Transfer Pricing Transfer Pricing Ensuring the right cost in a multi division companyEnsuring the right cost in a multi division company

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The information contained herein represents personal views of the speaker.

The information contained herein is general in nature and subject to change. Applicability to specific

situations is to be determined through consultation with your tax adviser.

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Transfer Pricing – What/ Why/ HowTransfer Pricing – What/ Why/ How

Transfer Pricing is used to determine price of a product/ service transferred from one subsidiary to another within a Group or one division to another within a Company

Transfer Pricing, if effectively used, helps Groups/ Companies to:

•Undertake independent performance evaluation of each company/ division•Coordinate production, sales and pricing decisions of different companies/ divisions•Allocate resources effectively•Lower overall tax incidence and reduce tax risks

Common ways to set Transfer Prices:

•Market-based Transfer Pricing•Negotiated Transfer Pricing•Cost-based Transfer Pricing

- Full Cost- Cost-plus- Marginal Cost- Variable Cost plus Opportunity cost

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International Transfer PricingInternational Transfer Pricing

Parent Co. Country A

35% tax on Rs. 10

Cost - Rs.120

Sub Co. Country C

Sale price - Rs. 190

40% tax on Rs. 20

Sub Co. Country B

Zero tax on Rs. 40

Tax Haven

Sale price Rs.130

Sal

e pr

ice

Rs.

170 N

o direct transaction

To prevent profit shifting by transfer price manipulationTo prevent profit shifting by transfer price manipulation

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Domestic Transfer PricingDomestic Transfer Pricing

Loss making company

Profit making company

Shifting of Expenses

Shifting of Income

Tax @~33%

No Tax due to loss

Tax @~33%

Reduced tax due to

profit shifting

Loss to Indian Revenue as a result of the above

Tax Holiday Unit

Taxable Unit/ company

Shifting of Expenses

Shifting of Income

Tax Exemption

Tax @ ~33%

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Arm’s Length PriceArm’s Length Price

Associated Enterprises

Sec 92A of the Act

International transactions

Sec 92B of the Act

Specified Domestic transactions

Sec 92BA of the Act

Arm’s Length PriceSec 92C of the Act

Transfer Pricing

Sec 92 of the Act

Arm’s Length Price

Section 92(1) - Any income arising from an international transaction shall be computed having regard to the arm's length price

Explanation - For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm's length price

Section 92(2A) – Any allowance for an expenditure or interest or allocation of any cost or any income in relation to the specified domestic transaction shall be computed having regards to the arm’s length price

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Arm’s Length PriceArm’s Length Price

Arm’s Length Price

Section 40A(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction :

Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm's length price as defined in clause (ii) of section 92F

Section 80-IA (8) Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date :

Explanation - For the purposes of this sub-section, "market value", in relation to any goods or services, means -(i)  the price that such goods or services would ordinarily fetch in the open market; or(ii)  the arm's length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA

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Transfer Pricing MethodsTransfer Pricing Methods

Six Prescribed Methods

Traditional Transaction Methods

Transactional Profit Methods

Profit SplitCost PlusResale PriceComparable Uncontrolled

Price

Transactional Net Margin

No hierarchy or preference of methods prescribed under the ActNo hierarchy or preference of methods prescribed under the Act

Other Method

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Transfer Pricing MethodsTransfer Pricing Methods

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Some Examples – International Transfer Pricing Some Examples – International Transfer Pricing

Foreign Parent has a Subsidiary in India engaged in contract manufacturing/ service provision for/ to it

Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a risk insulated captive, for this transaction

Local Subsidiary also has own domestic manufacturing and sale business

India captive segment to be drawn using correct cost pool and appropriate allocation keys

Foreign Parent has a Subsidiary in India engaged in contract manufacturing/ service provision for/ to it

Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a risk insulated captive, for this transaction

Local Subsidiary also has own domestic manufacturing and sale business

India captive segment to be drawn using correct cost pool and appropriate allocation keys

Parent Parent

Subsidiary(Contract

Manufacturer)

Subsidiary(Contract Service

Provider)

Outside India

India

Local manufacturing and Sale

Local manufacturing and Sale

Indian Parent has Foreign Subsidiary engaged in marketing and distribution of its goods

Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a routine/ low risk bearing distributor

If India export segment is benchmarked – appropriate cost allocation needs to be undertaken

If Foreign Subsidiary is benchmarked, cost details of the Foreign Subsidiary required for India reporting and disclosure

If Foreign Subsidiary also has own local business, correct cost allocation to India buy-sell activity imperative

Indian Parent has Foreign Subsidiary engaged in marketing and distribution of its goods

Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a routine/ low risk bearing distributor

If India export segment is benchmarked – appropriate cost allocation needs to be undertaken

If Foreign Subsidiary is benchmarked, cost details of the Foreign Subsidiary required for India reporting and disclosure

If Foreign Subsidiary also has own local business, correct cost allocation to India buy-sell activity imperative

Subsidiary

Parent (Full-fledged manufacturer)

Outside India

India

Local Sales

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Some Examples – Domestic Transfer Pricing Some Examples – Domestic Transfer Pricing

Tax holiday unit Other unit

Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID)

Inter unit transfer of manufactured goods for sale

Non Tax holiday unit (HO)

Tax holiday unit

Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID)

Inter unit transfer of services

• Appropriate allocation keys should be used to allocate common HO costs to tax holiday unit• Revenue may challenge use of ad-hoc allocation keys• Key to demonstrate arm’s length profits in tax holiday unit and not “More than ordinary profits”

• Appropriate allocation keys should be used to allocate common HO costs to tax holiday unit• Revenue may challenge use of ad-hoc allocation keys• Key to demonstrate arm’s length profits in tax holiday unit and not “More than ordinary profits”

HO performs R&D, Selling & Marketing and other leadership functions

• Cost details of the Transferor important while applying methods such as CUP, CPM or TNMM• Cost details of the Transferee important while applying methods such as RPM or TNMM• Cost details of both while applying methods such as PSM

• Cost details of the Transferor important while applying methods such as CUP, CPM or TNMM• Cost details of the Transferee important while applying methods such as RPM or TNMM• Cost details of both while applying methods such as PSM

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ConclusionConclusion

• Significant interplay between cost records/ details and Transfer Pricing

• Accurate cost details critical for both multi-unit as well as multi entity groups

• Verifiability and documentation necessary – Audits/ examination by Revenue

• Consistency between cost records/ MIS and Transfer Pricing records critical

Need for working together!

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Thank YouThank You