TRANSFER PRICING Prepared by PAMS PROFESSIONAL GROUP INTRODUCTION

TRANSFER PRICING Prepared by PAMS PROFESSIONAL GROUP

INTRODUCTION : § Transfer pricing is the setting of the price for Goods & services sold between the Associated Enterprise. § Transfer price doesn’t differ much from market price. § Example : When subsidiary company sells goods to a parent company, the cost of those goods is the transfer price. § The transfer price can also be known as a transfer cost.

APPLICABILITY : § Section 92 of Income Tax Act, 1956 provides : INTERNATIONAL TRANSACTIONS (Sec 92 B) INCOME ALLOCATION OF COST in relation to SPECIFIED DOMESTIC TRANSACTIONS (Sec 92 BA) EXPENDITURE INTEREST Computed on Arm’s Length Price (ALP) Note : If due to ALP there is reduction in the income or increasing the losses then transfer pricing provisions shall not apply.

ASSOCIATED ENTERPRISE (Sec 92 A): § Two enterprises shall be treated as AE’s if at any time during the P. Y. : 1 holds at least 26% shares (Voting Power) of other enterprise Any person holds at least 26% of each of such enterprise. 1 appoints < Half of BOD or 1 or more Executive Director in other enterprise. Any person appoints < Half of BOD or 1 or more Executive Director in each enterprise. Loan given to other enterprise > 51% of Total Assets of other enterprise. Guarantees at least 10% of Total Borrowing of other enterprise.

ASSOCIATED ENTERPRISE (Sec 92 A): § Two enterprises shall be treated as AE’s if at any time during the P. Y. : Raw material > 90% is supplied by 1 to another enterprise. Goods manufactured sold to other enterprise & Price 1 enterprise controlled by Individual/HUF and other controlled by such Individual/members or his relative or jointly 1 enterprise has > 10% interest in another enterprise being Partnership Firm, AOP, BOI Any relationship of mutual interest, as may be prescribed.

INTERNATIONAL TRANSACTION : § Section 92 B of Income Tax Act, 1956 states : Transaction b/w 2 or more Associated Enterprises (A. E) At least one must be Non – Resident (NR) A. E. - 1 A. E. - 2 International Transaction Resident Non - Resident YES Non – Resident Non - Resident YES

ALP – COMPUTATION : § Sec 92 C (1) provides ALP Computation as per the Most Appropriate Methods as follow Comparable Uncontrolled price (CUP) Method Resale Price Method (RPM) Cost Plus Method (CPM) Profit Split Method (PSM) Transactional Net Margin Method (TNMM)

CUP METHOD : § The Comparable Uncontrolled Price (CUP) method requires comparison between § price of property or services transferred in a controlled transaction to the § price charged for property or services transferred in an uncontrolled transaction § in comparable circumstances. Particulars Amount (XX) Price charged/paid in cup transaction XXX (+)/(-) Adj. for difference between international transaction & comparable uncontrolled transaction XX ALP XXX Applicability : When Comparable uncontrolled transaction is available.

Resale Price METHOD : § Begins with the price at which a product that has been purchased from an associated enterprise and § resold to an independent enterprise. Particulars Amount (XX) Price charged for goods sold to unrelated enterprise (-) Normal G. P. margin in similar transaction XXX XX XXX (-) Purchase related expenses ALP (XX) XXX Applicability : When goods purchased from A. E is t/f (sale) to unrelated person.

Cost Plus METHOD : § Products manufactured / services rendered in a controlled transaction by comparing § the gross profit margin applied to the direct and indirect costs incurred for production or for rendering services by the tested party against § the margin earned by the party or by an independent party under uncontrolled similar conditions. Particulars Amount (XX) Direct Cost + Indirect Cost of Production (-) Normal G. P. margin in similar transaction XXX XX XXX (+)/(-) Adj. for difference between international transaction & comparable uncontrolled transaction (XX) ALP XXX Applicability : When goods manufactured by 1 A. E sold A. E to other.

Profit Split METHOD : § It is applicable in international transactions involving transfer of unique intangibles or in multiple international transactions, which are so interrelated that they cannot be evaluated separately for determining the arm’s length price of any one transaction. § First find Total Profit earned in Joint Venture with it’s A. E. and divide in the ratio of manpower employed, functions performed, risk taken etc. Particulars Amount (XX) Cost Incurred by Assesse XXX (+) Share of Profit of such enterprise ALP XX XXX Applicability : Where assesse executes an order in joint venture with it’s A. E.

TNMM METHOD : § Net profit earned by other players in the same industry under the same or similar consideration taken into account for computing ALP. § TNMM examines the net profit margin relative to an appropriate base realized on the transaction. § Under TNMM comparable need to be broadly similar. § Significant product diversity and some functional diversity between the controlled and uncontrolled parties are acceptable. § In such a situation, net margin or operating profit is the most reliable and viable indicator of profit level. § Operating Profit = Profit before tax + Finance Cost

TOLERANCE BAND : § Sec 92 C (2) provides that if difference between Rs. 150 Rs. 153. 5 Actual Transaction Price Arm Length Price (ALP) Up to 3% (1% in case of trading) When ALP’s are 5 or less than 5 Ignore 150 * 3% = Rs 4. 5 In this case difference between Actual Price & ALP is up to 3% so actual transaction price i. e. 150 is treated as ALP.

RANGE CONCEPT : § Rule 10 CA depicts about the following steps to be followed in order to find a range between our ALP should Lie : When ALP’s are 6 or more than 6 Step 1 Step 2 Step 3 Step 4 • Arrange the values in Ascending Order. • Arrive at a range starting from “ 35 th Percentile” & ending at “ 65 th Percentile”. • If Actual price falls between range then it deemed to be ALP. • If Actual price doesn’t fall between range then Median (i. e. 50%) deemed to be ALP.

RANGE CONCEPT (Example) : Actual Transaction Price – Rs 150/S. No. 1 2 3 4 5 6 7 ALP 162 158 136 145 170 152 154 S. No. 1 2 3 4 5 6 7 ALP 136 145 152 154 158 162 170 Step - 1 Step - 2 Percentile Calculation Value 35 th 7*(35/100) = 2. 45 3 65 th 7*(65/100) = 4. 55 5 The ALP range begins at 152 (3 rd Number) & ends at 158 (5 th Number).

RANGE CONCEPT (Example) : Step - 3 § If actual transaction price is within the range (152 -158) then the actual transaction price shall be treated as deemed to be ALP, § But in our example, Actual Transaction price (i. e. 150) doesn’t fall within the range so ALP shall be median of data. Step - 4 Median 50 th Calculation Value 7*(50/100) = 3. 5 4 The ALP is at 4 th number i. e. Rs. 154.

ALP by A. O: § Under sec 92 C (3) A. O shall determine ALP in the following cases : Assesse fails to compute ALP as per Most appropriate Method (92 C(1)). Opportunity of being heard shall be given to Assesse Data used for computing ALP is not reliable or incorrect. Documents are not maintained by Assesse as per Sec 92 D. Assesse fails to furnish info & docs required u/s 92 D.

ALP by A. O - Effects: § If ALP is computed by A. O. under Sec. 92 C (3) then : § If income of 1 enterprise is increased by A. O. the income of the other Associated enterprise shall not change [Unaffected] § If income of 1 enterprise is increased by A. O, then deduction under chapter VI – A & Sec 10 AA shall not be allowed against increased part of its income

MAINTENANCE OF INFORMATION & DOCUMENTS : § Sec 92 D of Income tax Act, 1956 : § Assesse required to maintain documents as specified by CBDT. § Documents are required to be maintained only if value of International transaction is More than 1 Cr. § Documents required to be kept for 8 years from the end of relevant A. Y. 1. Background of the Company and its Associated Enterprises 2. Functional Analysis to document the Functions, Risks and Assets deployed 3. Industry Overview 4. Comparability/Benchmarking analysis to prove the Arm’s Length nature of International Transactions entered into between Associated Enterprises

Report of CA (Sec 92 E) : § Assesse required to file report of CA in the form No. 3 CEB up to 30 th Nov of A. Y. § Penalties : Section 271 AA Default i. Failure in keeping & maintaining info & Docs are per Sec 92 D Penalty ii. Fails to report transaction 2 % of transactions value iii. Fails to furnish info & doc. (Master File) Rs. 5, 000 271 G Failure to furnish info & documents as per Sec 92 D. 2 % of transactions value 271 BA Failure to furnish report of CA as per Sec 92 E. Rs. 1, 000

SUMMARY : SECTION NUMBER Description Further Description Applicability – International Transaction + Specified Domestic Transaction. Computation of ALP – ALP shall not apply if it gains to assesse. Section 92 A Associated Enterprise Applicability Section 92 B International Transaction At least 1 enterprise is Non – Resident Section 92 C (1) Computation of ALP 5 most appropriate method Section 92 C (2) Tolerance Band 3 % of Actual Transaction Price Rule 10 CA Range Concept 4 Steps to be followed ALP calculation by A. O. Applicability & Effect Section 92 D Documentation for TP IT > 1 Cr. + for 8 Yrs Section 92 E Report from CA Form 3 CEB up to 30 th Nov of A. Y. Section 92 C (3)

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