3. Applicability – SDT…
• The Finance Act 2012 extended the scope of Transfer Pricing
provision to ‘Specified Domestic Transactions (‘SDT’)
• The SDT would include the following:
• Expenditure for which payment is made or to be made to
domestic related parties-40A 2(b) payment
• Tax Holiday/ Deductions claimed by the taxpayer, where;
• Transfer of goods or services between various
businesses of same taxpayer
• More than ordinary profits derived from transactions
with closely connected persons
Transfer Pricing provisions to apply to the ‘Specified Domestic Transactions’ if
the aggregate value exceeds five crores
3
4. ..Applicability – SDT..
• 92BA. For the purposes of this section and sections 92, 92C, 92D and
92E, "specified domestic transaction" in case of an assessee means
any of the following transactions, not being an international
transaction, namely:—
(i) any expenditure in respect of which payment has been made or is to be
made to a person referred to in section 40A(2)(b) –
JGarg Economic Advisors 4
5. ..Applicability – SDT..
• Section 40A(1)
– Applicability restricted to the computation of income under the head
“Profits and gains of business or profession”
• Section 40A(2)
– Applicable on expenditure in respect of which payment has been made
or it to be made
– Expenditure in respect of goods, services or facilities
• Q&A
– Interest free loan given to related party
– Corporate guarantee without any charge
– Goods sold at lower value
– Capital expenditure
JGarg Economic Advisors 5
6. ..Applicability – SDT..
(ii) any transaction referred to in section 80A
Assessee
Undertaking/ unit / Goods/ Services
enterprise / eligible Any other business
business
JGarg Economic Advisors 6
7. ..Applicability – SDT..
(iii) any transfer of goods or services referred to in sub-section (8) of
section 80-IA
Assessee
Undertaking/ unit /
Goods/ Services
enterprise / eligible Any other business
business
JGarg Economic Advisors 7
8. ..Applicability – SDT..
(iv) any business transacted between the assessee and other person as
referred to in sub-section (10) of section 80-IA
Close Connection
Independent tax
Assessee
payer
Any other reason
Eligible business with
more than ordinary
profits
JGarg Economic Advisors 8
9. ..Applicability – SDT..
(v) any transaction, referred to in any other section under Chapter VI-A or
section 10AA, to which provisions of sub-section (8) or sub-section
(10) of section 80-IA are applicable;
– 10AA - Special provisions in respect of newly established Units in Special
Economic Zones.
– 80IAB - Deductions in respect of profits and gains by an undertaking or
enterprise engaged in development of Special Economic Zone.
– 80IB - Deduction in respect of profits and gains from certain industrial
undertakings other than infrastructure development undertakings.
– 80 IC - Special provisions in respect of certain undertakings or enterprises in
certain special category States
– 80ID - Deduction in respect of profits and gains from business of hotels and
convention centers in specified area.
– 80IE - Special provisions in respect of certain undertakings in North-Eastern
States
JGarg Economic Advisors 9
10. ..Applicability – SDT..
(vi) any other transaction as may be prescribed
and where the aggregate of such transactions entered into by the assessee
in the previous year exceeds a sum of five crore rupees.
JGarg Economic Advisors 10
11. Compliance…
• Taxpayer must compute the arm’s length price of SDT as per the
methods prescribed under section 92C.
• Burden of proof is on the taxpayer to establish the arm’s length
price and to maintain related documents.
• Must obtain a report under Form 3CEB (or any other as prescribed)
from a Chartered Accountant and file it before tax authorities
within due date of filing of return of income.
• For assessment year 2011-12 and onwards, due date would be 30
November.
• Tax payer must submit the transfer pricing document to the tax
authorities, within 30 days of the receipt of notice from the
department.
JGarg Economic Advisors 11
12. …Compliance
• Penalties
– Non maintenance of documents, fail to report transaction, maintain or
furnishes an incorrect information or document – 2% of the value of
SDT – Section 271AA
– Non filing of Form 3CEB – Rs.100,000/ - Section 271BA
– Failure to furnish information or document to tax authorities – 2% of
the value of SDT – Section 271G
JGarg Economic Advisors 12
13. Arm’s Length Principle…
• Prices set for transactions between group entities
• should,
• for tax purposes,
• be derived from
• prices which would have been applied by unrelated parties
• in similar transactions under similar conditions in the open market.
JGarg Economic Advisors 13
14. TP Documentation…
• Refer section 92D of the Act read with Rule 10D of the Rules
Types of Documents
Transaction Computation
Enterprise - wise
specific related
JGarg Economic Advisors 14
15. …TP Documentation…
• Enterprise-wise documents
– Ownership structure of the taxpayer
– Profile of the Group
– Name of Associated Enterprises, address,, legal status, country of
tax residence, ownership linkage and business
– Business of the taxpayer, description of industry
JGarg Economic Advisors 15
17. …TP Documentation…
• Computation – related documents
– Most appropriate method
– Computation of arm’s length price
– Assumptions, policies and price negotiation
– Transfer pricing adjustment
JGarg Economic Advisors 17
18. …TP Documentation…
• Section 92 D of the Act read with Rule 10E of the Rules
– Should be prepared on contemporaneous basis
– Should be kept and maintained for 8 years from the end of the
relevant assessment year
– No fresh documentation required for continuing transactions
unless there is some significant change which can have impact on
pricing
JGarg Economic Advisors 18
20. Flow Chart
Comparable
Business Transaction Environment Method
Transaction
Documentation
Computation of Arm’s Length
Price
Form 3CEB
JGarg Economic Advisors
21. Transfer Pricing Methods
TP Methods
OECD Guidelines Indian Regulations
CUP Methods CUP Methods
Resale Price Method Resale Price Method
Cost Plus Method Cost Plus Method
Profit Split Method Profit Split Method
Transactional Net Margin Method Transactional Net Margin Method
JGarg Economic Advisors 21
22. ..TP Methods..
• In general
– Comparable Uncontrolled Price (“CUP”) Method compare prices
– Resale Price Method (“RPM”) compares gross margins
– Cost Plus Method (“CPM” compares profit mark-ups on costs
– Profit Split Method (“PSM”) refers to the (total) profits from
transactions and splits them among the parties based on the level
of contribution
– Transactional Net Margin Method (“TNMM”) analyses net profit in
relation to an appropriate base, such as costs, sales or assets
JGarg Economic Advisors 22
23. TP Methods – CUP…
• CUP Method
– Most direct way of determining an ALP
– It compares the price charged for goods or services transferred in
SDT to the price charged for property or services transferred in a
comparable uncontrolled transaction.
– Price is adjusted to account for differences, if any, between the SDT
and the comparable uncontrolled transactions or between the
enterprises entering into such transactions, which could materially
affect the price in the open market.
JGarg Economic Advisors 23
26. …TP Methods – CUP
• Comparability
– The comparability of property transferred in SDT and an
uncontrolled transaction is most decisive for the application.
– Intended purpose of use, branding or customer perception and
preference would impact applicability.
– Market comparability is another important factor to be considered.
– Contractual term including quantity of property sold or acquired,
volume discounts, applicable currency, marketing, advertising,
after sale support, duration of contract, terms of delivery, terms of
payment etc can not be ignored.
JGarg Economic Advisors 26
27. CUP – Case Study 1
AB India Ltd. 200 customers
A Ltd.
XY India Ltd. 210 customers
JGarg Economic Advisors
28. CUP – Case Study 1
• FAR
FAR A Ltd & AB India Ltd. A Ltd. & XY India Ltd.
F.1. Procurement A Ltd. A Ltd.
F.2. Packaging A Ltd A Ltd
F.3. Marketing AB India Ltd. XY India Ltd.
F.4. Sales to final AB India Ltd. XY India Ltd.
customer
F.5. After sales support AB India Ltd. XY India Ltd.
A.1. Warehouse A Ltd. A Ltd.
A.2. Logistics AB Ltd. XY India
A.3. Brand A Ltd. A Ltd.
A.4. Distribution network AB Ltd. XY India
JGarg Economic Advisors 28
29. CUP – Case Study 1
• FAR
FAR A Ltd & AB India Ltd. A Ltd. & XY India Ltd.
A.5. Customer list AB Ltd. XY India
R.1. Product risk A Ltd A Ltd
R.2. Product service risk AB India Ltd. XY India Ltd.
R.3. Credit risk AB India Ltd. XY India Ltd.
R.4. Product AB India Ltd. XY India Ltd.
obsolescence risk
JGarg Economic Advisors 29
30. CUP – Case Study 1
• Other information
Transaction Detail A Ltd & AB India Ltd. A Ltd. & XY India Ltd.
Product Cotton Shirts of same Cotton Shirts of same
fabric and brand fabric and brand
Payment terms 30 days 30 days
Delivery terms FOB C&F
Market in which A Ltd Wholesale Wholesale
operates
Market in which AB India Retail Retail
& XY India operates
Conditions prevailing in Same Same
the market
JGarg Economic Advisors 30
31. CUP – Case Study 1
• Conclusion
– Transaction between A Ltd. & AB Ltd. (‘Controlled transaction’) and A Ltd. & XY
India Ltd (‘Uncontrolled transaction’) are comparable.
– However, difference for adjustments in delivery terms need to be carry out.
– Hence, CUP is the most appropriate method.
JGarg Economic Advisors 31
32. CUP – Case Study 1
• Steps to follow
– Identify controlled transaction
– Identify uncontrolled transaction
– Is price data or data for calculating profit margin available for each
transaction?
– Are the physical characteristics of inventories and nature of services involved
in controlled transactions and uncontrolled transaction are same or similar?
– Is market level same – retail, wholesaler, OEM, secondary etc.?
– Do the transactions differ in volume or timing?
– Are there any differences in the terms of trade, payment terms, conditions for
returns, or conditions regarding contract renewal?
– Are there any differences in the functions of the seller or buyer (e.g. in terms
of R&D, marketing, and after-sales service)?
JGarg Economic Advisors 32
33. CUP – Case Study 1
• Steps to follow
– Are there any differences in the terms of trade, payment terms, conditions for
returns, or conditions regarding contract renewal?
– Are there any differences in the functions of the seller or buyer (e.g. in terms
of R&D, marketing, and after-sales service)?
– Are intangible properties used by the seller or buyer in transactions?
– Are there any differences in terms of business strategy (e.g., policy toward
market development and penetration) or timing of market entry?
– Are there any differences in government regulation (e.g. price regulation),
market size, or competition, etc. affecting prices and profit margins?
– Are there any special circumstances dictating that transactions may not
reasonably be regarded as comparable (e.g. bankruptcy situations)?
JGarg Economic Advisors 33
34. TP Methods – RPM…
• Resale Price Method (‘RPM’)
– The resale price method measures an arm's length price by
subtracting the appropriate gross profit from the applicable resale
price for the property involved in the controlled transaction under
review.
– The price is adjusted to take into account the functional and other
differences, including differences in accounting practices, if any,
between the SDT and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which
could materially affect the amount of gross profit margin in the
open market.
JGarg Economic Advisors 34
35. RPM – Case Study 2
Third party
A Ltd. AB India Ltd.
customers
- AB India Ltd. is a distributor of product A in India.
-AB India does not engage in unique or original advertising or sales promotion
activities, and makes no use of its own trademarks or other such properties in its
distribution activities.
- No internal comparable available
- Financial data in respect of distributor of comparable product available
JGarg Economic Advisors
36. RPM – Case Study 2
• FAR
FAR A Ltd & AB India Comparable 1 Comparable 2
Ltd.
F.1. Procurement A Ltd. Third party Third party
from
F.2. Packaging A Ltd Third party Third party
F.3. Marketing AB India Ltd. Comparable 1 Comparable 2
(2 % of sales) (3% of sales) (25% of sales)
F.4. Sales to final AB India Ltd. Comparable 1 Comparable 2
customer
F.5. After sales AB India Ltd. Comparable 1 Comparable 2
support
JGarg Economic Advisors 36
37. RPM – Case Study 2
• FAR
FAR A Ltd & AB India Comparable 1 Comparable 2
Ltd.
A.1. Warehouse A Ltd. Third party Comparable 2
A.2. Logistics AB India Ltd. Comparable 1 Comparable 2
A.3. Brand A Ltd. Third party Comparable 2
A.4. Distribution AB India Ltd. Comparable 1 Comparable 2
network
A.5. Customer list AB India Ltd. Comparable 1 Comparable 2
JGarg Economic Advisors 37
38. RPM – Case Study 2
• FAR
FAR A Ltd & AB India Comparable 1 Comparable 2
Ltd.
R.1. Product risk A Ltd Third party Comparable 2
R.2. Product AB India Ltd. Comparable 1 Comparable 2
service risk
R.3. Credit risk AB India Ltd. Comparable 1 Comparable 2
R.4. Product AB India Ltd. Comparable 1 Comparable 2
obsolescence risk
JGarg Economic Advisors 38
39. RPM – Case Study 2
• Conclusion
– Transaction between A Ltd. & AB Ltd. (‘Controlled transaction’) and
Comparable 1 transactions are comparable.
– Though Comparable 2 is distributor but cannot be considered comparable on
account of different FAR, for which it might be tough to carry out reasonable
adjustments.
JGarg Economic Advisors 39
40. …TP Methods – RPM
• Applicability
– Reseller should not make any material alterations to the product
traded.
• Comparability
– Product comparability not very important, however better the
product comparability better would be the results
– More functions and asset, higher risk would require higher gross
margin
– Accounting variations should be taken care
– Other factors like geographical differences, volume, high operating
cost may effect comparison
JGarg Economic Advisors 40
41. TP Methods – CPM…
• Cost Plus Method (‘CPM’)
– The cost plus method tests whether a profit mark-up charged in a
SDT is at arm’s length by reference to the mark-up charged in
uncontrolled transactions.
– Transfer pricing is calculated by adding a mark-up, earned in
uncontrolled transactions, to a direct and indirect cost of
production/ services relating to SDT.
JGarg Economic Advisors 41
43. CPM – Case Study 3
Distributors &
AB India Ltd. A Ltd.
Agents
Third party
manufacturer
-AB India Ltd is a manufacturer
- A India Ltd. is a distributor of product “A100” manufactured by AB India Ltd.
-A Ltd. also procures another product “A200” from third party contract manufacturer
and distributes the same
- A India ltd owns all intangibles
JGarg Economic Advisors
44. CPM – Case Study 3
• FAR
FAR Controlled Transaction Uncontrolled
Transaction
F.1. Designing & A Ltd. A Ltd.
conceptualization
F.2. Raw material AB India Ltd. Third party
procurement & manufacturer
manufacturing
F.3. Marketing & sales A Ltd A Ltd.
F.4. Distribution A Ltd. A Ltd.
JGarg Economic Advisors 44
45. CPM – Case Study 3
• FAR
FAR Controlled Transaction Uncontrolled
Transaction
A.1. Manufacturing AB India Ltd Third party
facility
A.2. Warehouse A Ltd. A Ltd.
A.3. Trade mark & brand A Ltd. A Ltd.
name
A.4. Design A Ltd. A Ltd.
A.5. Customer list A Ltd. A Ltd.
A.6. Distribution A Ltd. A Ltd.
network
JGarg Economic Advisors 45
46. CPM – Case Study 3
• FAR
FAR Controlled Transaction Uncontrolled
Transaction
R.1. Product risk A Ltd A Ltd
R.2. Market risk A Ltd A Ltd
R.3. Capacity risk AB India Ltd. Third party
R.4. Credit risk A Ltd. A Ltd.
JGarg Economic Advisors 46
47. CPM – Case Study 3
• Conclusion
– AB India Ltd. being simpler entity should be considered as the ‘tested party’
– As financial data would be available for the tested party and third party, gross
margin earned by the third party would be considered as arm’s length mark-
up
– If tested party would be earning less, it can be concluded that the transaction
is at arm’s length.
– However, if financial data for third party contract manufacturer is not
available, it may be tough to apply CPM.
JGarg Economic Advisors 47
48. ...TP Methods - CPM
• Applicability
– CPM is useful in case of long-term buy-and-supply agreements,
pricing of semi-finished goods, toll or contract manufacturing,
services of purchasing agents, contract research etc.
• Comparability
– Product comparability not very important, however better the
product comparability better would be the results
– More functions and asset, higher risk would require higher gross
margin
– Accounting variations should be taken care
– Other factors like geographical differences, volume, high operating
cost may effect comparison
JGarg Economic Advisors 48
49. TP Methods – PSM…
• Profit Split Method (‘PSM’)
– This method aims to determine what division of total profits
independent enterprise would expect in relation to the relevant
transactions.
– The profits should be split on an economically valid basis that
reflects the functions and risks of each of the parties.
– In order to apply this method, it is necessary to identify the total
profit arising from the related party transactions and split that
profit between the parties according to their respective
contributions.
JGarg Economic Advisors 49
50. ..TP Methods – PSM..
• Applicability
– In certain very complex trading relationships involving very
interrelated transactions, it is sometimes genuinely difficult to
evaluate those transactions on a separate basis.
Approaches
– There are two approaches to this method;
• Total profits split, and
• Residual profit split
JGarg Economic Advisors 50
51. ..TP Methods – PSM
• Total Profit Split
– Total profits from the controlled transactions made by all the
enterprises involved in earning those profits are split between
those enterprises based on the relative value of the functions that
each carries out.
Residual Profit Split
– Total profit of the overall trade made by the associated enterprises
is considered.
– Firstly, each participant is allocated sufficient profit to provide it
with a basic return appropriate to the functions carried out.
– Secondly, any profit (or loss) left after the allocation of basic
returns would be split as appropriate between the parties – based
on an analysis of how this residual would have been split between
third parties.
JGarg Economic Advisors 51
52. TP Methods – TNMM…
• Transactional Net Margin Method (‘TNMM’)
– The TNMM examines the net profit margin relative to an
appropriate base that a tax payer realizes from SDT vis-à-vis
comparable uncontrolled transactions.
– Thus, the TNMM operates in a manner similar to the cost plus and
resale price methods.
– The TNMM is based on the economic theory that returns earned
by an enterprise operating under similar conditions, in the same
market and industry, tend to become more equal after some time.
JGarg Economic Advisors 52
53. … TP Methods – TNMM
• Applicability
– If other methods are not applicable
• Procedure
– Selection of Tested Party
– Data – Current year vs. Multiple year
– Aggregation of transaction
– Identification of comparables
– Profit level indicator
• Operating Margin = OP/Sales X 100
• Net Cost Plus = OP/ Total Operating Expenses X 100
• Berry Ratio = GP/ Operating Expenses
• Return on Asset = OP/ Operating Asset X 100
JGarg Economic Advisors 53
