Sunitha Suri

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

  • Specific anti-avoidance measures in respect of transactions with persons located in Notified Jurisdictional area was introduced in the Act under sec 94A
  • We have seen in earlier sections that transactions with the AEs are subject to transfer pricing provisions.
  • This is generally sufficient to cover all the related party transactions, since most countries exchange information to the tax authorities of the other country.
  • Where the exchange of information regarding the tax residence of a particular country is difficult to obtain, the CBDT had come up with the idea of Notified Jurisdictional Area (NJA) where any transaction with the resident of that country or jurisdiction would have to comply with transfer pricing provisions irrespective of whether the other entity is an AE or not.
  • Further, rate of TDS was also prescribed for specified transactions with residents of NJA.
  • Some significant features for NJA entities are
Anti Avoidance
  • CBDT had earlier in November 2013, notified Cyprus as NJA.
  • However, after the negotiation of India – Cyprus treaty, this notification has been rescinded in December 2016.

Question

If a country is a Notified Jurisdictional Area, then

  1. SHRs do not apply for transactions with the AEs in that country
  2. Even for non-AEs, TP provisions have to be applied in case of transactions with entities resident of NJA
  3. The tolerance range is not applicable for entities of NJA
  4. All of the above

Answer d.

For a country identified as a Notified Jurisdictional Area, the beneficial SHRs are not applicable and even for non-AEs, TP provisions have to be applied in case of transactions with entities resident of NJA. Further tolerance range (3% / 1%) is not applicable for ALP for entities in NJA.

Dispute Mitigation strategies in transfer pricing

Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

Advance Pricing Agreements (APA)

Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

Mutual Agreement Procedure

Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
Read More

Introduction to Transfer Pricing

Introduction to Transfer Pricing Transfer Price “Transfer Price” is the price at which an enterprise charges for its transaction within its group entitiesInternational transaction involves more than one tax jurisdiction, and due to disparity in tax rates and method of computing income, the parties may try to adjust the transfer pricesSince the …
Read More

Introduction to Transfer Pricing

Introduction to Transfer Pricing

Transfer Price

  • “Transfer Price” is the price at which an enterprise charges for its transaction within its group entities
  • International transaction involves more than one tax jurisdiction, and due to disparity in tax rates and method of computing income, the parties may try to adjust the transfer prices
  • Since the parties are related there is a possibility that the price at which the transactions are carried out can be fixed in such a way that profits can be parked in the country which has less tax and entity in high tax country earns less or no profits
  • This would allow the Multinational Enterprise’s to reduce overall tax cost.
  • To reduce the tax arbitrage, the principal of Arm’s Length Price (‘ALP’) is applied
  • ALP is the price that independent enterprises would charge between them for a particular transaction. Transfer pricing is a process of arriving at the price for goods and services which are transacted between entities which are under a common control under the assumption that they are independent parties
  • The transactions may be in the form of purchase, sale, interest, royalty, services, reimbursement etc.

Necessity for Transfer Pricing Provisions

  • MNE operate in different countries under various models such as subsidiary, branch, project office, liaison office etc.
Pricing Provisions
Pricing Provisions 1
  • However, true comparison between an independent transaction and related party transaction is often not possible due to many commercial and financial conditions governing a transaction
  • Further, in many situations, related parties enter into transactions which normally independent enterprises would not enter into, such as license of intellectual property and so on

Practical difficulties in applying ALP

  1. True comparison difficult
  2. It might be impossible to find an uncontrolled comparable transaction which could make the comparison difficult
  3. Availability of data and reliability of availability data
  4. Timely availability of data and their reliability would pose a problem in applying TP provisions
  5. Absence of market price for certain transactions
  6. Some transaction between related parties may be unique and unrelated parties may not engage in similar activities which makes it difficult to compare.
  7. Absence of market price including transactions involving “intangibles”
  8. When the transaction involves intangibles, valuation and pricing is a big problem and may distort the pricing mechanism.
  9. Administrative burden
  10. Applying the TP provisions would cause additional administrative burden on the assessee.
  11. Time lag
  12. The agreement between the related parties would have been entered in a different time and the transaction at a different point of time and the assessment at a different point of time. The taxpayer may not have relevant information at the time of entering the agreement with related parties. The information regarding market price of similar products or services at would be different at different period of time and time lag would cause difficulties in applying the Arms’ length price.

Question:

Why are Transfer Pricing Provisions needed? Which of the following is an appropriate reason?

  1. To bring parity between domestic enterprises and MNEs and to make accurate assessment of economic contributions
  2. To minimize double taxation
  3. To reduce artificial pricing distortion and determine real profits
  4. All of the above

Answer d.

  • Transfer Pricing Provisions are required not only to bring parity between domestic enterprises and MNEs but for other reasons such as to minimize double taxation, to reduce artificial pricing distortion and determine real profits.

Transfer Pricing provisions in India prior to 2001

  • Transfer pricing provisions existed prior to 2001 by way of section 92 of the Income Tax Act, 1961 (‘Act’) and Rule 10 and Rule 11 of the Income Tax Rules, 1962 (“Rules’)
  • The provisions required the AO to examine the transactions between closely connected entities (between resident and non-resident) to ensure that reasonable profits are being made from the transactions
  • In case of no profit or less than normal profits to the Indian resident, the AO is obliged to apply the rules to arrive at the reasonable profit
  • Normal profits would be such % of the turnover, which arises or arrives to the non-resident as the AO may consider reasonable
  • It is pertinent to determine normal profits as % of sales and there was no prescribed methodology to compute the specific price of any transaction. In other words it was profit specific and not transaction specific.
  • The Act however, gave powers to the AO to compute profits in such other manner as he deems suitable

This has many shortcomings:

Pricing provisions2001
Pricing provisions2001 1

Transfer Pricing rules and regulations

  • Transfer Pricing Regulations (‘TPR’) or Transfer Pricing Provisions (‘TPP’) was included in Chapter X of the Act, through the Finance Act, providing for mechanism to compute income of cross border transactions.
  • Older section 92 was substituted with section 92, 92A, 92B, 92C, 92CA, 92D, 92E and 92F.
  • This marked a paradigm shift in the way cross border transaction between related entities were assessed.

Dispute Mitigation strategies in transfer pricing

Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

Advance Pricing Agreements (APA)

Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

Mutual Agreement Procedure

Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
Read More

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

Anti-Avoidance measures in certain jurisdictions – Transfer pricing Specific anti-avoidance measures in respect of transactions with persons located in Notified Jurisdictional area was introduced in the Act under sec 94AWe have seen in earlier sections that transactions with the AEs are subject to transfer pricing provisions.This is generally sufficient to cover …
Read More

Income from transaction with Non-Residents – Transfer Pricing

Income from transaction with Non-Residents – Transfer Pricing

Applicability

  • Section 92 is the charging section for Chapter X of the Act. Sec 92 provides that any income arising from an ‘International transaction’ shall be computed having regard to ALP.
  • For this purpose, the allowance for any expense or interest shall be determined on the basis of ALP.
  • Further, where two or more enterprises enter into mutual agreement or arrangement for cost allocation or cost contribution, they would also be covered within sec 92 and would be subject to ALP.

This provision will not be applicable –

While determining ALP under the provisions of TPR, if the income works out to a figure lower than the income shown in the books of accounts or if the expense works out to a figure higher than the one in the books of accounts. The terms referred in the section are defined in section 92F

Associated Enterprises [Section 92A]

Definition of the term Associated Enterprise

  • The term AE in relation to ‘another enterprise’ is defined in section 92A(1):
  • which participates, directly or indirectly, or through one or more intermediaries, in the management or control or capital of the other enterprise
  • in respect of which one or 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 the management or control or capital of the other enterprise

Deemed Associated Enterprises

  • Section 92A(2) provides that two enterprises shall be deemed to be associated enterprises for the purposes of sub-section(1) if, at any time during the previous year:
Deemed Associated
Deemed Associated 1
Deemed Associated 2
Deemed Associated 3
Deemed Associated 4
Deemed Associated 5
  • It is important to understand that both direct and indirect holding of voting rights would be covered in the definition.

Meaning of certain terms

  • To understand who would be regarded as associated enterprises, we need to understand the term ‘Enterprise’. Section 92F defines the terms relevant to Chapter X
  • The term ‘enterprise’ is defined in Section 92F to mean a person who is or who proposes to engage in any activity relating to the production, storage, supply, distribution, acquisition or control of articles or goods, or know-how etc, or the provision of services of any kind, or in carrying out any work in pursuance of a contract, or in investment, or providing loan or in the business of acquiring, holding, underwriting or dealing with shares, debentures or other securities of any other body corporate, whether such activity or business is carried on, directly or through one or more of its units or divisions or subsidiaries, or whether such unit or division or subsidiary is located at the same place where the enterprise is located or at a different place or places. This includes Permanent Establishment.
  • Permanent Establishment includes a fixed place of business through which the business of the enterprise is wholly or partly carried on
  • Important Notes:
  • Definition of AE does not refer to the residential status of the transacting enterprises.
  • Even if the conditions regarding two enterprises to be AEs are met only on one day of the PY, the enterprises would be regarded as AEs for the relevant PY.

Question

A USA Inc holds 50% equity shares in B USA Inc and B USA Inc holds 26% shares in C Ind Ltd. Whether A USA and C Ind Ltd are AEs.

  1. They are not AEs since A USA Inc does not hold more than 26% of voting rights in C Ind Ltd
  2. They are not AEs since A USA Inc is non-resident in India.
  3. A USA and C Ind are AEs.

Answer c.

A USA Inc does hold more than 26% of voting rights in C Ind Ltd not directly but indirectly. The Section 92A is clear that both direct or indirect holding would have to be considered. Further the definition of AE does not refer to residential status, so whether both are residents or residents does not matter

Question

Two enterprises shall be deemed to be associated enterprises if a loan advanced by one enterprise to the other enterprise constitutes?

  1. 50% or more of the book value of the total assets of the other enterprise
  2. Less than 50% of the book value of the total assets of the other enterprise
  3. More than 51% of the book value of the total assets of the other enterprise
  4. 51% or more of the book value of the total assets of the other enterprise

Answer d.

Two enterprises shall be deemed to be associated enterprises if a loan advanced by one enterprise to the other enterprise constitutes 51% or more of the book value of the total assets of the other enterprise.

Question

H Inc. (USA) advanced loan of Rs.130 crores to P India. Select the correct statement.

  1. Both are Associated enterprises when P India has total assets worth Rs.250 crores
  2. Both are Associated enterprises when P India has total assets worth Rs.260 crores
  3. Both are Associated enterprises when P India has total assets worth Rs.300 crores
  4. Both are Associated enterprises irrespective of the loan amount

Answer a.

Two enterprises shall be deemed to be associated enterprises if a loan advanced by one enterprise to the other enterprise constitutes 51% or more of the book value of the total assets of the other enterprise. Rs 130 crores is more than 51% of Rs.250 crores.

Question

Z India Private Ltd. borrowed Rs.1000 crores from an CitiBank. Y Plc (UK) guaranteed the borrowings of Z India. Select the correct statement.

  1. Both are Associated enterprises when the Y Plc guarantees Rs.80 crores on behalf of Z India
  2. Both are Associated enterprises when the Y Plc guarantees Rs.98 crores on behalf of Z India
  3. Both are Associated enterprises irrespective of amount of guarantee made by Y Plc
  4. Both are Associated enterprises when the Y Plc guarantees Rs.100 crores on behalf of Z India

Answer d.

Two enterprises shall be deemed to be associated enterprise when one enterprise Guarantees 10% or more of the total borrowings of the other enterprise. In this case the guaranteed amount is 10% of the borrowings so they are AEs.

Question

A India and B Singapore shall be deemed to be AEs.

  1. Only if more than half of the Board of Directors of each of the A India and B Singapore are appointed by AB Inc, USA
  2. Only if one Executive Director of each of the A India and B Singapore are appointed by AB Inc, USA
  3. Only if one Executive Members of the Governing Board of each of the A India and B Singapore are appointed by AB Inc, USA
  4. Even if one of the above conditions is satisfied.

Answer d.

A India and B Singapore shall be deemed to be AEs if more than half of the Board of Directors of each of the A India and B Singapore are appointed by AB Inc, USA, or one Executive Director of each of the A India and B Singapore are appointed by AB Inc, USA or one Executive Members of the Governing Board of each of the A India and B Singapore are appointed by AB Inc, USA

Question

Alpha Inc (USA) supplied raw material K, worth Rs.270 crores to Beta India during the FY 2019-20. Both enterprises would be deemed as associated enterprises when Beta India consumed total raw material K of

  1. Rs 400 crore during FY 2019-20
  2. Rs 540 crore during FY 2019-20
  3. Rs 2700 crores during FY 2019-20
  4. Rs 300 crores during FY 2019-20

Answer d.

Alpha and Beta would be deemed as AEs if 90% or more of raw materials and consumables required for the manufacturing of goods Beta are supplied by the Alpha. Rs 270 crore meets the threshold 90% they are not AEs

Question

A Inc USA had 28% shares in B India. On 2nd April 2019, A USA sold 5% of its shares in B India to M India. Which of the below statement is correct?

  1. A and B are AEs forever since once an AE always an AE
  2. A and B are not AEs for FY 2019-20 since as on March 31, 2019 A USA has less than 26% of shareholding in B India
  3. M India and B India are AEs
  4. A and B are AEs for FY 2019-20 since as per section 92A, if the conditions are met any time during the year.

Answer d.

Section 92A(2) provides that two enterprises shall be deemed to be associated enterprises for the purposes of sub-section(1) if, at any time during the previous year.

Dispute Mitigation strategies in transfer pricing

Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

Advance Pricing Agreements (APA)

Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

Mutual Agreement Procedure

Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
Read More

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

Anti-Avoidance measures in certain jurisdictions – Transfer pricing Specific anti-avoidance measures in respect of transactions with persons located in Notified Jurisdictional area was introduced in the Act under sec 94AWe have seen in earlier sections that transactions with the AEs are subject to transfer pricing provisions.This is generally sufficient to cover …
Read More

International Transaction [Section 92B] – Transfer Pricing

International Transaction [Section 92B] – Transfer Pricing

  • Transfer pricing provisions are applicable to determine the arm’s length price of international transaction and specified domestic transaction. Though, specified domestic transactions are also part of the transfer pricing provisions, it predominantly deals with international transaction. Therefore, it is essential to understand the term which is provided in Section 92B (1)

Transaction between two or more AEs either or both are NRs.

AEsorNRs
AEsorNRs 1
AEsorNRs 2

Summary

Summary

Question               

Which of the following is an international transaction?

  1. Nippon USA purchases goods from Nippon Japan amounting to $1 million
  2. Interest of Rs 10 crores paid by K Ltd (India) to Singapore branch of HSBC Bank
  3. K India purchases spare parts from its subsidiary P India Ltd amounting to Rs 2 lakhs
  4. Indian branch of R USA paying royalty to R Singapore (WOS of R USA) amounting to USD 10 million.

Answer d.

It is an international transaction. Both are AEs and both are non-residents and Indian branch of the non-resident which has business connection in India is paying the royalty.

Intangible property (‘IP’):

The term intangible property includes

IP
IP 1
IP 2
  • To understand what constitutes an ‘International transaction’, we need to understand what ‘Transaction’ is. Section 92F defines the term ‘Transaction’ to include an arrangement, understanding or action in concert
  • Whether or not such arrangement, understanding or action is formal or in writing; or
  • Whether or not such arrangement, understanding or action is intended to be enforceable by legal proceeding.

Financing transaction

  • It was litigated whether receipt of security premium below market value in respect of issue of shares would be regarded as International transaction in the case of Vodafone India Services (P) Ltd vs UOI [2014] 50 Taxmann.com 300 (Bombay).
  • Vodafone India offered shares at a premium of Rs 8509 ( Face value of Rs 10) per share to its parent company. However, the AO and the TPO contended that the share premium ought to have been Rs 53,775 and treated the difference as income in the hands of the assessee.
  • It was held in the court as follows:
  • The activity of issue of shares to AE at a price below the FMV does not give rise to any income. There should be income arising from international transaction on application of TP provisions
  • Income will not include capital receipts, unless such receipts are specifically covered. The share premium is a capital amount and cannot come within the purview of international transaction CBDT’s instruction No.2/2015 dated 29-01-2015
  • CBDT had also accepted the judgement of Bombay High Court and did not appeal further. So this the settled position now.

Question

HML India issued 10,000 shares at Rs.110 (face vale of Rs.10 each) at a premium of Rs.100 per share to its holding company, R International. Choose the correct statement

  1. Transfer pricing provisions would not be applicable on such transaction irrespective of the market value of shares
  2. Transfer pricing provisions would be applicable on such transaction when the fair market value of share is Rs.150 per share.
  3. Transfer pricing provisions would be applicable on such transactions when the fair market value of shares is Rs.90 per share

Answer a.

Based on the Vodofone ruling by Bombay HC, the activity of issue of shares to AE at a price below the FMV does not give rise to any income. There should be income arising from international transaction on application of TP provisions.

Deemed International Transaction – Section 92B(2)

  • Where in respect of a transaction entered into by an enterprise with a person other than an AE (‘Other Person’)
  • There exists a prior agreement in relation to the relevant transaction between the other person and the AE
  • Where the terms of the relevant transactions are determined in substance between such other person and the AE and
  • Either the enterprise or the AE or both of them are NRs
  • Then such transaction entered into between the enterprise and the other person shall be deemed to be an international transaction entered in between AEs whether or not such other person is a NR.

Example

  • Let us say that A India Ltd (‘A’) has an AE B US Inc (‘B’). B has entered into a contract with C India Ltd (‘C’) for supply of certain laptops to all its subsidiaries across the world. Pursuant to that contract, if A purchases laptop from C, then that transaction would be deemed to be an international transaction. In this example, it is immaterial if C is a resident or a non-resident until either A or B or both are non-resident.

Question

A Ltd (India) is the subsidiary of AB International (USA). A Ltd import certain goods from B international (Singapore), independent third party. There exists a prior agreement between B International and AB International (USA) for import of such goods. Such transaction of import from third party:

  1. Shall not be deemed to be an international transaction as both parties (i.e. A Ltd and AB International) are not associated enterprises
  2. Shall be deemed to be an International transaction even of transaction is made with Independent third party
  3. None of the above

Answer b. Where in respect of a transaction entered into by an enterprise with a person other than an AE (‘Other Person’), there exists a prior agreement in relation to the relevant transaction between the other person and the AE, Where the terms of the relevant transactions are determined in substance between such other person and the AE and either the enterprise or the AE or both of them are NRs, then it would be regarded as deemed international transaction

Dispute Mitigation strategies in transfer pricing

Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

Advance Pricing Agreements (APA)

Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

Mutual Agreement Procedure

Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
Read More

Anti-Avoidance measures in certain jurisdictions – Transfer pricing

Anti-Avoidance measures in certain jurisdictions – Transfer pricing Specific anti-avoidance measures in respect of transactions with persons located in Notified Jurisdictional area was introduced in the Act under sec 94AWe have seen in earlier sections that transactions with the AEs are subject to transfer pricing provisions.This is generally sufficient to cover …
Read More

Specified Domestic Transactions – Transfer Pricing

Specified Domestic Transactions – Transfer Pricing

Introduction

  • The concept of Specified Domestic Transactions (SDT) was introduced in Finance Act 2012. Prior to that the AO were empowered to disallow payments made to related parties which were unreasonable or excessive under section 40A(2)(b) of the Act. Further, TPPs were applicable only for international transactions.
  • SC in the case of Re Glaxo Smithkline Asia P Ltd recognised the complications of arriving at the Fair Market value (FMV) in case of transactions involving related parties and suggested why transfer pricing provisions could not be extended to domestic transactions as well
  • This led to introduction of section 92BA of the Act and enactment of provisions for Specified Domestic Transactions (‘SDT’).
  • Initially the provisions were applicable for transactions covered under 40A(2)(b) of the Act and the threshold limit was INR 5 crores.
  • Finance Act, 2015 enhanced the threshold limit from INR 5 crores to INR 20 crores. Finance Act, 2017 amended the section 92BA of the Act by deleting clause (i) – reference to transactions under section 40A(2)(b) thereby further reducing the compliance requirements
  • Currently, the provisions are applicable only for transactions involving units enjoying tax holiday benefits [ section 80A, 80-IA(8), 80-IA(10), 10AA], where the aggregate of transactions during the year exceed INR 20 Crores.

Meaning of SDT

  • As per section 92BA, for the purpose of sections 92, 92C (Computation of arm’s length price), 92D (Maintenance and keeping of information and documents) and 92E (Furnishing of report from an accountant), in case of an assessee the specified domestic transaction shall mean any of the following transactions, not being an international transaction, namely
SDT

Features of SDT

  • Basically, SDT covers transactions which take place between closely held enterprises where one of the enterprise enjoys profit-linked deductions.
  • If one unit of an entity enjoys profit-linked deductions (SEZ units) while others don’t (DTA), then provisions of SDT are applicable
  • The idea behind such provision is to ensure that the transfer price in such transactions is not fixed in such a way that the entity that enjoys profit-linked deduction does not garner more than its due share of profits from a transaction.
  • Once any domestic transaction falls within the ambit of section 92BA, it would be treated in the same way an international transaction is to be treated. Method of determining ALP, documentation to be maintained, reference to TPO, penalty provisions are all similar to international transaction.
  • It has to be noted that SDT provisions are applicable only if the aggregate value of such transactions is Rs 20 crores or more during any previous year.

Safe harbour rules for SDT

  • Initially, SHRs were provided only for international transactions. However, CBDT extended the SHRs for SDT subsequently.
harbour rules

Question

Xerox Limited is claiming profit linked deduction under section 80-IA and it has obtained certain services amounting to Rs.12 crore with its other Indian group concern during the FY 18-19. In this case Xeros India is

  1. Not Required to maintain documentation under Rule 10D as it is a specified domestic transaction
  2. Required to maintain documentation under Rule 10D as aggregate value of transaction is more than 1 crore
  3. Not Required to maintain documentation under Rule 10D as provisions of specified domestic transaction are not applicable

Answer c.

Once SDT is applicable, the documentation requirement shall be applicable. However, in this case, SDT is not applicable, since the aggregate value of the SDT is only Rs 12 crores, as the threshold limit is Rs 20 crores.

Dispute Mitigation strategies in transfer pricing

Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

Advance Pricing Agreements (APA)

Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

Mutual Agreement Procedure

Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing

Fundamentals of Base Erosion and Profit Shifting – Transfer Pricing Introduction In the past few decades, the world has seen large movement of capital and investment from developed and developing countries.This has resulted in huge economic development, boosted trade and increases foreign direct investment in various countries.Many developing countries (low – cost …
Read More

Additional reporting by Multinational companies – Transfer pricing

Additional reporting by Multinational companies – Transfer pricing The OECD had devised many action plans to combat BEPS. OECD also recommended a three-tier documentation approach for transfer pricing under Action Plan 13. Three tier documentation Advantages of three tier reporting Elements of CbC and Master File reporting requirement and related matters have been incorporated …
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Arm’s Length Principle – Transfer Pricing

Arm’s Length Principle – Transfer Pricing

Why Arm’s length price?

  • The cornerstone of the Transfer Pricing Provision is determining an Arm’s Length Price (‘ALP’) of a transaction between Associated Enterprises.  
  • This course will provide you the methods to be adopted for determining the ALP and factors which needs to be considered in order to identify comparable uncontrolled transactions.
  • ALP is defined in section 92F(ii) to mean price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions.
  • Section 92C deals with the method for determining arm’s length price and the factors which are to be considered for applicability or non-applicability of a particular method to a given situation.
  • The factors as well as methods incorporated in this section are not exhaustive and the CBDT may prescribe further factors and methods.

Prescribed Methods

  • Section 92C provides that the arm’s length price in relation to an international transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe. The prescribed methods are
Prescribed Methods
  • Out of the above Most Appropriate Method (‘MAM’) shall be applied for determining the ALP.
  • There is no necessity to apply the methods sequentially to check if it is the most appropriate method.
  • However, as a good practice, it is best to evaluate all the methods for suitability and then arrive at the Most Appropriate Method.
  • Rule 10B(1) provides for determining of ALP.
  • The Rule explains how ALP under the 6 methods has to be determined.

CUP Method

  • Under this method the price charged or paid for any item under any comparable uncontrolled transaction or transactions should be identifiable
  • Adjustment to account for differences between the international transaction and comparable uncontrolled transactions or between the enterprises entering into such transactions which could materially affect the price in the open market can be made
  • The adjusted price will be considered as ALP
  • The requirement of product or services similarity is highest. Further, the quality, quantity, time of the transaction along with the geographical location in which the goods are transacted also play an important role in determining if the prices are comparable.
  • This often makes it very difficult in using this method as Most Appropriate Method.
CUP Method

Internal CUP is always preferable over external CUP since the reliability of data and similarity of product etc. can be easily verified.

Illustration

  • Avian Ltd sells 10,000 units of product A to its AE in Singapore at USD 20 per unit. It also sells the similar units with slight modification to unrelated party C for USD 18 per unit. For the AE, Avian uses a special casing which is not used for the unrelated party. The cost of the casing per unit is estimated to be USD 1.75 per unit
Illustration

Question

Par India Ltd sold 1 million protective guards to Mars International (UK), which is a group company. The arm’s length price of protective guards can be ascertained under CUP method, where

  1. Par India sells similar protective guards to Kars International (Swiss) which is another group company
  2. Par India sells 100 similar protective guards to an unrelated Indian company
  3. Par India sells similar protective guards to Ritz (Singapore) which is not an AE
  4. Par India sells different type of protective guards to Mike (UK) which not an AE but differentiation of product is very extensive.

Answer c.

Internal CUP can be applied if the entity carries out similar comparable transaction in terms of product/ service type, geographical location, volume etc with an unrelated party. Since this meets all the criteria it can be used as an Internal CUP for determining ALP.

Question

Genesys India Ltd has purchased 1 lakh kits of raw material from Genesys Australia, its parent company. The sale of similar type, quality and volume between two unrelated third parties would be regarded as

  1. Internal CUP
  2. External CUP
  3. None of the above

Answer b.

The sale of similar type, quality and volume between two unrelated third parties would be regarded as external CUP since the Genesys is not part of the transaction

Question

Prime India purchased 1000 components from Prime USA for $10 each. Prime India purchased 1200 components from an unrelated party for $9 each. However, the components purchased from Prime USA has an additional part, the cost of which can be attributed to $1.25 per component. What is the ALP?

  1. ALP is $10.25
  2. ALP is $9
  3. ALP is $10

Answer c.

The comparable price would be $9 before adjustment. Since the additional component cost is $1.25, the same has to be added to the identified price i.e. $ 9+$1.25, which makes it $10.25. If the ALP is taken as $10.25 instead of the transaction price of $10, then it would reduce the profit or increase the loss as the case may be. Accordingly, Arm’s length principle would not apply and transaction price would not be altered. Accordingly, the ALP id $20.

RPM

  • This method is applicable when an item obtained by the enterprise from an AE is resold or provided to an unrelated enterprise
  • Following adjustments can be made to such resale price
  • Normal gross profit margin
  • Expenses incurred in connection with obtaining the item
  • Other functional differences which could materially affect the gross profit margin in the open market
  • Here again the requirement of product similarity is very high since it requires gross profit comparison. Non-availability of gross profit details of comparable companies makes this method difficult to use.

Example

  • G Ltd imports its artificial turf from its New Zealand AE and sells them in Indian market. The price it paid to the AE is USD 10,000. The exchange rate is 1USD – Rs 65 The other direct expenses incurred in connection with the sales are Rs 50,000. G Ltd sold the goods to Indian retailers for Rs 800,000. The average profit made by competitive entities is 6% on sales. Find the ALP?
RPM

Question

RPM can be used in the which of the following circumstances?

  1. AmanCo India imports pens from its parent company and resells the same without any value addition to the retailers in India
  2. Ans: Correct. RPM can be used since an item obtained by the enterprise from an AE is resold or provided to an unrelated enterprise
  3. Amax India exports laptops to its subsidiary in Philippines which resells them after configuration it to its retailers
  4. Ans: Incorrect. RPM can be used when an item obtained by the enterprise from an AE is resold or provided to an unrelated enterprise. In this case Amax India exports laptops to its subsidiary in Philippines which in turn resells after configuration. Accordingly, RPM cannot be used.
  5. AmanCo India imports some parts of camera from its parent company in KDK form and it assembles the same with indigenous components and sells it to the retailers in India
  6. Ans: Incorrect. RPM can be used when an item obtained by the enterprise from an AE is resold or provided to an unrelated enterprise. In this case AmanCo India imports only parts of camera and the other components it purchases locally so RPM cannot be used.

CPM

  • This method is applicable where the goods produced are sold to AEs or services rendered to AEs.
  • Under this method, the direct and indirect costs of production incurred by the enterprise for the item should be determined.
  • The amount of normal gross profit mark-up to such costs arising from the same or similar uncontrolled transaction. This gross profit margin can be adjusted to take into account any functional or other material differences in the open market
  • Here again the product / service similarity is very high.
  • Since this method is dependent on cost structure which is specific to the industry and type of product and services, obtaining comparables may be difficult.

Illustration:

  • A India Ltd sells all the manufactured garments to B US Inc. The purchases are made locally and A India Ltd incurs other costs which amounts to Rs 10,00,000.
  • Companies operating in similar industry make a margin of 12% on cost. A India Ltd invoices B USA Inc for Rs 10,75,000. Find ALP

Solution

CPM

PSM

  • Primarily applied in international transactions involving transfer of unique intangibles or in multiple international transactions which are so inter-related that they cannot be evaluated separately for the purpose of determining the ALP of one transaction.
  • In this method, combined net profit of the AEs arising from the international transactions are determined.
  • The relative contribution of each AE to earning of such combined net profit is then evaluated on the basis of Functions performed, Assets employed, Risks assumed (‘FAR analysis’) by each enterprise.
  • This evaluation is done based on reliable market data which can indicate how such contribution would be evaluated by unrelated enterprises performing similar functions.
  • The combined net profit is then split amongst the AEs in proportion to their relative contribution.
  • Sometimes the net profit is split into basic profit and super profit (residual profit) so as to ensure that the enterprise receive basic return appropriate to the type of international transaction.

Illustration

  • AB Inc USA entered into a contract for constructing a metrorail project in India for which its subsidiaries in Japan and India worked together.
  •  The entire contract price was US$ 200 million dollars.
  • The project earned a profit of Rs US$50 million of which routine contribution is $20 million whereas the relative efforts put by the group companies are 40%, 30% and 30% respectively.
  • Non-routine profits are split among group companies on the basis of ownership of non-routine intangibles i.e 20%, 30% and 50%.
  • Compute ALP of the related party in US, Japan and India.

Solution:

PSM

Question

PSM is typically applicable in which of the following circumstances

  1. In international transactions that are so interrelated that they cannot be evaluated separately to determine Arm’s length price of any one transaction.
  2. When there is a tri-patriate agreement between AEs
  3. It is a residual method and is applicable in the event that no other method is applicable.

Answer a.

PSM is typically applicable in international transactions that are so interrelated that they cannot be evaluated separately to determine Arm’s length price of any one transaction

Question

Operating profits are distributed to the AEs usually in the following manner.

  1. Basic profit and residual profit
  2. Gross profit and net profit
  3. As a percentage of revenue

Answer a.

Sometimes the net profit is split into basic profit and super profit (residual profit) so as to ensure that the enterprise receive basic return appropriate to the type of international transaction

 

TNMM

  • In this method, the net margin realized by the enterprise from an international transaction with an AE is computed having regard to cost incurred or sales effected or assets employed or having to any other relevant base. It is referred to as Profit Level Indicator (‘PLI’).
  • The net margin realized by the enterprise from uncontrolled transaction or by an unrelated enterprise for a similar transaction is computed using the same PLI.
  • Profit margin is adjusted to take into account differences which could materially affect the net profit margin in the open market.
  • This method requires functional similarity rather than product or service similarity and accordingly widely used.

Illustration

  • KPO Ltd renders services to its parent company in UK and other group companies.
  • They also provide services to other unrelated parties but those services are not comparable to the services rendered to the AE.
  • Similar companies earn a margin on cost @ 17.5% The details of KPO Ltd is as under: Find ALP
TNMM

Solution:

TNMM 1

Question

TNMM is widely used as Most appropriate method because

  1. This method focuses on margins earned by the enterprise rather than transaction price of similar transaction
  2. It is the easy to apply this method as data on net margins of comparable companies are easily available.
  3. TNMM requires functional similarity rather than product or service similarity when compared with other methods
  4. All of the above.

Answer d.

TNMM focuses on margins earned by the enterprise rather than transaction price of similar transaction and data on net margins of comparable companies are easily available. TNMM requires functional similarity rather than product or service similarity when compared with other methods.

Any other method

  • Any method which takes into account the price which has been charged or paid or would have been charged or paid for same or similar uncontrolled transactions under similar circumstances considering all facts.
  • This method is also widely used as it is often difficult to obtain comparable uncontrolled entities performing similar transactions.

Example

  • Let us say a company Seafair India Ltd is engaged in building a seaport with the technology support of its parent company Seafair UK Plc. The project is envisaged to be completed in 5 years, till which time there would be no revenue. In the meantime, Seafair would pay technical fee to the parent company. How to benchmark the transaction in the absence of margin and similar uncontrolled companies?
  • In situations like this where the company does not earn revenue, we have to look into other ways by which this can be benchmarked. Some of the examples are
  • Floating a tender to obtain quote from unrelated parties for performing similar services and that quote can be used for benchmarking the transaction under ‘Under other method’
  • Often companies undertaking projects involving a substantial construction period, take loans from consortium of banks. These banks often evaluate and approve expenditure beyond a certain threshold. If the technical fee falls within such expenditure, the approval can be used to benchmark the transaction.

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Economic analysis – Transfer Pricing

Economic analysis – Transfer Pricing

Characterization of the transacting parties

  • For applying the above methods, following factors needs to be analyzed with respect to the transactions
  • Specific characteristic of the property transferred or services rendered
  • The functions performed taking into account assets employed and risks assumed by the respective parties.
  • Characterization of entities based on functions performed by each associate enterprise, assets employed by them to carry out the functions and risks assumed by each enterprise in carrying out the functions.
  • Conditions prevailing in the market in which the respective parties operate, laws of the territory, labour and capital markets level of competition etc. are to be considered for such analysis
  • Rule 10B provides that comparable transaction data should relate to the financial year in which the international transaction has been entered into.
  • If CPM, RPM or TNMM is the MAM, then the data of the uncontrolled transaction to be used shall be
  • The data relating to current year
  • The data relating to the FY immediately preceding the current year, if the data relating to the current year is not available at the time of furnishing the return of Income.
  • However, where the data relating to the current year is subsequently available at the time of determination of ALP during the course of assessment proceedings then such data shall be used.
  • Further, if the data for the current year is available but is not functionally comparable, that particular entity should not be used even if previous year is comparable.
transacting parties
  • Tested party and profit level indicator are main parameters in identifying the comparable transaction and the profit margin that has to be compared.
  • This also helps in identifying the Most Appropriate Method

Tested Party

  • There are various participants in an international transaction. In a transaction of say purchase and sale of goods, there is a purchaser and there is a seller.
  • Similarly, in case of services, there is a service provider and a service receiver. So, of the parties in the controlled transaction, the party whose transaction is benchmarked / compared is known as the tested party.
  • In order to find comparables, one party has to be considered as tested party.
  • The following attributes are relevant for choosing the tested party namely:
  • Profitability / pricing of the tested party can be verified based on appropriate data
  • Reliable data can be obtained within reasonable timeframe
  • If the data requires reasonable adjustments, such reliable adjustment can be made.
  • It should be the least complex entity in the transaction.
  • It does not own valuable / significant intangibles

Profit level Indicator

  • Profit level indicator is the ratio of profits earned on an appropriate measure such as sales, costs, capital employed etc.,
  • In CPM, RPM which component should be in the denominator is fixed i.e in case of CPM, it is total cost and in case of RPM it is sales or turnover, etc. In TNMM, it depends on the transactions.
  • The denominator has to be chosen in such a way that it has to be independent of controlled transactions.
  • For example, if the entity has sales to AEs, then the denominator is cost and if the international transaction is purchases, then it would be sales.
  • However, in real situations, an entity may have both purchase / sales or income / expense transactions with its AEs. What would be the denominator in such situations?
    • The least tainted transaction i.e sales or cost would be considered in the denominator.
    • This PLI is applied across all the comparable companies to measure to arrive at ALP.

Question

In order to determine the most appropriate method and choose comparables for international transaction, which enterprise would be selected as the tested party?

  1. Always the enterprise in India
  2. Always the foreign AE
  3. Either of the participants
  4. Any uncontrolled enterprise

Answer c.

Correct. In order to find comparables, one of the AEs has to be considered as tested party. Generally, the enterprise whose profitability can be verified based on appropriate data and which is least complex and does not own significant intangible is considered as the tested party.

Question

Profit Level Indicator (‘PLI’) means

  1. Break-even point
  2. Profit distribution between AEs
  3. Ratio that measure relationships between profits and cost incurred or resources employed, or revenue earned or any other appropriate parameter

Answer c.

PLI is a ratio that measure relationships between profits and cost incurred or resources employed, or revenue earned or any other appropriate parameter. Numerator is often operating profit and the denominator could be either revenue, cost, capital employed etc.,

Question

What component would be representative in the denominator of the PLI in the case of contract manufacturer who purchases the components and sells the finished goods to its AEs.

  1. PLI denominator would be sales since it would be the dependent transaction
  2. PLI denominator would be capital employed since it would have no relationship to controlled transaction.
  3. PLI denominator would be cost since sales is done to AEs and PLI it would be the highest tainted component
  4. PLI denominator could be value added cost or conversion cost

Answer d.

Since the purchase cost and the sales revenue are both tainted since both are from / to AEs, the conversion cost which would largely be with uncontrolled parties could be used as the PLI denominator.

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FAR Analysis – Transfer Pricing

FAR Analysis – Transfer Pricing

  • Functional, asset and risk analysis is often referred to as FAR analysis.
  • When transactions between the AEs are examined for the purpose of determining the ALP, one has to analyse the three components closely, namely
FAR Analysis

Functions performed

  • Functions performed by different parties are examined to ascertain which party performs the most significant activities and which one performs the routine activities.
  • Suppose A Inc (US Company) is a manufacturer of a product and B Ltd (Indian Company) is a distributor while A Inc identifies undertakes the manufacturing process, employs intangibles, conducts quality checks etc. and B Ltd is engaged in identifying the end customer and distributing it, functions of A Inc is significant and not B Ltd. Enterprise which performs key or significant activities has to earn higher return out of the total return.
  • Some of the significant functions are
  • Manufacturing, production or assembly work
  • Purchase and material management
  • Logistic support
  • Business process management
  • Administration functions
  • Finance/ budgeting / Treasury
  • Warehouse / inventory management
  • Quality control
  • Comparing the activities performed in a controlled transaction with that of uncontrolled transaction is a good metric to ascertain the economic value of the activity performed.

Assets Employed

  • In order to perform the requisite functions, each party should deploy assets.
  • The assets employed therefore corroborate with the functions in a transaction.
  • Further, ownership of the intangible assets also plays a key role in the profits attributable to each entity.
  • If one entity has the legal ownership of significant intangible asset and other entity uses the same to perform its functions, then the first entity would be recognised as employing significant assets.

Risks assumed

  • In any business transaction or operation, there are risks involved. Often higher the risk, higher the expected returns.
  • So the party which assumes high risk is expected to remunerate the other party with lower or marginal return.
  • For example, a contract manufacturer who does not assume any product risk will not be remunerated same as the entrepreneur manufacturer.

Common risks that are assumed in a business operations are:

Credit risk

Normally, an enterprise offers some credit period to the customers and if the customer does not pay then such loss has to be borne by the person assuming credit risk

Market risk

Market risk arises due to competition, pricing pressure, etc.

Foreign exchange risk

Enterprises often transact in foreign currency which is different from reporting currency. Any fluctuation in the foreign currency would affect the profit.

Obsolescence risk

The product or services which an enterprise offers may become obsolete over time and the enterprise may have to invent new products / services to stay in business

Technology risk

There is a rapid change in technology and this may result in products become outdated or there may be higher costs for updating the technology.

Capacity utilization risk

Capacity utilization risk relating to loss of profit due to unutilized capacity. Lack of demand for a product or a lock out may result in lower capacity utilization.

Question

Swasta India Ltd manufactures cars by procuring raw materials both from AEs abroad and also locally which are coordinated by the parent company. It has an agreement by which the parent company has to provide necessary intangible and also controls the quality of manufacture, quality of raw material, manufacturing process automation etc. They export all the cars to its unrelated distributors abroad and also sell them in India to unrelated retailers.?

  1. Swasta does not assume credit risk
  2. Swasta does not assume foreign currency risk
  3. Swasta does not assume market risk
  4. Swasta does not assume technology risk

Answer d.

Swasta India has a agreement with its parent company for provision of intangibles, control the manufacturing process etc., We can assume that there are clauses in the agreement which would indemnify Swasta for any deficiency in the raw material, quality or technology. Though it will bear the risk to its ultimate customer the same would be indemnified by the parent company. 

Sourcing information

  • Official publication, reports, studies etc.,
  • Market research studies
  • Price publications including stock exchange and commodity market operations
  • Agreements with AEs and with other unrelated enterprises for similar transactions
  • Letters, communication or other correspondences
  • Accounting policies followed

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Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

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Read More

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Determination of ALP – Transfer Pricing

Determination of ALP – Transfer Pricing

  • Rule 10C deals with the determination of most appropriate method. Under this Rule, the method is best suited to the facts and circumstances, and which provides the most reliable measure of ALP in relation to the international transaction will be considered to be the MAM. Factors that needs to be considered are:
  • Nature or class of transaction
  • The class or classes of AEs and FAR
  • Availability and reliability of data
  • Degree of comparability between the transactions
  • Extent to which reliable and accurate adjustment can be made to account for the difference
  • The nature, extent and reliability of assumptions required to be made in application of a method
  • In case of international transaction or Specified Domestic Transaction (‘SDT’) undertaken on or after 01.04.2014 where more than one price is determined by the MAM, the ALP shall be computed in the prescribed manner specified in Rule 10CA.

When there are more than one Arm’s Length Price

  • As per Rule 10CA(1), in such situations where in respect of an international transaction or SDT, the application of the MAM referred into section 92C(1) results in determination of more than one price, then, the ALP has to be computed on the basis of dataset constructed by placing such prices in an ascending order as provided in Rule 10CA(2).
  • The CBDT has issued rules for use of Multiyear data and range concept and would be applicable only in cases where RPM, CPM or TNMM has been selected as MAM.
  • For each comparable, the data shall relate to the current year.
  • If such data is not available at the time of furnishing the RoI, data pertaining to upto 2 preceding financial years may be used.
  • If the current year is Y0, Previous year is Y1 and previous to that year is Y2, then the rules do not envisage use of data if only data of Y2 is available. Such comparable can be used only if Y0 and Y1 data are available. Similarly, if Y0 data is not comparable, then that data should be rejected.
  • When using multi-year data, data for each comparable should be weighted average of the selected years.

Use of tolerance band

  • If there are fewer than 6 comparables, then arithmetic mean shall apply along with tolerance range benefit.
  • The CBDT has notified that where the variation between ALP as determined under section 92C and the transaction price does not exceed 1% of the transaction price in case of wholesale trading and 3% on other cases, then the transaction price will be regarded as ALP.
  • Wholesale trading means, transactions fulfilling following conditions, namely:
  • Purchase cost of finished goods is 80% or more of the total cost pertaining to such trading activities; and
  • Average monthly closing inventory of such goods is 10% or less of sales pertaining to such trading activities

Illustration

tolerance band

Use of Range concept

  • Range concept can be used for CUP Method as well in addition to CPM, RPM and TNMM. For applying range concept, at least 6 comparable entries in the data set must be available.
  • Arrange the data set in the ascending order.
  • The arm’s length range would be data points lying between 35th and 65th percentile of the dataset.
  • If the transaction price falls within the range, then the same shall be deemed to be ALP. If the 35th & 65th percentile is not a whole number, then value corresponding to the number succeeding the above number should be considered.
  • If it is a whole number, then it shall be average of the dataset of such value and the next higher value is to be taken
  • If the transaction price falls outside the range, the median has to be calculated. Median is the 50th percentile of the dataset. That median is considered as the ALP

Summary of methods and use of range

Range concept

Reference to percentile

For the purpose of illustration, we shall assume following scenarios:

Case 1 – the dataset has 7 values

Case 2 – the dataset has 20 values

percentile
percentile 1
percentile 2

Computation of weights

weights

Question

Where the most appropriate method for determination of ALP of an international transaction is RPM, or CPM or TNMM then, the data to be used for analyzing the comparability of an uncontrolled transaction with an international transaction shall be the data relating to –

  1. Current year only
  2. Current year data and financial Year immediately preceding the current year, if the data relating to the Current year is not available at the time of furnishing the return of income
  3. Data of preceding 3 years
  4. Data of preceding 2 years

Answer b.

Current year data has to be used. However, financial Year immediately preceding the current year data can be used, if the data relating to the Current year is not available at the time of furnishing the return of income

Question

TTK India Limited enters into certain transactions by way of sale to TTK International (UK) of Rs.24.25 lakhs. It determines arm’s length price of such transaction as Rs.25 lakhs and Rs.23 lakhs under CUP method. Such calculation is made by using two comparable. The arm’s length price of such transaction would be

  1. Rs. 24.25 lakhs
  2. Rs. 25 lakhs
  3. Rs 24 lakhs

Answer a.

Since there are only two comparable transactions, arithmetic mean of the prices has to be computed.  The arithmetic mean of Rs 25 lakhs and Rs 23 lakhs is Rs 24 Lakhs. Since the transaction price is excess of ALP, the ALP would be the transaction price, i.e. Rs 24.25 lakhs.

Question

Actual transaction price would be taken as arm’s length price, where variations between the arm’s length price (determined by use of Arithmetic Mean), and actual transaction price does not exceed

  1. 1% of Arm’s length price – in case of wholesale trading and 3% of Arm’s length price – in case of other business
  2. 3% of transaction price in all cases
  3. 1% of arm’s length price
  4. 1% of actual transaction price – in case of wholesale trading and 3% of actual transaction price – in case of other business

Answer d.

The tolerance band is 1% of actual transaction price – in case of wholesale trading and 3% of actual transaction price – in case of other business

Question

Range concept is applicable when

  1. More than one price is determined by use of most appropriate method
  2. Arm’s length price is determined by use of Transaction Net Profit Method (TNMM), or comparable uncontrolled price method (CUP method) or cost plus method (CPM) or resale price method (RPM)
  3. Six or more comparables are available in the datasets
  4. All of the above

Answer d.

Range concept is applicable when six or more comparables are available in the dataset, and the most appropriate method is either CUP, CPM, RPM or TNMM.

Question

Range concept is not applicable when

  1. Most appropriate method is PSM
  2. Most appropriate method is a combination of two or methods
  3. Most appropriate method TNMM

Answer a.

Range concept is not applicable for PSM but can be used for CUP, RPM and TNMM

Question

Under Transfer pricing, actual transaction price or profit margin would be accepted if it falls in the range of

  1. 35th – 65th percentile of the given data set
  2. 65th – 75th percentile of the given data set
  3. 25th – 75th percentile of the given data set
  4. 15th – 35th percentile of the given data set

Answer a.

The range concept prescribes the range to be vale in the dataset between 35th and 65th percentile.

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Returns, Audit and other miscellaneous provisions – Transfer pricing

Returns, Audit and other miscellaneous provisions – Transfer pricing

Records to be maintained

  • Each person who has entered into international transaction has to maintain certain information and documents in respect thereof as may be prescribed by Central Board of Direct Taxes (‘CBDT’).
  • Apart from that, if the person belongs to an International Group and if the group meets certain monetary threshold, then the person is required to additionally maintain and submit prescribed information and document regarding the international group.
  • Each person undertaking an international transaction has to maintain the following documents in accordance with Rule 10D of the Income Tax Rules, 1962.
  • Ownership structure
  • Profile of the multinational group alongwith name, address, legal status and country of residence with whom the entity has international transaction
  • Business of the assessee and industry analysis
  • Nature, terms and price of the international transaction made with AE
  • FAR analysis
  • Economic analysis and market analyses, forecast, budgets or any financial estimates prepared by the assessee relevant to the international transaction
  • Record of uncontrolled transaction taken into account for analyzing their comparability with the international transaction including the nature, terms and conditions relating to such transactions
  • A record of analysis performed to evaluate comparability of uncontrolled transactions with relevant international transactions
  • Description of the methods considered for determining ALP and method selected MAM along with explanation as to such method was so selected and how such method was applied in each case.
  • The record of the actual working carried out for determining the ALP including deails of the comparable data and financial information used to apply MAM, adjustments, if any, made
  • The assumptions, policies and price negotiations, if any which have critically affected the determination of ALP
  • Any other information, data which may be relevant.
  • The monetary threshold for the above requirements is Rs 10 million. If the person has entered into international transaction with aggregate value of less than or equal to Rs 10 million, then there is no requirement of maintenance of documentation. However, there would still be requirement to file the return of details of international transaction.

Audit Report

  • Every person who enters into an international transaction during the previous year is required to obtain a report from a Chartered Accountant and furnish such report on or before the specified date on the prescribed form 3CEB.
  • This report is in two parts. The first part of the auditor is report states that he has examined the accounts and records of the assessee relating to the international transactions entered into by the assessee during the relevant year. He also has to certify that the information furnished in the Annexure are true and correct.
  • The second part of the report contains the Annexure, carrying the particulars of the international transaction, AEs, details of transaction, MAM and ALP etc.
  • Till Assessment Year 2018-19 the specified date on which the report has to be furnished was on or before he due date under section 139(1) i.e filing of return of income which is 30th November of the relevant AY. However, in Finance Budget 2020, i.e from AY 2020-21 it is proposed to advance the due date for furnishing the report by one month before the due date under section 139(1) i.e. October 31 every year.

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Dispute Mitigation strategies in transfer pricing Determining ALP is not an exact science and often may lead to different answer depending on many factors.This has resulted in huge litigation leaving the assessee and the income tax authorities often in the loggerheads.The data available at the time of concluding the agreement / …
Read More

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Advance Pricing Agreements (APA) APA objective APA is an agreement between the taxpayer and the taxing authority on an appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future. Section 92CC empowers the Board to enter into APA with any person undertaking an international transaction.Purpose …
Read More

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Mutual Agreement Procedure Mutual Agreement Procedure (‘MAP’) is a procedure set out in most treaties which permit designated Government representatives to work together to resolve international tax disputes including issues involving double taxation, questions regarding residential status, tax recovery etc. MAP is used to eliminate double taxation that can arise from transfer …
Read More

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Read More

Additional reporting by Multinational companies – Transfer pricing

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Read More

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Read More
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