INDIAN ACCOUNTANCY PROFESSION : MARCHING TOWARDS GLOBAL CENTRE STAGE

ISSUES IN Transfer pricing

Background
Globalization Increased Cross Border Inter Company Transactions Manipulation of transfer prices in order to minimize the tax burden Tax authorities forced to regulate transfer prices Arms Length Principle

Legislative Framework
5 The chapter of transfer pricing was Introduced in The Finance Act, 2001 through Sections 92A to 92F of the Indian Income tax Act, 1961. Built on OECD deviations. guidelines, but with significant

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It aims to provide statutory framework that will create a reasonable, fair and equitable tax base.

Meaning & Applicability

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Meaning:
Transfer Pricing relates to determination of correct market
price i.e. arms length price relating to sale of goods and provision of services, allowance for any expense or interest arising from the international transaction. Their is an International transaction(s) [defined in Sec 92B] between

Provisions applicable only if:

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Two or more Associated enterprises [defined in Sec 92A].

Provisions do not apply certain cases [Section 92(3)]

Exceptions:
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International Transaction
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Cross border transaction between associated enterprises entering into one or more of the following transactions:
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Purchase, sale or lease of Tangible or Intangible Property Provision of services

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Lending or borrowing of money

Any transaction having a bearing on profits, income, losses or assets

Mutual agreement between Associated Enterprises for allocation/apportionment of any cost, contribution or expense. and there must be at least one non resident involved in the international transaction

Associated Enterprises
3 Direct Control/Control through intermediary 3 Holding 26% of voting power 3 Advance of not less than 51% of the total assets of borrowing company 3 Guarantees not less than 10% on behalf of borrower 3 Appointment of more than 50% of the Board of Directors 3 Dependence for 90% or more of the total raw material or other consumables

Method of determining Arms Length Price

5 Meaning: Arms Length Price
3 3 Price which two independent firms would agree on. Price which is generally charged in a transaction between persons other than associated enterprises or unrelated parties.

5 Methods of Computation of Arms Length Price:

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Comparable Uncontrolled Price Method (CUP) Resale Price Method Cost Plus Method (C+) Profit Split Method Transaction Net Margin Method (TNM) Such other Method as may be prescribed by the Board

5 Comparable Search Process is Conducted with the help of software PROWESS developed by Centre for Monitoring Indian
Economy Private Limited (CMIE).

Method of determining Arms Length Price

Type of Transaction
Manufacturing of goods

Possible method
CUP, C+, Profit split

Sale of goods
Provision of services

CUP, Resale price, Profit split, TNM CUP, C+, TNM

Financing (loans, deposits, guarantees) CUP, Profit split, TNM Transfer of intangibles (technology, brand, know how) CUP, C+

Accountants Report
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Furnishing of Report: Every person entering into international transaction is required to furnish the Accountants reportwith the tax authorities in FORM NO. 3CEB. Due Date of Filing: To be submitted by the due date of filing annual return of income. At present, Due Date is 30th September for the Company Assessees and 31st July for other Assessees. No Basic Threshold Limit: The report is required to be submitted irrespective of the amount of international transaction. Practical Aspect: Normally, when due date of filing return of income is extended, the due date for filing report under this section 92E is not extended unless otherwise extended.
(Source: Board September 2010) Circular No. 225/72/2010/ITA.II/CBDT dated 27th

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Documentation
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Kept and maintained in by every person.
List of documents prescribed in Rule 10D.

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Kept and maintained for a period of 9 years from end of relevant tax year.
Furnished within 30 days of Revenues request. Documentation is not required to be maintained if the aggregate value of all international transactions does not exceed one crore rupees.

Assessment / Audit
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Mandatory Audit: Aggregate value transaction exceeds 15 crore rupees. of international

Time Limit: Audit is to be completed within 45 months from end of relevant tax year.

Reference to Transfer Pricing Officer (TPO): If total value of international transaction exceeds the limit of 15 crore rupees, the Assessing Officer has to refer the matter to TPO. Appeal: Tax payer can approach commissioner of appeals against the adjustments made. Further aggrieved party can approach tax tribunal and on question of law to High Court and Supreme Court for relief.

Miscellaneous Issues

5 Burden of Proof 5 Penalties 5 Safe Harbour Provisions

(Amendment by Finance Act, 2009)

5 Dispute Resolution Panel

(Amendment by Finance Act, 2009)

Method of Computation of Arms Length Price Comparable Uncontrolled Price Method

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Comparison of price charged with comparable uncontrolled transaction. The price charged in a comparable uncontrolled transaction is adjust to account for differences. The price so adjusted is taken to be arms length price. Example: 3 X, a company in US, sells softwares of Accounting Programmes to Indian subsidiary Y for resale @ USD 3.5 million. 3 X also sells the same product to other resellers (say Z) in India with identical terms. 3 If X sells to Z the same software for USD 4 million, then the CUP price for sales by X to Y would also be USD 4 million, 0.5 million charged less to Y by X.

Method of Computation of Arms Length Price Resale Price Method

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Price at which a product is resold to an independent enterprise by an associated enterprise is determined. Such resale price is adjusted by reasonable expenses incurred by the enterprise in a comparable uncontrolled transaction. The price so arrived is further reduced by the amount of normal profit margin The price so adjusted and arrived is taken to be arms length price. Example: 3 X sold to Y at Rs. 1000 (Profit: Rs. 300) 3 Y sold to Z at Rs. 2000 (Profit of Rs. 500 for Z) 3 Arms Length Price: Rs. 2000 -- Rs. 500=Rs. 1500

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Method of Computation of Arms Length Price Profit Split Method

Net Revenues from all Transactions

Minus functional/assets returns to each party based on market benchmarks

Residual Profit share for Related Party X

Residual Profit share for Related Party Y

Residual Profit Split based on each partys ownership of non routine intangibles (e.g. network reach )

Appropriateness of Method: For pharmaceuticals or

software manufacturing units where business processes are spread between several units in different countries.

Method of Computation of Arms Length Price Cost Plus Method

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Determines arms length price by adding an appropriate gross profit margin to an associated entitys costs of producing products or services. The gross profit margin is calculated with reference to comparative uncontrolled transaction. The gross profit margin should include a return for capital used and risks accepted by the entity.

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Example:
3 3 Y Indian Company is a wholly owned subsidiary of X who manufactures luxury cars. Y is being charged at Rs. 100000 per car by X, which is also its cost. Comparable company to Y in India, based on the analysis of financial statements, earns 40% on costs. Applying the above margin of 40%, the transfer price under this method work out to be Rs. 140000 (Retail Price in India i.e. Rs. 100000 + Rs. 40000 i.e. Margins of comparables companies).

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Method of Computation of Arms Length Price Transaction Net Margin Method

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This method requires comparison between net margins derived from the operations of the uncontrolled parties and net margins derived by an associated enterprise from similar operations. Net margin is indicated by the rate of return on sales or cost or operating assets and this forms the base of TNMM.

The net profit margin realized from associated enterprises is established to be same as the net profit margin from uncontrolled parties. The net profit margin thus established is then taken into account to arrive at an arms length price in relation to international transaction with associated enterprises.

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