Basics of Transfer Pricing_Kartikeya

8/9/2019 Basics of Transfer Pricing_Kartikeya

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Basics of Transfer PricingA presentation regarding the multifarious regulations in

accordance with the subject matter of Transfer Pricing

juxtapositioned in the Indian Scenario

Kumar Kartikeya Prakash

5th Year

Symbiosis Law School, Pune


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Transfer Pricing

y Transfer pricing (TP) is the act of

pricing of goods and services or

intangibles when the same is given for

use or consumption to a related party

(e.g. Subsidiary or associated

enterprises)

y TP is a tact for MNCs to evade tax

liabilities and park their profits in low

tax rate jurisdictions and therefore,

increase the overall profit of the

organization.

Aztec Software and

Technology Service Ltd.

vs. ACIT


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Transfer Pricing

y TP can be of either market based i.e.

equivalent to what is being charged in

the outside market for similar goods, or

non market based.

y TP is generally understood as Transfer

Pricing Manipulation (TPM) where

non market based pricing strategies are

used for fixing price for inter corporate

cross broader transactions.

y TPM are discouraged by Governments

with the helps of various regulations.


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TP Regulations:

Laws in US Global Scenario Indian Perspective

S. 262 of theRevenue Act,

1921.

OECD Guidelinesof 1995

Recommendations ofExpert Group, set up

in Nov 1999

S. 45 of the Revenue

Act, 1928

OECD Guidelines of

2009

Finance Act, 2001 and

amendment of S. 92-92F ofIT Act, 1961 and Rule 10A-

10E of IT Rules, 1962

S. 482 of Internal

Revenue Code

Proposed Changes in

Chapter I-III of OECD

Guidelines, 2009

Direct Tax Code

(Proposed)


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Pre-2001 Scenario in India:

1. Sec. 40A(2) of Income Tax Act

(IT Act), 1961 provides for

deduction of excessive or

unreasonable sum paid to a

related parties.

2. Some other provisions as 10A,

80IA of IT Act, 1961 provides

for adjustment of profits of a

unit entitled to a tax holiday,

arising due to close

connection with the taxpayer.

3. The definition of related

parties was borrowed from

Companies Act, 1956 and MRTP

Act,1969.

4. The former S.92 of the same Act

allows recomputation of profits

from a transaction between

resident and non-resident

having close connection which

is lesser than ordinary profits.

Some basic provisions were existed under Income Tax, Custom andExcise Legislations such as:


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Pre 2001 Scenario in India:

5. S. 93 laid down the tax liability of transactions between resident

and non-resident for the purpose of avoiding tax.

6. Rule 10 and 11 of Income Tax Rules, 1962 provides for computation

of taxable income of a non-resident when it is difficult to ascertain.

Shortcomings:

1. The termClose Connection was not defined.

2. No detailed methodology was provided for computation of

ordinary profit out of a transaction.

3. Any adjustment of account due to recomputation of income made

by Revenue authorities was labeled on resident company only.

4. Having surrounded by ambiguity, they were seldom invoked by the

revenue authorities.


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TP Regulations in India:

y Transfer Pricing Rules are applicable to all the enterprises that enter

into an International Transaction with an Associated Enterprises

(AE).

y It even embraces to the transactions involving a mere book entry

having no apparent financial impact.

y The ultimate aim is to arrive at the comparable price as available to

any unrelated party in open market conditions.

y Based on the Article 9 of OECD model convention, the Government of

India also enacted laws effective from Financial Year 2001- 2002 by

which rules have been framed to determine income arising from an

international transaction or the cost of transaction between associated

enterprises to be computed on the basis of Arms Length Principle.


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International Transaction:

Sec. 92By Transaction between two or more Associated Enterprises (AE) of

which either or both of whom are non-residents.

y Transactions (It almost covers every type of transaction a company

can enter into): [read along with sec 92F(v) of IT Act,1961]

Purchase, sale or lease of tangible or intangible property

Provision of services

Lending or borrowing of money

Any other transaction having a bearing on the profits, income,

losses or asset

Mutual cost sharing agreement


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Deemed International

Transaction: Sec. 92B(2)y Transaction entered by AE with a person other than AE, be deemed to

be between two AEs, if prior agreement exists in relation to the

relevant transaction between such other Person and AE / terms of

relevant transaction are determined in substance between such other

person and AE. [Under DTC- C has to be a non- resident company.]

Prior Agreement / Determination

of Terms

Purchase of Goods

Parent

Company AE1

Indian

Subsidiary AE2Third Party (C)


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Associated Enterprise: Sec. 92A

y The word enterprise has got a wide and extensive definition under

section 92F(iii).

y An associated enterprise relationship would be deemed to exist,

inter-alia, in cases of:

1. (a) Where an enterprise participates directly or indirectly, in the

management or control or capital of the other enterprise. [section

92A(1)] or

(b) when the persons in-charge of management or control or capital

of two or more enterprises are the same persons. [section 92A(1)]

and

2. Fulfillment of any condition mentioned under section 92A(2).

Upcoming Direct Tax Code (DTC) has omitted the sub-clause 1 of

section 92A.


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Arms Length Pricing: Sec. 92C

y The arms length principle of transfer pricing states that the amount

charge by one related party to other must be same as if the party is not

related. An arms length price of that transaction would be uncontrolled

price.

y Methods prescribed under sec 92C:

1. Comparable UncontrolledPrice Method(CUP),

2. Resale Price Method(RPM),

3. CostPlus method(CPM),

4. Profit Split Method(PSM),

5. Transactional Net Margin Method(TNMM) and

6. Any other prescribed by CBDT (However, no method has yet been

prescribed).

No order can be passed for

adjustments by TPO without following

any of the methods prescribedunder

the sec 92C.

- Nimbus Communications Ltd. v.

ACIT


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Comparable Uncontrolled Price

Method (CUP): Internal

USCO

A B

Customers Customers

Indian relatedcompany

Indian unrelated

company

Sale Salewarranty

Warranty at a

standard rate of

INR 1,000 p.a.

Cardinal principle of TP- Treat like with like & eliminate differences

with suitable adj

ustments.- ACIT v. T Two International Pvt. Ltd.


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Comparable Uncontrolled Price

Meth

od (CUP): External

US Company

(AE1)

Indian

Subsidiary

AE2

International

transaction

Independent US

Company (third

party)

Independent

Indian Company

International

transaction

Price at which the transaction

is completed between

independent parties will be

external CUP.


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Resale Price Method

(RPM):

A

B C

End Costumer

US Software

development co.

Retail price

of software INR 5000

Comparable

independent distributor

Earns margin of 10%

Final retail price in

India

Rs.

5,000

Less: margin earned

by comparable

distributors

Rs. 500

Transfer pricing

using RPM

Rs.

4500

Related Indian

distributor co.

End Costumer


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Cost Plus Method (CPM):

y Based on cost plus comparable mark up calculation-

Parent

car manufacturer

Assembly plant

USCo

INCo. XA company

comparable

to INCo.

Earns 20% on costs

for its assembly plant

Assuming Indian companys

cost is Rs. 100, transfer price

under cost plus method would

be Rs. 120


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Profit Split Method (PSM):

A

B

C

D

E

Customer

US intangible

holding co.

Related

manufacturing

Indian Co.

Provides tangibles

and intangibles

Pays value

& Royalty

To determine the arms length price

for such fees and royalty to be paid byB

Sells its

production

Related marketing

company

ACompany

comparable to B

A company

comparable to C

Sells its production


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Transactional Net Margin Method

(TNMM):y Compares net profit margins

derived from the operations of

uncontrolled parties and

associated enterprise on similar

operations.

y The net profit margin realized by

AE is computed in relation to

costs incurred, sales effected or

assets employed.

TNMM differs from RPM and

CP M to the extent that it

involves a comparison of

margins at the net profit

level as against the gross

profit level prescribedunder

RPM and CPM.

TNMM requires comparison of net profit

margins not of operating profit margins.

Addl.CIT v. Tej Diam


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MostAppropriate Method

(MAM):Rule 10C(2)

y Factors determining MAM

Nature and class of international transaction

Class of associated enterprises and FAR analysis

Availability, coverage and reliability of data

Degree of comparability

Extent and reliability of

economic adjustments

Nature, extent and reliability

of assumptions

If proper FAR analysis is carried

out then the TPO can not reject the

comparable summarily without

assigning any cogent reason.

ACIT vs. M/s. Toshiba India

Pvt. Ltd.


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Computation ofALP: Sec. 92C

Burden ofProof:

y The primary responsibility is on the taxpayer to determine Arms

Length Price in accordance with the Transfer Pricing Regulation.

y Intervention by the Tax officer depends upon the reliability and

correctness of data undertaken for determination of ALP. [Para 4.13-

4.16 of OECD Guidelines 2009]

Computation:

y Where more than one prices are determined through most

appropriate method then [Section 92C(2)]-

ALP = Arithmetic mean (AM) of such prices or

ALP = +/- 5% ofALP determined (only in marginal

cases not as a routine process)


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Functional Comparability:

It has to be shown that analysis

carried out is judicial and is

done after taking into account all

relevant facts and circumstances

of the case. The TPO can carry

out a fresh economic search only

if the comparables drawn by the

taxpayer are insu fficient or have

any other deficiency.-

Mentor Graphics (P) Ltd.

(Delhi ITAT)

Comparability shall be judged on following parameters mentioned

under Rule 10B (2):

1. The specific characteristics

2. FAR analysis

3. The contractual Terms

4. Conditions prevailing in the market.

Tribunalupheld the validity of selection of

foreign comparable companies provided,

data pertaining to those companies must

be available in Pu blic domain.

Ranbaxy Labs (Delhi ITAT) and

Development Consultant (Kolkata

ITAT).


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Adjustments: Rule 10B(3)y An uncontrolled transaction shall be comparable to an international

transaction if there are no differences that materially affect price/costcharged or profit margin in the open market and reasonably accurate

adjustments can be made for enhancing comparability.

y Under Indian Law, adjustment is permitted only to comparables not to

the tested party and scarcity of data on comparables is a challenge.

Case Laws:

y The Tribu nal recognized that differences in business models and higher cost

incu rred d

u ring the start-

u p phase calls for economic adj

ustments. Skoda

Auto India Pvt Ltd (Pune ITAT)

y Adjustment needs to be made for, (a) difference in risk profile, (b) difference

in working capital position, and (c) difference in accounting policies.Philips

Software Centre Pvt Ltd. (Bangalore ITAT)


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Reference to Transfer

Pricing Officer: Sec. 92CA

y Transfer pricing Officers (TPOs) designated by CBDT, have

authority over assessment of cross-border transactions.

y It is mandatory for Assessing Officer to refer all cross border

transactions of INR 150 million or above to the TPOs.

y The TPO on the basis of materials or information or documents in his

possession may determine the arms length price, after providing the

assessee an opportunity of being heard.

y TPOs role would be limited to determination of arms length price in

relation to international transactions, which wou ld be binding on the

assessing officer.


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Documentation Requirements:

Sec. 92D

and Rule 10D

yy DocumentationDocumentation requirementrequirement contentcontent inin subsub--rulerule ((11)) ofof RuleRule 1010DD cancan bebe

summarizedsummarized asas belowbelow::

CLAUSES OF

RULE 10D(1)

DOCUMENTATION REQUIREMENTS

Clauses (a), (b), (c)

and (d)

Group Overview :

Description of ownership structu re and

interest, profile of mu ltinational gro

u p of

which the enterprises are the part, broad

description of bu siness and broad

description of international transactions.


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Sec. 92D and Rule 10D

CLAUSES OFRULE 10D(1)

DOCUMENTATIONDOCUMENTATION REQUIREMENTSREQUIREMENTS

ClauseClause (c)(c) IndustryIndustry ScenarioScenario ::

Information/documentsInformation/documents regardingregarding industryindustry inin whichwhich thethe

enterpriseenterprise operatesoperates..

ClauseClause (e)(e) FunctionalFunctional AnalysisAnalysis ::

DescriptionDescription ofof functionsfunctions performed,performed, riskrisk assumedassumed andand

assetsassets employedemployed byby thethe enterpriseenterprise andand thethe associatedassociated

enterpriseenterprise..

[[QuarkQuark SystemsSystems LtdLtd.. ITATITAT ChandigarhChandigarh-- StressStress onon criticalcritical

importanceimportance ofof conductingconducting FARFAR andand FiltersFilters mustmust bebe basedbased onon

cogentcogent reasoningreasoning notnot onon unsoundunsound assumptionsassumptions..]]


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Sec. 92D

and Rule 10D

CLAUSES OF

RULE 10D(1)

DOCUMENTATION REQUIREMENTS

Clauses (f), (g), (h),

(i), (j), (k), (l) and

(m)

Economic Analysis :

Application of the most appropriate method to

establish arms length price selection of the

most appropriate method, workings of arms

length price, analysis performed for

comparability and adjustments,etc.


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Documentary Requirements:

Sec. 92D and Rule 10D

Accountants Report:

Sec 92E

y In the course of proceedings

under the Act, requirement to

furnish information or documents

within a period of thirty days

from the date of receipt of a

notice or an extended period not

exceeding thirty days.

y No maintenance of prescribed

documentation where

international transaction does not

exceed INR10 million.

y A report from a Chartered

Accountant in Form 3CEB is to be

furnished along with the return

of income before the specified

date, i.e., 30th September of the

relevant assessment year in case

of a company and 31st July of the

relevant assessment year in case

of other assessee. [Rule 10E]

[[UnderUnder DTCDTC-- ReportReport toto bebe filed filed byby

TPOTPO andand filedfiled beforebefore 3131ststAugustAugust..]]


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Penal Provisions:

SectionSection DefaultDefault QuantumQuantum

SS..271271AA AA FailureFailure toto keepkeep andand maintainmaintain

anyany s uchsuch information information oror

documentsdocu ments asas req uiredrequ ired inin

thethe proposedproposed subsub--section(section(11))

oror subsub--sectionsection ((22)) ofof sectionsection

9292DD

22%% ofof thethe valuevalue ofof eacheach

international international transactiontransaction enteredentered

intointo..

[[VertexVertex CustomersCustomers ServicesServices DelhiDelhi

ITATITAT-- NoNo penaltypenalty proceedingproceeding whenwhen

computationcomputation ofof TPTP is is donedone inin

accordanceaccordance withwith law,law, inin goodgood faithfaith andand

withwith duedue diligencediligence..]]

SS..271271BA BA FailureFailu re toto furnishfu rnish aa reportreport

from from anan accountantaccou ntant asas

requiredrequired inin sectionsection 9292EE

RsRs.. 11,,0000,,000000


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Penal Provisions:

SectionSection DefaultDefault QuantumQuantum

SS..271271GG FailureFailure toto furnishfurnish anyany informationinformation

withinwithin aa periodperiod ofof 3030 daysdays fromfrom

thethe datedate ofof receiptreceipt ofof noticenotice inin

thisthis regardregard asas requiredrequired byby thethe

AOAO oror CIT(A)CIT(A) inin thethe coursecourse ofof

anyany proceedingsproceedings inin thethe actact asas

perper subsub--section(section(33)) ofof sectionsection

9292DD ofof thethe ActAct..

22%% ofof thethe valuevalue ofof eacheach

internationalinternational transactionstransactions

forfor eacheach suchsuch failurefailure..

[[CargillCargill IndiaIndia PvtPvt.. LtdLtd.. vv..

DCITDCIT-- NoticesNotices underu nder secsec

9292D(D(33)) toto thethe taxpayertaxpayer mustmust bebe

issuedissued onon specificspecific points points forfor

furnishingfurnishing informationinformation..]]

SecSec.. 271271

((11)) (c)(c)

PenaltyPenalty forfor concealmentconcealment 100100%% -- 300300%% ofof thethe taxtax

evadedevaded..


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Direct Tax Code:

y Proposed Changes in:

1. Definition of Associated Enterprises.

2. Meaning of International Transaction and Deemed International

Transaction.

3. Transfer Pricing Assessment.

4. Safe Harbour Rules.

5. Advance Pricing Guidelines.

6. Penalty Provisions.

7. Anti- Avoidance Measures.

8. Dispute Resolution Panel.


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The Bringing Home the Bacon

Approach:

FAR Analysis (Functions performed, assets utilized and risk

undertaken)

Financial Analysis of

Taxpayer entities:Functions and

Adjustments

Economic and Functional Analysis

Selection of MAP

Planning

Prior Defense:

Documentation

Active Defense:

Audit, Appeals or

Litigation Reports

Analysis of comparable

uncontrolled transaction:

Internal or External


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Basics of Transfer Pricing_Kartikeya

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