TRANSFER PRICING Transfer Pricing Compiled by Aishwarya Sai

TRANSFER PRICING Transfer Pricing Compiled by Aishwarya & Sai Prasanth Compiled by Sai Prasanth & Aishwarya H R

Background: Due to Various strategies adopted by MNC to evade tax Introduced in Finance Act, 2001 Sections Covered: 92 to 94 B Objectives: Protection of Tax base No discrimination between MNE group and Independent Enterprises Equitable sharing of tax revenues between the nations i. e. the residence and source countries

MNC Group Scenario: 1 AX Ltd (Singapore) A Ltd (India) To Purchases 1, 000 By Sales 5, 000 To third From AX l. TD party Purchases 10, 000 PROFIT = Rs. 4, 000 By Sales 1, 000 to A Ltd. PROFIT = Rs. 90, 000 TAX @10% = Rs. 9, 000 TAX @30% = Rs. 1, 20, 000 Total Tax = Rs. 1, 29, 000 Cont…

MNC Group AX Ltd (Singapore) A Ltd (India) To Purchases 5, 000 By Sales 5, 000 To third From AX l. TD party Purchases 10, 000 PROFIT = Rs. 4, 90, 000 PROFIT = Rs. 0 TAX @30% = Rs. 0 By Sales 5, 000 to A Ltd. TAX @10% = Rs. 49, 000 Total Tax Evasion : 1, 29, 000 - 49, 000 = 80, 000 /-

What is Transfer Pricing? ? Transfer Price: Is the price at which goods, services, intangibles are transferred to another entity. Transfer Price in Tax: Is the price at which goods, services, intangibles are transferred to another entity being an Associate Enterprise.

Sec 92 – Charging Section Computation of Income from International Transaction having regard to Arm’s length price. International Transaction – Section 92 B Associate Enterprise – Section 92 A Arm’s Length Price – Section 92 C (computation)

Section 92 B – International Transactions between two or more AE’s either or both of whom are Non. Residents Transaction With Transaction By Resident O Non-resident P (Note) Non-Resident P P Note: Above example is framed without considering deemed AE provisions.

Section 92 B – International Transactions involving • Purchase, Sale of tangible property and / or intangible property, • Lease of tangible property and / or intangible property, • Provision of services, financing, • Cost sharing / cost contribution arrangements Having bearing on • • • Existence of prior agreement • Between an unrelated third party and AE of the entity and terms are determined in substance by the AE • For undertaking the transaction with such unrelated third party Profits, Losses, Income, Assets or Liabilities International Transaction 92 B(1) Deemed International Transaction 92 B(2)

Section 92 A – Associated Enterprise by one enterprise in another enterprise; or Means direct or indirect participation in Section 92 A (1) (a) & (b) A Ltd Capital S Ltd Management Control by the same person in both the enterprises A Ltd At any time during the year P Ltd Q Ltd

Section 92 A – Associated Enterprise Section 92 A (2) (a) & (b) DEEMED ASSOCIATE ENTERPRISES CAPITAL Holding Not less than 26% of the voting power directly or indirectly In the other Enterprise In each of such enterprises

Example for Section 92(A)(a) Holds >=26% C Ltd. A Ltd. Example for Section 92(A)(b) A Ltd. Holds >=26% B Ltd. C Ltd.

Section 92 A – Associated Enterprise Section 92 A (2) (e) & (f) DEEMED ASSOCIATE ENTERPRISES MANAGEMENT Appointment of More than Appointment of One or More (>=1) half(>50%) of directors/ Executive Directors/ Executive Members of Governing Board By a) The Other Enterprise b) The same person(s) in both the enterprises

Section 92 A – Associated Enterprise Section 92 A (2) (c) to (m) except (e) & (f) CONTROL c) Loan >=51% of Book Value of Total Assets d) Guarantee >=10% of total borrowings g) Use of know-how, copy right etc. of which other enterprise is owner h) Purchase of 90% or more raw material and consumables i) Influencing the sale of goods and pricing thereof j) Controlled by an Individual or his relative or jointly k) Controlled by HUF, member of such HUF or relative of such member or jointly l) Firm/AOP/BOI >= 10% interest in such firm/AOP/BOI m) There exists between two enterprises, any relation of mutual interest, as may be prescribed.

Sec 92 F - Arm’s Length Price (ALP) Transactions under uncontrolled conditions A Ltd. B ltd. Independent Enterprises

A small recap. . Ø When 2 or more Associated Enterprises enters into an International Transaction, then the provisions of Transfer Pricing will apply. A Ltd India C Ltd India AE Selling pens at Rs. 100 Non AE Selling pens at Rs. 120 = ALP B Ltd USA D Ltd India

What is Tested Party ü In Computation of Arm’s Length Price, the entity whose profit margin is taken up for comparison is known as “Tested Party” ü Identification of the tested party is very important as it also determines the selection of comparables. ü Which party should be selected as Tested Party? -Assessee or Associated Enterprise ü Tested Party should be selected based on: -for which most reliable comparable can be found -with less complex functional analysis

Transfer Pricing Methods Comparable Uncontrolled Price Method Resale Price Method Traditional transaction method Cost Plus Method Profit Split Method Transactional Net Margin Method Other Method- as prescribed by CBDT Transaction profit method

Comparable Uncontrolled Price (CUP) ü Compares price charged for property/ service transferred in controlled transactions with price charged in comparable uncontrolled transactions. ü Requires very high standard of comparability. ü Most direct and reliable way to apply the arm’s length principle – but can be used in case of similarity of product and services.

Comparable Uncontrolled Price (CUP) 1. Internal CUP A Ltd 2. External CUP AE Non-AE B Ltd C Ltd A Ltd P Ltd AE C Ltd R Ltd

Steps to Compute ALP: 1. Identification of one or more Uncontrolled transaction 2. Adjustment of prices 3. Adjusted price shall be the ALP

Example 1: The following are the sales made by A Ltd, India AE B Ltd, USA Particulars Non AE C Ltd, UK No of Cells Phones 1, 000 units Price per Phone Rs. 10, 000 pu Rs. 15, 000 pu Condition to Sale FOB CIF Insurance & Freight - Rs. 700 pu Warranty - Rs. 500 pu

Computation of ALP: Sale Value per unit to Non- AE, C ltd 15, 000 Less: Functional differences adjustments a) Insurance & Freight (700) b) Warranty (500) ALP Transaction Value TP Adjustment pu No of Units TP Adjustment 13, 800 Rs. 10, 000 Rs. 3, 800 1, 000 Rs. 38 L

Resale Price Method (RPM): ü RPM is applicable for only 1 type of transaction i. e. , when goods are purchased from AE and resold to Non-AE without making any substantial value addition. Steps to compute ALP: Ø Identify the International transaction ØIdentify the price at which such goods are resold to Unrelated Party ØIdentify the Normal Gross profit margin earned by purchasing the goods from Unrelated party Ø Deduct the Normal Gross profit from the Resale price ØAdjustment for differences ØAdjusted price shall be ALP

Format for computing ALP: Particulars Amount Resale Price XXX Less: Normal Gross Profit margin (XX) ALP XXX

Example: A ltd. , USA supplies pens to its AE B Ltd. , India at Rs. 2, 500 per box. B ltd sells the same at Rs. 3, 000 per box. B ltd also imports pens from C ltd. , China for Rs. 1, 500 per box. The boxes are sold at Rs. 2, 000 per box. Computation of ALP: Particulars Sale Price Less: Purchase price from Non-AE, C ltd Gross Profit Amt 2, 000 (1, 500) 500 Gross Profit margin= 500/2000*100 = 25% Resale Price 3, 000 Less: Normal Gross profit margin (25%) (750) ALP 2, 250 Transaction Price 2, 500 TP Adjustment 250

Cost Plus Method (CPM): In this method the direct and indirect cost are aggregated to which normal gross profit margin is added. Steps to compute ALP: 1. Identification of Direct & Indirect costs of production in respect of goods transferred to an AE 2. Identification of one or more comparable uncontrolled transactions 3. Determination of Normal gross mark – up on costs in the comparable uncontrolled transaction 4. Adjustment for the differences 5. Adjusted price shall be the ALP

Format for computing ALP: Particulars Amount Total Direct and Indirect cost XX Add: Normal Gross Profit Margin XX ALP XX

Example: A ltd, India is providing Software Development Services Particulars AE B ltd, USA Non AE C ltd, UK Revenue 5, 000 3, 000 Direct Cost 1, 000 800 Indirect Cost 2, 000 1, 700

Computation of Gross Profit Margin: Amt Particulars Revenue from C Ltd 3, 000 Less: Total Cost Direct Cost 800 Indirect Cost 1, 700 2, 500 Gross Profit margin on cost 500/2500*100=20% Direct Cost 1, 000 Indirect Cost 2, 000 Total Cost + 20% Margin ALP 3, 000 3, 600 6, 600 Transaction Value i. e. , Actual Revenue 5, 000 TP Adjustment 1, 600

Profit Split Method (PSM): Application of PSM: ü Transfer of Unique Intangibles üWhere there are multiple International transactions which are so inter-related Steps to compute ALP: 1. Identification of combined Net profit arising from AE 2. Identification of relative contribution made by each AE 3. Identification of reliable external market data 4. Combined NP should be split amongst AE based on relative contribution 5. Profit thus apportioned is taken to arrive at an ALP

Transactional Net Margin Method (TNMM): 31 ü If transaction cannot be benchmarked in any of the earlier methods, then TNMM is applicable. Steps to compute ALP: 1. Identification of Net profit margin realised by AE 2. Identification of Net profit margin realised by Non-AE 3. Adjustment for differences 4. Adjusted ALP

Other Method: ü When Internal or External comparables cannot be identified then, Other Method can be used as MAM. ü Transactions for which Other Method could be used: § Sale of Fixed Asset § Sale of unique patents, etc. ü Rule 10 AB does not provide any methodology for computing the ALP. üData which may be used for Comparability purpose: § Third party Quotations § Valuation Reports, etc.

Most Appropriate Method (MAM) Factors to be considered: Ø The nature and class of International transaction Ø The class or classes of AE’s entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprise Ø The availability, coverage and reliability of data necessary for application of the method ØThe degree of comparability existing between the international transaction and the uncontrolled transaction ØThe extent to which reliable and accurate adjustments can be made to account for the differences

Mean and Range Arithmetic Mean: If the comparables are less than 6. Tolerance Band: If the transaction value lies within the tolerance band then TP adjustment is not required to be made. Ø Tolerance Band shall be +/- 1% for Wholesale trading business Ø +/- 3% in all other cases

Range: If the comparables are 6 or more Example: Z ltd sold goods at Rs. 25 Data Set Comparables Price 1 A Ltd 20 2 B Ltd 22 3 C Ltd 26 4 D Ltd 30 5 E Ltd 33 6 F Ltd 35 7 G Ltd 38

Determination of Range (In case of more than 6 comparable companies) Particulars No. of Comparable Companies 7 35 th Percentile (7*0. 35=2. 45) 3 65 th Percentile (7*0. 65=4. 55) 5 Median (7*0. 5=3. 5) 4 Range of dataset = 3 to 5 ALP Range = Rs. 26 to Rs. 33 ALP (Median) = Rs. 30

Secondary Adjustment ü Applicability of Secondary Adjustment: § TP adjustment made on or after 01. 04. 2016 (i. e, FY 2016 -17 onwards) § Primary adjustment exceeds Rs. 1 Cr § If the excess money (ALP- Transaction Value) is not repatriated to India within 90 days from the relevant date. ü Interest Rates: § If the International transaction is in INR = 12 mths MCLR + 3. 25% § If the International transaction is in Foreign Currency = 6 mths LIBOR + 3% MCLR= Marginal Cost of fund Lending Rate of SBI on 1 st April LIBOR= London Inter-Bank Offered Rate as on 30 th Sep

Section 94 B – Limitation of Interest Deduction in certain cases Reason for insertion: Preference of debt over equity as a measure to finance business as to claim huge amount of interest as expense. Impact: Such expense is allowed as an expense is as follows: Ø 30% of EBITA -Which ever is less ØInterest paid or payable Excess interest amount will be carried forward for 8 years. Applicability of this Section: If the amount of interest paid or payable is exceeds Rs. 1 crore

Section 92 BA – Specified Domestic Transactions Generally, Shifting of profits within the AE’s where both are Residents results revenue neutral. But shifting of profits from profit making entity to entity which are in Tax Holiday results in significant loss to Government. Threshold limit: Rs. 20 Crores Transactions also covered under SDT 80 A 80 IA(8) 80 IA(10)

Three-Tier Documentation The BEPS report recommends that countries adopt a standardized approach to transfer pricing documentation. Master File Local File Country-by. Country Report

Master File ØWho is required to file? Ø Threshold: Both conditions needs to be satisfied i. e. , A + B A. Consolidated group revenue exceeds Rs. 500 Cr AND B. Either 1. Aggregate International Transaction Value exceeds Rs. 50 Cr OR 2. International transaction value in respect of Intangible property exceeds Rs. 10 Cr Ø Due Date Before due date U/s 139(1)

Country By Country Report ØWho is required to file? Ø Threshold Limit Consolidated Group revenue of the preceeding FY must exceed Rs. 5500 Cr Ø Details required to be furnished: ü Details of group revenue, profit/loss before tax, amount of tax paid, capital and accumulated earnings, No. of employees and tangible assets ü Details of each entity of Multinational group. Ø Due date Within 12 months from the end of the Accounting year.

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