TRANSFER PRICING UNDER INCOME TAX ACT, 1961 N.Madhan B.Com., CA & Grad CWA 1 22 August 2015
Contents Concept of Transfer Pricing Important Terminologies Nature of Methods & its Applicability Importance of FAR Current Trends in Transfer Pricing 2
Concept & Importance of T P It s a process of setting prices for transactions between related parties Would the transactions happen at the same price if the parties are not related? Concern for all developed countries that TP is used as a tool to manipulate prices Most of the CFOs / Tax Heads of MNCs view this issue as one of their top 5 agenda Recently OECD has come out with Action plan on BEPS 3
Important Terminologies Associated Enterprises International Transaction Deemed International Transaction Arm s length Price Arithmetic Mean 4
Associated Enterprises A Ltd, US holding directly or indirectly the shares/ control of B Ltd, India = A & B are related A Ltd, US holding directly or indirectly the shares/ control of B Ltd, India & C Ltd, Korea = A, B & C are related Deemed Associated Enterprises A Ltd giving loan to B Ltd A Ltd giving guarantee to B Ltd A Ltd dependent on B Ltd for raw materials A Ltd dependent on B Ltd for technical know-how 5
International Transaction Transaction affecting Profits/Assets/Losses Capital Financing / Business Restructuring Deemed International Transaction A Ltd, US enters into contract with B Ltd US for supply of goods to all the group companies of B Ltd worldwide. All the terms & conditions for the global transactions are agreed between A Ltd & B Ltd. Now, C Ltd India supply goods to a group company of B Ltd at a pre-determined price 6
Arm s Length Principle Parent Co. Unrelated Co. Y Sub Co. Unrelated Co. X Unrelated Co. Z 7
Arithmetic Mean Simple average of the comparable prices Cause for more than 60% of the litigations in India over the last 8 Assessment Years Weighted Average / Range Concept accepted in the recent budget 8
Process to arrive at the comparable Price Understand the business profile of Taxpayer Corroborate the business profile with the industry overview Determine all the International transactions of the Taxpayer Analyze the FAR of Taxpayer & AE Select the Most Appropriate Method Choose the Comparables Make proper adjustments to arrive at the price 9
Methods Arm s Length Principle Comparable Uncontrolled Price Method (CUP) Resale price Method (RPM) Cost Plus Method (CPLM) Profit Split Method (PSM) Transactional Net Margin Method (TNMM) Any other method as may be prescribed 10
Comparable Uncontrolled Price - CUP Can be used for any transaction Characteristics Most Reliable method Directly compares the price Can be external or internal Adjustments can be direct Data Availability Product compared should be identical Situations where CUP can be used Purchase of RM / FG / Services Sale of RM / FG / Services Royalty / Technical Know-how Purchase / Sale of Capital items 11
Resale Price Method RPM Used in case of a Taxpayer Reseller who buys goods/services from its AE for subsequent sale to unrelated party without any value addition Characteristics Compares the margin of Taxpayer at Gross Level with the comparables Product comparability can be diluted and what is essential is functional comparability Data Availability is difficult due to accounting differences / profile of parties Differences between FRD / LRD / Commissionaire Situations where RPM is used Mostly in case of Distributors / Resellers Example Apple India buys iphones from Apple US for sales to customers Take the final price and arrive at the Gross Margin for comparison with the comparable companies 12
Cost Plus Method CPM Used in case of a Taxpayer, who is a contract manufacturer / Service provider to its AE and who does not function as an entrepreneur Characteristics Compares the margin of Taxpayer at Gross Level with the comparables Product comparability can be diluted and what is essential is functional comparability Data Availability is difficult due to accounting differences / profile of parties Situations where CPM is used Mostly in case of Contract Manufacturers / Service Providers Example Indian software company working on a complete risk free model for its parent in US. 13
Profit Split Method - PSM Used when the transactions are so complex in nature or the transactions involve use of intangibles Characteristics Looks at the overall profits made by the Taxpayer & its AEs Determine the role played by each of the parties to the transaction and the consideration to be paid for the same Analyse the actual contribution made by the parties to the transaction Redistribute the contribution based on the FAR / role Product comparability can be diluted and what is essential is functional comparability Data Availability is difficult due to accounting differences / profile of parties Rarely used Situations where PSM is used MNCs having their manufacturing / distribution / HQ services decentralised 14
Transactional Net Margin Method - TNMM Lender of last resort Characteristics Can be applied to any situation Looks at the profitability at the net level Adopts various Profit Level Indicators PLI Reliable adjustments can be made in certain cases Data Availability is much better Commonly used 15
Tax officer s right To determine the arm s length price if he believes that Price not determined per most appropriate method Information/documentation not maintained Information/data not reliable/correct Failure to furnish the information/documentation 16
Penalties 2% of transaction value if prescribed information or documentation not maintained OR furnished. 100% to 300% of tax adjustment Rs 1 Lac for failure to submit Accountants report 17
1 Transfer pricing Recent trends and issues
Assessment process 1 AO to refer TP cases to TPO (under sec 92CA) 4 Assessing Officer ( AO ) TPO 2 AO to incorporate TPO s order in the Assessment Order Send notice to the taxpayer Hearing/ Document Analysis/ No site visits/ No interviews Copy of order sent to the AO and taxpayer 3 19
India litigation statistics Estimated transfer pricing adjustments in India Financial year No. of cases Cases adjusted Cases adjusted (%) Estimated adjustment (in million USD) 2001-02 1,061 239 23 203 2002-03 1,501 337 22 381 2003-04 1,768 471 27 572 2004-05 218 84 39 269 2005-06 1,726 670 39 1,023 2006-07 1,830 813 44 1,818 2007-08 2,301 1,138 49 3,873 2008-09 2,638 1,343 52 7,422 2009-10* 3600 approx. 1800 50 approx. 10,000 YoY increase by approx 100% Source : First report of the Rangachary Committee to review taxation of development centers and the IT sector * As per the Article published in Financial Express on 10 th March 2014 Page 20 20 Unique litigation
Litigation Trends in Transfer Pricing Arithmetic Mean Prior Year Data / Weighted Average Importance of FAR Basis of acceptance / rejection of comparables Basis of Adjustments & its reliability Beyond the obvious transactions Interest on delayed receivables Issue of Share capital Marketing Expenses 21
Recent Introductions in Transfer Pricing Formation of Dispute Resolution Panel Introduction of Safe Harbour Provisions Introduction of APA mechanism Government intervention on some high-pitched litigations 22
Questions?? 23
Thank You!!! N Madhan 98408-98157 iammadhan@gmail.com 24