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Transfer pricing basics

the whole concept of tranfer pricing in easier manner

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Transfer pricing basics

  1. 1. 1HEADS UP │ UPGRADING OURSELVES TRANSFER PRICING : BASICS Heads Up
  2. 2. 2HEADS UP │ UPGRADING OURSELVES Why Transfer Pricing ?  Rise of large number of MNEs  Increase in number of cross border transactions  Existence of different tax rates & rules in different jurisdictions  Transactions between group companies – not determined by market forces  Main motive of MNEs - to maximize stakeholder’s wealth
  3. 3. 3HEADS UP │ UPGRADING OURSELVES How profits are manipulated ? Indian Entity Group Entity Makes payment Provides Services India Low Tax Jurisdiction
  4. 4. 4HEADS UP │ UPGRADING OURSELVES Importance of Transfer Pricing Transfer Pricing rules are essential for Tax Administration and Tax Payers in order to:  Protect their tax base  Eliminate double taxation  Enhance cross border trade
  5. 5. 5HEADS UP │ UPGRADING OURSELVES Indian Regulations  Finance Act, 2001 recognized the need of TP provisions and introduced Chapter X  Chapter X containing section 92 to 92F provides detailed provisions for Transfer Pricing  Finance Act, 2012 extended the scope of TP provision to Specified Domestic Transactions  APA and Rollback provisions introduced to reduce litigation
  6. 6. 6HEADS UP │ UPGRADING OURSELVES Associated Enterprise Associated Enterprise Satisfying the “test of participation in mgmt., control or capital” Being Deemed AEs
  7. 7. 7HEADS UP │ UPGRADING OURSELVES International Transaction International Transaction means:  A transaction  Between two or more associated enterprise  Either or both of whom are non-residents  Transaction in the nature of: - Purchase, sale or lease of tangible/intangible property - Provision of services - Lending or borrowing of money - Other transaction having bearing on profits, incomes, losses or assets - Mutual agreement between AE for allocation/apportionment/contribution to any cost
  8. 8. 8HEADS UP │ UPGRADING OURSELVES Specified Domestic Transaction Transfer Pricing Regulations extended by Finance Act, 2012 to include SDTs. SDT means following transactions, not being an international transaction:  Expenditure for which payment made to person referred to in section 40A(2)(b)  Transactions referred to in section 80A  Transfer of goods or services referred in section 80-IA (8)  Business transacted between Assessee and other person referred to in section 80-IA (10)  Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provision of section 80-IA (8) or 80-IA (10) are applicable  Any other prescribed transaction Aggregate of transaction entered in previous year exceeds a sum of Rs. 5 crore rupees.
  9. 9. 9HEADS UP │ UPGRADING OURSELVES Arm’s Length Price Common Parlance : Price at which independent enterprises deal with each other, where the conditions of their commercial and financial relations are ordinarily determined by market forces. Section 92F(ii) of Act: A price which is applied or proposed to be applied in a transaction between persons other than associated enterprise, in uncontrolled conditions.
  10. 10. 10HEADS UP │ UPGRADING OURSELVES
  11. 11. 11HEADS UP │ UPGRADING OURSELVES Process of Computation of ALP (i) Analysis of specific features of controlled transaction (i.e. international transaction of SDT in question) (ii) Search for comparable uncontrolled transactions (iii) Comparability Analysis in accordance with sub rule (2) to (4) of Rule 10B (iv) Selection of Most Appropriate Method (v) Application of MAM to calculate ALP
  12. 12. 12HEADS UP │ UPGRADING OURSELVES Background & Industry Overview  Broad - based analysis of the taxpayer’s circumstances  An analysis of the industry, competition, economic and regulatory factors affecting the taxpayer and its environment  Helps understand the conditions in the controlled transaction as well as those in the uncontrolled transaction to be compared, in particular the economic circumstances of the transactions.
  13. 13. 13HEADS UP │ UPGRADING OURSELVES Analysis of specific features of controlled transaction Functional Analysis - Functions performed - R&D, Design & Engineering - Manufacturing, production & Assembly - Warehousing & Transportation, etc. - Assets Employed - Tangible Assets: Land & Building, Plant & Machinery, etc. - Intangible Assets: Patents, Trademarks, Licences, etc. - Risks Assumed - Financial Risks - Product & Market Risk - General Business Risks Characterisation: Necessary to carry search for similar comparables with similar characteristics
  14. 14. 14HEADS UP │ UPGRADING OURSELVES Selection of Tested Party  Tested party is the party to the transaction for which comparability is analysed. Such party’s financial indicators shall be tested against those of uncontrolled transactions  Choice of Tested Party necessary for applying Cost Plus Method, Resale Price Method or Transactional Net Margin Method  It may be the local or the foreign party  It should be less complex party in respect of which most reliable data for comparability is available and adjustments could be made easily
  15. 15. 15HEADS UP │ UPGRADING OURSELVES Comparables Comparables Internal Comparables External Comparables
  16. 16. 16HEADS UP │ UPGRADING OURSELVES Identification of External Comparables Database Screening Quantitative Screening Qualitative Screening Final Set of Comparables
  17. 17. 17HEADS UP │ UPGRADING OURSELVES Quantitative Filters
  18. 18. 18HEADS UP │ UPGRADING OURSELVES Most Appropriate Method  For determining comparability, MAM should be used  MAM should be the method best suited to the facts and circumstances of each particular IT/ SDT  It should provide the most reliable measure of an arm’s length price in relation to the IT/SDT  For determining the MAM, following factors should be kept in mind ‐ Nature and class of transactions ‐ Class of AEs and the functions performed by them ‐ Degree of comparability between the IT/SDT and CUT ‐ Extent to which reliable and accurate data is available and adjustments can be made
  19. 19. 19HEADS UP │ UPGRADING OURSELVES Comparable Uncontrolled Price Method  Most direct method of comparability analysis  Require a relatively high level of comparability to produce reliable results Price of comparable transaction xxx +/- Adjustment for material differences between comparable transaction and IT/SDT xxx +/- Adjustment in respect of material differences between enterprise to both the transactions xxx Arm’s length Price as per CUP method xxx
  20. 20. 20HEADS UP │ UPGRADING OURSELVES Resale Price Method  Used to determine ALP when goods purchased from AE resold without significant value addition  Involves working back from resale price received from unrelated parties to arrive at an arm’s length price Resale Price charged from unrelated party xxx Less: Normal Gross profit margin on similar transaction xxx Less: Expense in connection with purchase xxx +/- Stock adjustment and other adjustments on account of difference in transactions and enterprises xxx Arm’s length Price as per RPM xxx
  21. 21. 21HEADS UP │ UPGRADING OURSELVES Cost Plus Method  Used to determine ALP when goods & services are sold to AE  Compares the gross profit mark-up earned by the tested party for the provision of goods and services with gross profit mark-ups earned by comparable companies. Direct and Indirect costs incurred in respect of goods and services xxx Add: Normal gross profit under by comparables on similar transactions xxx +/- Adjustments on account of difference in transactions and enterprises xxx Arm’s length Price as per CPM xxx
  22. 22. 22HEADS UP │ UPGRADING OURSELVES Profit Split Method  Typically applied when both sides of the controlled transaction contribute significant intangible property  The profit is to be divided such as is expected in a joint venture relationship  PSM starts by identifying the profits to be divided between the Aes  These profits are subsequently divided between the AEs on the basis of value of each AEs‘ contribution, which should reflect the functions performed, risks undertaken and assets employed by each AE  PSM is of two types ‐ Total Profit Split Method ‐ Residual Profit Split Method
  23. 23. 23HEADS UP │ UPGRADING OURSELVES Transactional Net Margin Method This method is mainly applied in case of:  Provision of services  Distribution of finished goods where RPM can’t be applied  Transfer of semi-finished goods where CPM can’t be applied  Transactions involving intangibles where PSM can’t be employed This method involves:  Identification of PLI  Identification of net profit margin realised by the enterprise from international transaction  Identifying the net profit margin from CUT having regard to the same base and adjusting it for material difference in transactions/enterprise  The adjusted net profit margin is used to arrive at the arm’s length price of the IT/SDT
  24. 24. 24HEADS UP │ UPGRADING OURSELVES Transactional Net Margin Method - PLI
  25. 25. 25HEADS UP │ UPGRADING OURSELVES Other Method CBDT has notified such other method apart from the five methods already prescribed. It states “ the Other Method for determination of the arms' length price in relation to an international transaction shall be any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.” This method is typically used where the other methods can not be used (e.g. Managerial Remuneration). The various data which can be used for comparability purposes are:  Third party quotations  Valuation reports  Documents relating to negotiations,  Standard rate cards
  26. 26. 26HEADS UP │ UPGRADING OURSELVES Contemporaneity of Data  Data for current year should be used  Data for previous two years can also be used if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared
  27. 27. 27HEADS UP │ UPGRADING OURSELVES Contemporaneity of Data [Contd…] Current Developments:  Data for current year or FY preceding the current year shall be used for comparability  Where the CUT has been identified on the basis of data relating to the current year and the enterprise undertaking the said uncontrolled transaction has in either or both of the two financial years immediately preceding the current year undertaken similar comparable uncontrolled transaction, then the weighted average of the prices of the CUT undertaken in the current year and in the preceding two years shall be used.  Where the CUT has been identified on the basis of the data relating to the financial year immediately preceding the current year and the enterprises undertaking the said uncontrolled transaction, has in the financial year immediately preceding the said financial year undertaken the same or similar comparable uncontrolled transaction, then the weighted average of the prices of the CUT undertaken in the aforesaid period of two years shall be used for determining the arm’s length price.
  28. 28. 28HEADS UP │ UPGRADING OURSELVES Mean or Range  If the number of comparables is less than 6, then arithmetic mean of the margins should be used  If the number of comparables is greater than or equal to 6, then ‐ A dataset shall be constructed by arranging the weighted average margins in ascending order ‐ The arm’s length range shall begin from the thirty-fifth percentile of the dataset and end on the sixty-fifth percentile of the dataset. The data place of x percentile shall be computed as : Data place of x percentile = Total no. of data points in dataset * (x / 100) ‐ If the price at which the international transaction or the specified domestic transaction has actually been undertaken is outside the arm's length range, the arm's length price shall be taken to be the median of the dataset
  29. 29. 29HEADS UP │ UPGRADING OURSELVES Documentation Areas •Functions •Assets •Risk •Comparability •Method Selection •Benchmarking •Covered Entities •Covered Transactions •Company •Group •Industry Background Information Transaction Information Functional Analysis Economic Analysis
  30. 30. 30HEADS UP │ UPGRADING OURSELVES Penalties Failure to Keep and maintain information & Documents w.r.t IT/ SDT 2% of value of each transaction Failure to furnish report u/s 92E Rs. 1,00,000 Failure to furnish information and documents u/s 92D 2% of the value of each transaction Additionally penalties u/s 271 can also be initiated for any such failure
  31. 31. 31HEADS UP │ UPGRADING OURSELVES Heads Up

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