Overview of Transfer Pricing

Contents

Legislative framework

Transfer pricing study

Assessment and Litigation

Key Recent Developments

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Transfer Pricing in India- Background

April 1, 2001 onwards
Comprehensive legislation introduced in Union Budget 2001
Detailed Rules providing guidance for application of the legislation framed

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Concept of transfer pricing

Transfer Pricing refers to the pricing of

international transactions between two
associated enterprises

Due to the special relationship between related

parties, the transfer price may be different than
the price that would have been agreed between
unrelated parties

A price between unrelated parties is known as

the arms length price

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Concept
Associated
enterprise

Independent
entity

International transactions
- goods
- services
- intangibles
- loans

Resident

Transfer price

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Resident

Arms length price

Applicability

The provisions of Section 92 to 92F of the Act are applicable only if:

There are two or more enterprises (defined in Sec 92F)

The enterprises are Associated enterprises (defined in Sec 92A)

The enterprises enter into a transaction (defined in Sec 92F)

The transaction is an International transaction (defined in Sec 92B)

Provisions do not apply in certain cases (Section 92(3))

Further w.e.f. 1 April 2012, TP provisions shall also apply to specified domestic transactions
(SDT) (defined in Sec 92BA)

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Applicability
Consequences of these provisions:

Computation of income/ expenses having regard to the Arms length price

(Section 92(1))

Maintenance of prescribed Documentation (Section 92D read with Rule 10D)

Obtaining of Accountants report (under Form 3CEB) (Section 92E)

To ensure compliance with the arms length principle, stringent Penalties have
been prescribed

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Applicability

Section 92(1)
Any income (or expense or interest) arising from an
international transaction shall be computed having regard to
the arms length price

Section 92(3) The provisions are not intended to be applied in case

determination of arms length price reduces the income
chargeable to tax or increases the loss as the case may be

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Meaning of Associated enterprises (Section

92A)

Both A and B
are associated
enterprises of C

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D and E are also

associated
enterprises of C
since they have a
common ultimate
parent (A)

Direct or indirect participation

(through one or more
intermediaries) in management,
control or capital

Deemed Associated enterprises (Section

92A(2)
Equity Holding

Management

1. >= 26% direct /

indirect holding
by enterprise

6. Appointment >
50% of
Directors / one
or more
Executive
Director by an
enterprise

OR
2. By same
person in each
enterprise

3. Loan >= 51% of

Total Assets
4. Guarantees > =
10% of debt
5. > 10% interest
in Firm / AOP /
BOI

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OR
7. Appointment
by same
person in each
enterprise

Activities
8. 100%
dependence on
use of
intangibles for
manufacture /
processing /
business
9. Direct / indirect
supply of > = 90%
Raw Materials
under influenced
prices and
conditions
10. Sale under
influenced
prices and
conditions

Control

11. One enterprise

controlled by an
individual and
the other by
himself or his
relative or jointly
12. One enterprise
controlled by
HUF and the
other by
- a member of HUF
- his relative or
- Jointly by member
and relative

International transaction (Section 92B)

Transactions between two or more associated enterprises

Either or both of whom are non-residents

Transaction relates to:

purchase, sale or lease of tangible or intangible property; or

provision of services; or

lending or borrowing money; or

any other transaction having a bearing on the profits, income, losses or assets of
the enterprises; or

mutual agreements or arrangements for allocation or apportionment of, or any

contribution to, any cost or expense incurred
Scope expanded in Finance Act, 2012 to include - intangibles like marketing
intangibles, human capital, Business restructuring, inter-company guarantees, capital
funding, etc.

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Deemed international transaction Sec 92B(2)

Transactions with non-group companies deemed to be international
transactions subject to transfer pricing regulations
Prior agreement
As Parent

3rd party

Transaction between A and 3rd party

also subject to transfer pricing norms, if:

a prior agreement exists between

As parent and 3rd party (both nonresidents) in relation to services
rendered by A to the 3rd party; or

Determination of terms
As Parent

A
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3rd party

terms of transaction are

determined in substance by As
parent and 3rd party

Specified Domestic Transactions (SDT)

Scope of transfer pricing provisions expanded
(effective FY 2012-13 and onwards)

Applicable to specified domestic transactions if aggregate value of such transactions

exceeds INR 5 crores
Transactions that could be impacted include

Transfer of goods/services between related domestic companies wherein either

of them is eligible for tax holiday benefit

Transfer of goods / services between tax holiday eligible business / units and
other businesses / units of the taxpayer in India

Payments made to persons specified u/s 40A(2)(b) [definition amended]

All provisions applicable for determination of ALP for international transactions would
apply in case of SDT also. Also penal provisions applicable to international transactions
would apply to SDT

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Which ones of these entities are associated

enterprises of ABC India?

XYZ, Japan
100%

ABC, Japan

74%

ABC India

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100%

XYZ, Taiwan

Arms length price

Price applied or proposed to be applied in a transaction between persons other than
associated enterprises, in uncontrolled conditions

Determination of arms length prices using one of the Prescribed methods

Yes

The price thus determined

is the arms length price

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Whether you
arrive at a
single price ?

No

The arithmetic mean of such

prices which varies from
transfer price (not exceeding
3% (upper ceiling)
is the arms length price
(92C(2))

The Arms Length Range - How it works

In most cases, it is not possible to identify a

single price that can be considered to be an
uncontrolled price.
It may be that a number of different
comparables are equally comparable. Several
comparable transactions can therefore define
an arms length range of possible transfer
prices
Overall range may contain extremes. Indian
legislation recognizes only arithmetic mean
(with a +/-5% variation) though statistically and
internationally an inter-quartile range may be
more appropriate.
If transfer price falls within a +/- 5% range,
pricing should be defendable as arms length
from tax authority audit perspective

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Prescribed methods

Transfer Pricing Methods

Traditional Transaction Methods

Transactional Profit Methods

Other Method

Comparable
Uncontrolled
Price

Resale Price
Method

Cost Plus
Method

Profit Split
Method

Transactional
Net Margin
Method

Tax payer may apply any of the above methods that is considered most
appropriate for a transaction

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Comparables

All methods require comparables

Transfer price is set/ defended using data from

comparable companies

Comparable company should be independent and

similar to an associated enterprise.

Following factors are generally used in judging

comparability (Rule 10C(2)):

nature of transactions undertaken (i.e. type of

good, service etc.)

company functions

risks assumed

contractual terms (i.e. similar credit terms)

economic and market conditions

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Comparable Uncontrolled Price Method -Rule

10B(1)(a)

Compares the price charged in a controlled

transaction with the price in an uncontrolled
transaction

Requires strict comparability in products,

contractual terms, economic terms, etc

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Comparable Uncontrolled Price Method

Identification of price charged or paid in comparable transaction(s)

Such price adjusted to account for differences if any between international transaction
and uncontrolled transaction(s)

Adjusted price arrived above taken to be arms length price

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Comparable Uncontrolled Price Method

Internal CUP
Related party - B
Manufacturer A
Non-related party

External CUP

Non-related party A

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Non-related party B

Resale Price Method- Rule 10B(1)(b)

Compares the resale gross margin earned by associated enterprise with the resale gross
margin earned by comparable independent distributors
An arms length gross margin should be sufficient for a reseller to cover its operating
expenses and make an appropriate operating profit (in light of its functions and risks)
Preferred method for a distributor buying purely finished goods from a group company
without any value addition (if no CUP available)

Group Manufacturer
(Hong Kong)

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$75

Related Distributor
(India)

$100

Unrelated
Distributors

Resale Price Method

Identification of resale price by tested party

Resale price reduced by normal gross profit with reference to uncontrolled transaction(s)

Such price reduced by expenses incurred (customs duty etc.) in purchase of the
product/ services.

This price may be adjusted to account for functional and other differences if any

Adjusted price arrived above taken to be arms length price

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Cost Plus Method Rule 10B(1)(c)

Compares the gross profit on costs the associated enterprise earns with the gross
profit on costs earned by comparable independent companies
Preferred method for:
manufacturer supplying semi-finished goods
company providing services

Manufacturer A
(Indian)

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Cost + 40%

Related
Manufacturer
B (US)

US Market

Cost Plus Method

Identification of direct and indirect costs of production incurred in tested party transactions

Identification of normal gross profit with reference to uncontrolled transaction(s)

Normal gross profit adjusted to account for functional and other differences if any

Adjusted gross profit added to total costs identified in step 1

Sum arrived above is taken to be arms length price

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Profit Split Method-Rule 10B(1)(d)

Appropriate for transactions which are not capable of being evaluated separately
Calculates the combined operating profit resulting from a whole
inter-company transaction based on the relative value of each associated enterprise's
contribution to the operating profit

The contribution made by each party is determined on the basis of a division of functions
performed, valued, if possible using external comparable data
Applicable for analyzing tangible, intangible or services issues

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Profit Split Method

Determination of combined net profit of the associated enterprises arising out of
international transaction

Evaluation of relative contributions by each enterprise on the basis of functions performed, risks
assumed and assets employed

Splitting of combined net profit amongst enterprises in proportion to their

relative contributions

Profit thus apportioned to the tested party is used to arrive at the arms length price

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Transactional Net Margin Method-Rule 10B(1)(e)

Examines net operating profit from transactions as a percentage of a certain base (can
use different bases i.e. costs, turnover, etc) in respect of similar parties

Ideally, operating margin should be compared to operating margin earned by same

enterprise on uncontrolled transaction

Can compare to comparable transactions between independent parties

Applicable for any type of transaction and often used to supplement analysis under other
methods

Most frequently used method in India, due to lack of availability of comparable

uncontrolled prices and gross margin data required for application of the comparable
uncontrolled price method/ cost plus method/ resale price method

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Transactional Net Margin Method

Computation of net profit as a percentage of a certain base realised from the
international transaction.

Computation of net profit realized by the tested party or an unrelated enterprise

in a comparable uncontrolled transaction

Net profit from uncontrolled transaction adjusted to account for differences if any

The net profit thus established is taken into account to arrive at an arms length
price for the international transaction

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Which method applies?

Pharma Company USA

100kgs at
Rs 100 per
kg

Sale of tablets
10kgs at Rs
100 per kg

Pharma Company India

Which method applies to this transaction and why?

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Third parties

Documentation-Rule 10D
Entity related

Price related

Transaction related

Profile of industry

Transaction terms

Agreements

Profile of group

Invoices

Profile of Indian entity

Functional analysis (functions,

assets and risks)

Economic analysis (method

selection, comparable
benchmarking)

Pricing related
correspondence
(letters, emails etc)

Forecasts, budgets, estimates

Profile of associated
enterprises

Contemporaneous documentation requirement to be maintained by November 30 of relevant Assessment Year

Documentation to be retained for 9 years from financial year
Comprehensive Documentation is not required to be maintained if the aggregate value of all international transactions does not
exceed one crore rupees

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Accountants report-Rule 10E

Obtained by every tax payer filing a return in India and having international transaction

To be filed by due date for filing return of income (30 November)

Essentially comments on the following:

whether the tax payer has maintained the transfer pricing documentation as
required by the legislation,

whether as per the transfer pricing documentation the prices of international

transactions are at arms length, and

certifies the value of the international transactions as per the books of account and
as per the transfer pricing documentation are true and correct

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TP Penalties-Section 271
Default

Penalty

Post-inquiry adjustment (deemed

concealment of income)

100-300% of tax on the adjusted amount

Failure to maintain documents; report

2% of the transaction value

transactions; Maintains or furnishes

incorrect information/ documentation

Failure to furnish documents

2% of the transaction value

Failure to furnish accountants report

Rs 100,000

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Reading references

OECD guidelines and commentary

Guidance note from the Institute of Chartered

Accountants

BNA daily tax and transfer pricing reports

ITS worldwide weekly updates

For international case laws Intranet

(riacheckpoint.com)

www.ibfd.org

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Our Approach to Transfer pricing

Our proposed approach for transfer pricing review will be based on the following phases of
work as described in detail below:

Documentation/ Accountants report

Report writing/
Accountants report

Economic analysis

Functional analysis

Calculation of arms length result

Selection of Best
Method

Selection of
Comparables

Analysis of Functions, Risks, and Intangibles

Fact gathering
Mapping of international transaction

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Industry Analysis

Steps in a transfer pricing study

Investigation & data collection

Questionnaire
Interview

3
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Others

Assist in implementation
Litigation support

Documentation
Industry overview
Functional analysis
Economic analysis

Assessment Procedure

1
4

U/s 92CA the AO may refer

determination of ALP to the TPO, with
prior approval of Commissioner

AO would proceed to compute

income of the taxpayer in
conformity with ALP determined
by the TPO and pass a draft order

2
3

TPO would then notify the

taxpayer to produce evidence
supporting transfer price as
arms length

TPO would determine ALP by passing

an order based on information
gathered from the assesse/ other
sources and intimate the AO &
taxpayer

Dispute Resolution Panel

The AO to provide draft order to assessee,

TPOs order

in case any adjustment is proposed.

Show cause
notice

The assessee has to file the objections

AOs draft order

within 30 days of receipt of the draft order;

Directions of the DRP to be issued within 9

Within 30 days of
receipt of draft order

months of the end of month draft order

forwarded to Assessee;
The directions issued by the DRP Panel are

File Objections with

DRP

No response

appealable in the ITAT by the Assessee.

The department can appeal against the

AOs order

Within 9 Months
from end of the
month in which draft
order was forwarded
to Assessee

DRP directions for objections filed after 1

July 2012.
CIT(A)

DRP Order

AO Order

ITAT

Appeal
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Advance Pricing Arrangement (APA) regime

Introduced with effect from 1 July 2012

Framework enables unilateral, bilateral and multilateral APAs
APA to be binding on both the taxpayer and the tax authority for a period not
exceeding five years
APA team constitution notified. Unilateral APAs to lie with APA directorate headed
by DGIT and bilateral/ multilateral APAs to be handled by the Competent Authority
Detailed process guidelines released:

APA applications have a minimum filing fee based on value of international

transaction

APA framework includes mandatory pre-filing consultation

Provisions allow rejection, amendments and withdrawal of APA applications

Provisions contain Annual Reporting norms to monitor adherence to the terms

of the APA

Roll-back not allowed

Framework do not contain firewall provisions in respect of information shared

with APA authority during negotiations

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