reject
Matrix, out of which some are selected by the
assessee. During the course of TP proceedings, the
TPO accepts some and rejects some and brings some
more from the Accept-Reject Matrix.
 If database is available, the comparables selected
should be checked for functional similarity.
 The comparable should be selected for size analysis.
For example, it has been held that two outlier sizes
cannot be compared.
 To check if for any comparable, the last year was
abnormal year. For instance, whether the last year was
year of amalgamation, demerger etc. In such cases,
comparables are to be rejected.
 To check whether the comparables have more than 25
percent of turnover with their AEs. If yes, such
comparables are to be rejected.
 Whether
the financial results assigned to the
comparables are correct as per database.
 Whether the assessee’s Operating profit or operating Cost etc. are
consistent with those of comparables. For instance, whether all the criteria
were accepted or rejected uniformly for assessee as well as for the
comparables. For example, whether the Bad debts, provisions for bad
debts, donations etc. have been disallowed from both the assessee and
comparables computation.
 More often than not, this is the area where we found majority of audit
points.