Inside                                                                                                This IssueTheManagem...
INSTITUTE UPDATES                                                                    MISSION STATEMENT                    ...
From the Editor’s Desk                     The term ‘arm’s length’ has been defined in the Kohlers Dictionary for the     ...
President’s Communique                                                 We can see better with open eyes,                  ...
President’s Communiquefrom the experiences of the past and the current thinking        the Central Council Members CMA. Dr...
President’s CommuniqueThe Technical Directorate Extension Centres have started       Central Government has issued revised...
President’s Communiquethe Fund, a member should ensure to pay his up to date        met twice in order to finalize and lau...
Chairperson’s Communique                                                            interface, these figures would escalat...
COVER THEME         Arm’s Length Price—CMA in India—a Perspective                   Santonu Moitra                   M.Com...
COVER THEME     The profits derived by such enterprises carrying on           Overview of Indian Regulatory Process forbus...
COVER THEME    VVF Limited vs. DCIT—(ITANo. 673 -MUM - 08) :                C sells model A to X(a controlled transaction)...
COVER THEMEup is then added to those costs. This comparable gross            NP margin of AE transaction established/mark ...
COVER THEMEdivided between independent enterprises. Indicators           seeks to allocate the integrated profits of a tra...
COVER THEMEis due to the fact that the price or profit of an              ➢ Assets (both tangible and intangible) employed...
COVER THEMEto be taken into account when determining the                     (j) a record of the actual working carried ou...
COVER THEMEtransactions including the Indian and foreign tax           attempt to attribute profits to a PE transfer prici...
COVER THEME               International Transfer Pricing : The Current                           Landscape in India       ...
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Article by CA. Sudha G. Bhushan on thin capitalisation

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  1. 1. Inside This IssueTheManagement AccountantOfficial Organ of the Institute of Cost Accountants of India established in year 1944 (Foundermember of IFAC, SAFA and CAPA) Volume 47 No. 5 May 2012 C O N T E N T S0507 EDITORIAL Case Study 0554 Sustainable Growth in Indian Jute Industry—An0508 PRESIDENT’S COMMUNIQUE Exploratory Study by Ashim Paul 0558 Diagnosing BSNL As A Business—Performance0512 CHAIRPERSON’S COMMUNIQUE Analysis of A Fully Owned Government Company— A Case Study of Bharat Sanchar Nigam Ltd. Cover Theme by John Thomas & Ramesh Damarla0513 Arm’s Length Price—CMA is India—a Perspective Human Resource Management Dr. Santonu Moitra 0565 Organization Development : An Orientation to0521 International Transfer Pricing : The Current Land- Change Management by Dr. Anand Bansal scape in India by Dr. Sujit Kumar Roy & Pallab Pyne 0569 An empirical study of relationships between relational psychological contract and employees’0528 Thin Capitalisation and Arm‘s Length Pricing attitudes towards OCB factors and its application in by A Sekar & Sudha G Bhushan Indian Industry by Mihir Ajgaonkar, Dr. Utpal Baul & Dr. S. M. Phadke0535 Arm’s Length Pricing in India by Dr. Sukamal Datta Project Management Taxation 0573 Project Management Team Handling Challenges to Multinational Corporation by Dr. Javed Masood0538 Tax Titbits—Finance Bill, 2012—What Next? Banking by S. Rajaratnam 0576 Sustainable Development : Few Aspects in Indian Coming Home to Roost : Bilateral Investment Banking Sector by Pradipta Gangopadhyay0540 Agreements : Coping With Treaty Boomerangs Financial Reporting by P. Ravindran 0579 ‘Crime and Punishment’ : An introspection into two infamous financial reporting frauds across the world0544 Documents for Availing Cenvat Credit—Some by Dr. Arindam Gupta Issues by M. Govindarajan Economic Matters Costing 0588 Black Money : Methods and Means of Controlling at0549 Salient Features and Observations on CARR Origin by D. Venkata Narayana (Pharmaceutical Industry), 2011 Security Analysis by V. R. Kedia & Dipti Kejriwal 0590 Test of Market Efficiency by Dr. M. Appala Raju Budget Analysis 0594 Institute News0552 Is the Union Budget of India (2012-2013) Realistic and Achievable? 0617 Letters to Editor by Dr. Dilip Kumar Datta 0622 Book Review IDEALS THE INSTITUTE STANDS FOR❏ to develop the Cost and Management Accountancy profession ❏ to develop the body of members and properlyequip them for functions ❏ to ensure sound professional ethics ❏ to keep abreast of new developments. The contents of this journal are the copyright of The Institute of Cost Accountants of India, whose permission is necessary for reproduction in whole or in part.The Management Accountant |May 2012 505
  2. 2. INSTITUTE UPDATES MISSION STATEMENT “The Institute of Cost Accountants of India PRESIDENT M. Gopalakrishnan Professionals would ethically drive enterprises globally email : president@icwai.org by creating value to stakeholders in the socio-econo- VICE PRESIDENT Rakesh Singh mic context through competencies drawn from the email : vicepresident@icwai.org COUNCIL MEMBERS integration of strategy, management and accounting.” Amit Anand Apte, A. Om Prakash, Aruna Vilas Soman, A.S. Durga Prasad, Dr. Sanjiban Bandyopadhyaya, Hari Krishan Goel, Manas Kumar Thakur, P.V.S. Jagan Mohan Rao, VISION STATEMENT Pramodkumar Vithaldasji Bhattad, Sanjay Gupta, S.R. Bhargave, Suresh Chandra Mohanty, “The Institute of Cost Accountants of India would T.C.A. Srinivasa Prasad GOVERNMENT NOMINEES be the preferred source of resources and professionals A. K. Srivastava, Nandna Munshi Ashish Kumar, G. Sreekumar, K. Govindaraj for the financial leadership of enterprises globally.’’ Senior Director (Research) Chandana Bose research.cb@icwai.org Senior Director (Studies) DISCLAIMER R N Pal studies.rnpal@icwai.org The views expressed by the authors are personal Director (Technical) J. P. Singh and do not necessarily represent the views and technical.jps@icwai.org Director (Internal Control & Systems) should not be attributed to the Institute. Arnab Chakraborty internalcontrol.arnab@icwai.org Amitava Das The Management Accountant Technical Data Director (Examinations) exam.amitava@icwai.org Periodicity Monthly Director (CAT), (Training & Placement) L. Gurumurthy Language English cat.gurumurthy@icwai.org Overall size — 26.5 cm. x 19.5 cm. Director (Professional Development) J. K. Budhiraja Printed Area — 24 cm. x 17 cm. pd.budhiraja@icwai.org Screens — up to 130 Director (Continuing Education Programme) D. Chandru Subscription cep.chandru@icwai.org Rs. 600/- (Inland) p.a.Director (Discipline, Administration, Membership & Legal) Single Copy: Rs. 60/- & Joint Secretary Kaushik Banerjee Overseas membership.kb@icwai.org US $150 for Airmail Director (Finance) US $ 100 for Surface Mail S. R. Saha fna.saha@icwai.org Concessional Subscription Rates for Registered Director (Administration–Delhi Office & Public Students & Grads of the Institute Relations) Rs. 300/- p.a. S. C. Gupta admin.gupta@icwai.org Single Copy: Rs. 30/- (for Students & Grads) EDITOR Revised Rates for Advertisement Rajendra Bose rnj.rajendra@icwai.org The Management Accountant Editorial Office & Headquarters Rs. (US $) CMA Bhawan 12, Sudder Street, Kolkata-700 016 Back Cover (colour only) 50,000 2,500 Phone : (033) 2252-1031/34/35, Inside Cover (colour only) 35,000 2,000 Fax : (033) 2252-1602/1492 Ordy.Full page (B/W only) 20,000 1,500 Website : www.icwai.org Delhi Office Ordy. Half page (B/W only) 12,000 1,250 CMA Bhawan Ordy. Qrtr. page (B/W only) 7,500 750 3, Institutional Area, Lodi Road The Institute reserves the right to refuse any matter of New Delhi-110003 Phone : (011) 24622156, 24618645, advertisement detrimental to the interest of the Institute. Fax : (011) 24622156, 24631532, 24618645 The decision of the Editor in this regard will be final.506 The Management Accountant |May 2012
  3. 3. From the Editor’s Desk The term ‘arm’s length’ has been defined in the Kohlers Dictionary for the Accountants as something done ‘‘on a commercial basis, dealing with or as though dealing with independent, unrelated persons; competitive; straightforward; involving no favouritism or irregularity; as, arms length purchase’’. It is also suggested in the said dictionary that transactions between affiliated companies are not ordinarily regarded as being at arms length even though expressed in terms of market values. The point in particular is that, if two or three divisions or units/ plants of a company enter into commercial transactions, say, intercompany transfer of goods and services, there will be no impact on the profit/loss of the entity even if one division charges another a price which is more or less than their commercial value. So for the entity, it remains a zero sum game. However, if the transaction is between two independent parties and the transaction is entered into for a price less than its commercial value, it impacts the ultimate profit or loss of the entities. It is this relative gain or loss of the business entities which makes arms length pricing a very important aspect of the transfer pricing mechanism. It is very common to find multi-divisional/multi-locational conglomerates which, by their inherent nature, have production and distribution facilities spread across International different states and even countries with varied tax jurisdictions and implications. Decision to host a particular facility in a particular location or country is influenced transfer by the strategic considerations. However, when the goods and services are pricing is one exchanged between two or more divisions of the same enterprise, but located in such area, different tax jurisdictions, the tax authorities will view the supplier of the goods and services as seller and the receiver as buyer, even though the transaction is which essentially between two divisions or units of the same enterprise. This principle, upholds arms known as the arms length principle, is now part of the international consensus length and also the cornerstone of the OECD principles of transfer pricing guidelines for the multinational enterprises around the world. Arms length pricing would not principle, but only help the revenue authorities to get their reasonable share of tax revenues from ends up in a the activities of the multinational entities in their territories, but would also lead to fair international allocation of income. maze of Although the logic of arm’s length pricing appears to be straightforward, but in disputes while reality it requires robust economic analysis and a clear understanding of not only practically the functioning of the market, but also of the subtle factors like the economic divers applying it. and the mechanisms in the market. Behind the theory of arm’s length pricing there is clearly an assumption that there is a free flow of information in the market and the parties involved—the multinational entities and the revenue authorities of the respective tax jurisdiction—are able to gather it whenever needed. Such an assumption, however, is not only naive, but it faces challenge from the theory of efficient market hypothesis, which comes in a strong, semi-strong and weak form. Indeed, the world we live in is better explained, not by such phenomena as perfect market or perfect information, but by the existence of imperfect market where information asymmetry prevails. Parties involved in such a situation can come up with differing interpretations for the same event and get muddled up in disputes. International transfer pricing is one such area, which upholds arms length principle, but ends up in a maze of disputes while practically applying it. Perhaps, this explains why India is locked in tax disputes with several multinational entities involving thousands of crores in tax revenues. Considering the importance of the topic, the timing for deliberations on arm’s length pricing in the pages of the Management Accountant could not be more perfect! I hope that our eminent contributors to this issue of the magazine will enlighten us on the various aspects of the problem and offer food for thoughts for our readers.The Management Accountant |May 2012 507
  4. 4. President’s Communique We can see better with open eyes, we can hear better with open ears and we can perform better with open minds —Anonymous Dear Professional Colleagues, The value addition provided by a profession supplements and strengthens the statutory role which it normally plays under the legal framework by the government. As long as this aspect is recognized by the profession, the respect for it increases. Sometimes we get a rare opportunity to present this aspect to the Government during the formulation of the statute, so that the same can be incorporated in an appropriate form in the regulations. Our Institute utilized this opportunity when the new CARR and CAR notifications incorporated the Part III - Performance Reporting to the management, as a part of the report to be M. Gopalakrishnan, President submitted by the Cost Auditor. This key aspect was discussed in the recent interview I gave to the Economic Times, which not only highlighted the value added role played by the CMAs but also touched on the most vital aspect of the ‘‘need for intelligent decisions based on thorough knowledge of the … internal working’’. The new notifications have respected the managements role in developing internal decision systems based on a robust cost and management platform and have mandated the cost auditors to concentrate more on testing the internal cost reporting systems and introduce best practices that are enshrined in Cost Accounting Standards into those systems. This aspect has been recognized by the Cost Audit and Assurance Standard Board, when it has put ‘‘acquiring knowledge of the business process’’ as the first point in the Exposure Draft on CAAS 320. The Government also looks at ethical, economical, efficient and effective operations and safeguarding resources against loss, as the building blocks of the implementation of the various schemes. The CAG’s office has highlighted this as the key aspect in the policy document defining the role played by them in discharging their constitutional functions. While the role of external financial accounting professionals, who are engaged in transaction audits for Government schemes have been predominant so far, our Institute has been constantly representing for a role for the last three aspects i.e. efficient and effective operations and safeguarding resources against loss, which can be done only by CMAs. The Institute has also got the go ahead for conducting training programme for the Govt. officials on this aspect. But let us also admit that this requires tremendous effort in capacity building amongst our practicing professionals, whose number is growing day by day. The Regional Councils and Chapters have to play a major role on this aspect, and I have been also highlighting this aspect during my interactions with them. The technical guidance on this matter is always available from the Institute and the newly formed CEP-2, will also help in conducting the capacity building seminars for the practitioners. I am glad to inform you that the Ministry of Corporate Affairs has formed a Committee to formulate a Policy Document on Corporate Governance under the chairmanship of Shri Adi Godrej, and our Institute has been made a member and I attended the first meeting of the Committee held on 5th April 2012. During the meeting Dr. M. Veerappa Moily, Honourable Union Minister of Corporate Affairs, articulated the Governments view on laying down a policy on Corporate Governance and the background for the creation of the Committee consisting of representatives from industry, professional bodies and other stakeholders to discuss and arrive at a well structured policy on Corporate Governance drawing508 The Management Accountant |May 2012
  5. 5. President’s Communiquefrom the experiences of the past and the current thinking the Central Council Members CMA. Dr.Sanjibanon the subject. Bandyopdhayaya and CMA. Manas Kr. Thakur were ableMembers may recall that the Institute has been made a to have detailed interaction with members and chaptermember of the Government Accounting Standards Board, representatives who attended the conference.w.e.f. Jan 2012. The first meeting of the Board was held One of the major initiatives of the Ministry of Corporateon 20th April, 2012 at New Delhi. The activities of the Affairs, the Indian Institute of Corporate Affairs, movedDirectorate of Advanced Studies started off in full swing into their state-of-art new premises at Manesar, whichwith the Board of Advanced Studies holding its first was inaugurated by the Honourable Prime Ministermeeting on 7th April, 2012 followed by the next meeting Dr.Manmohan Singh ji. It was heartening to note theon 20th April 2011. This has accelerated the starting of Prime Minister in his speech highlighting the role ofthe Advanced Courses that have been planned by the professional bodies along with the corporate sector in theInstitute. The details have been given elsewhere in this growth of the Indian economy.message. I was happy to inaugurate the new extended conferenceThe Council meeting held on 31stMarch 2012, also took hall by the Lucknow Chapter on 21st April 2012, alongsome key decisions on holding of conferences. It was with the Vice President. We had very good interactiondecided that the various national conferences will be held with the large number of members present on thein all the four regions so that each region gets an occasion in which the developmental works that canopportunity to hold at least one national event per year. taken up for the profession were discussed.The National Cost Convention, National Practitioners Student’s mattersConvention, National Student’s Convention and the StudiesNational Regional Council and Chapters Convention will To facilitate the student community, the Studiesbe held in each of the four regions. It was also decided Directorate already started a new logistics systemthat each Region will hold one Regional Conference per whereby, the students on the registration day itself willyear in a city as decided by the Regional Council, instead be provided with the requisite study material. Althoughof multitude of Regional Conferences being held in this process has taken off well, I find that many chaptersvarious cities in some Regions. The First Foundation Day are still following the old manual system, in spite of theof the Institute will be held at New Delhi on 19th May continuous communication from the Directorate of2012, which falls on the day on which the Act was passed Studies about implementation of the IEPS system forby the Parliament. student registration. This is putting lot of students intoAs a strong believer in embracing best practice and problems as some of the chapters are accumulating theinstalling systems in all operations of the Institute, sincere applications and completing the registrations in oneeffort is on to install new system driven operations and go in the last minute. I request the Regional Councilshaving standard operating practice in place. A and Chapters to co-operate with the Directorate ofcomprehensive guideline is almost in its final shape. Studies so that the students at large are benefitted by theAs the Institutes operations are expanding, new recruits initiative.are taking place in various departments. I hope that with Examinationthe combinations of the experience of the senior The Examination Directorate is busy in making allexecutives and the enthusiasm of the new blood Institute arrangement for the ensuing June 2012 term ofwill thrive further in the right direction. examination all over India and overseas centers. ThisI am also happy to inform you that myself and Vice time, for further strengthening the process of conduct ofPresident, Shri Rakesh Singh were invited to attend the examination, photo attendance sheet along with photo1st meeting of the reconstituted Quality Review Board admit card will be in place which will streamline theof the Institute, held on 10th April 2012 under the examination process further.Chairmanship of Shri R.S Sharma, Ex-CMD, ONGC. We Technical Directorateassured that the Institute shall provide full support for I am happy to note that the CASB in its 52nd meetingthe efficient and effective functioning of the Board. held on 16th April has cleared the Guidance Note on CAS-Regional Council and Chapter Events 7 on Employee Cost. In addition, the CAASB in its 9thThe meeting organized on 11th April 2012, jointly by meeting held on 17th April has cleared the CAAS-320 onConfederation of Indian Industry and our Institute, was Planning an Audit of Cost Statements and CAAS-340 ona good event showcasing the benefits of institute industry Audit Documentation. Both the drafts are likely to bepartnership. Myself and Vice President accompanied by discussed by the Council in its forthcoming meeting.The Management Accountant |May 2012 509
  6. 6. President’s CommuniqueThe Technical Directorate Extension Centres have started Central Government has issued revised version of Formtheir activities in right earnest and the meeting of CFOs 23C and Form 23D with effect from 21st April, 2012. Priorfrom various industries was organised on 25th April, to revised version, the companies who would like to2012 at Chennai. Myself, Vice President, Shri. B. R. appoint same cost auditor for multi products/ units werePrabhakar Chairman, SIRC, Shri J. P. Singh, Director required to file individual Form 23C for each of products(Technical) and Ms. Chandra. V, Advisor (TDEC- under cost audit but new version allows filing of singleChennai) used the meet to trigger Special Interest Group Form 23C if a company wants to appoint one and thefocusing on sector specific issues, which was welcomed same cost auditor for the multi products/ units. Suchby the CFOs present. filing would facilitate cost accountant appointed as costTraining and Placement Directorate auditor for all the products of same "company" to bePlacement counted as one "Company" for the purpose of limit underI am also pleased to inform you that the Campus section 224(1B) of the Companies Act, 1956. Similarly,Placement Programme for December 2011 qualified Form 23D relating to information by cost auditor toCMAs has been successfully completed in all the four Central Government would facilitate the one and sameRegions during the month of April. Corporate like TCS, cost auditor to furnish the information of his/herHCL GENPACT visited our campus for the first time and appointment as cost auditor for the multi products/units.showed lot of interest in hiring our CMAs. PSUs like Coal The revised version of new Forms 23C and 23D alongIndia, ONGC and other Corporate like Wipro, Saint with instructions for filing up these forms are hosted onGobain, Pidilite, CIPLA, Amtek, Accenture, Mukund, the Institute website and MCA21 website.Suzlon and Nestle India visited our campus to find their CEP-I Directoratefuture managers. Some more Banks/Corporate have also I am pleased to inform that well known internationalexpressed their willingness to recruit our qualified CMAs authority on Accounting Standards, Dr. T P Ghosh,in the month of May 2012. The credit for making the entire Professor, IMT Dubai conducted the workshop by theplacement program a success goes to the integrated Institute in order to help the Corporates to update theirapproach adopted by Placement Directorate under the knowledge on the Revised Schedule VI to the Companiesguidance of Chairman-Members in Industry Committee Act 1956. As expected, Dr.Ghosh was able to impart aand the Regional Councils and I compliment them for practical approach to the concept, which has triggeredtheir efforts. the demand for more such workshops in future.Training I request the members to go thru the calendar ofI have already shared the news of the tie up we have Management Development Programmes for the yearmade with Food Corporation of India for engaging cost 2012-13 which has been brought out by the Directoratetrainees. Many more Corporate have expressed their incorporating the new topics and other contemporaryinterest to absorb our Intermediate qualified students as topics for up-dation of the CMA professionals. The sameTrainees. While nearly 500 companies have already is being published in the Journal for the information andbeen compiled for Training our students, many use of our members and others.Corporate giants like MMTC, NBCC, NHPC and Chennai CEP-2 DirectorateMetro Water have recruited Intermediate qualifiedstudents as Trainees in the recent months. Majority of I am happy that the CEP-2 Directorate is planning to bringthe students undergoing Training are enrolled with soon the webinars of some of the technical sessions ofPracticing Cost Accountants. With the scope for practice the eminent faculty members for the benefit of ourexpanding, I am sure more and more students would members and students. The Directorate had discussionsenroll with Practicing Members. As the Industry is with many Government Departments and othernowadays concerned about the employability factor of organizations for organizing exclusive tailor made in-the students of this country, I am sure our students trained house programmes for them during the year 2012-13.by Industry and Practicing Members would have a great Membership Directoratefuture. I am glad to inform you that the scheme of BenevolentProfessional Development Directorate Fund is being redesigned for providing more benefit toAs all of you are aware, the Ministry of Corporate Affairs the members of the Fund. For this purpose, the LifeCost Audit Branch vide General Circular No. 15/2011 Membership fee for the Benevolent Fund has been raiseddated 11th April, 2011 changed the procedure for to Rs. 2500/- (one-time payment) from the existing fee ofappointment of cost auditors by the companies. The Rs. 2000/-. For the purpose of obtaining benefit from510 The Management Accountant |May 2012
  7. 7. President’s Communiquethe Fund, a member should ensure to pay his up to date met twice in order to finalize and launch two of its initialAssociate/Fellow membership fees to the Institute and courses on :his name should continue to exist in the Register of (I) Business Valuation and Corporate Restructuring,Members of the Institute. I request the members to take andfull advantage of the membership to the Benevolent (II) Treasury and Financial Risk ManagementFund. The above two courses are expected to be launchedJournal Directorate soon and the details on the courses shall also soon beI am happy to share that ‘The Management Accountant’ made available to interested candidates. It has beenjournal has now come with a new professional ‘avataar’ decided that more of such advanced studies courses in—in full colour, thereby fulfilling the wishes of all our the field of cost and management accountancy andmembers. This has improved the external look and get other allied disciplines, that enjoy market demand andup of the journal significantly and is now comparable scope can be launched for our members in the future. Iwith some of the best of the journals in the country. I am glad that best of the minds from academia andcomplement the Chairman and the members of the industry comprising the Advanced Studies Board areJournal Committee for this. The use of ‘map litho’ paper putting their efforts and experience in designing theseof the best quality and superior printing has contributed courses for the benefit of our members and the profession,to a great extent in the beautification process. I am also on the whole.happy to know that the efforts to continually enhance My best wishes to the members and their families forthe qualitative aspect of the journal by inviting practical Budh Purnima and other festivals during the month,articles from corporate managers, industry experts andpracticing members is bearing fruition. As members can Sincerely yours,see that the April 2012 journal has 90% of the coveragefrom the practical point of view. I request all subjectmatter experts in various industries to continue tocontribute to the knowledge base of one and all throughthe official organ of the Institute. CMA M. Gopalakrishnan PresidentAdvanced Studies Directorate The Institute of Cost Accountants of IndiaIn the month of April, the Board of Advanced Studies 1st May 2012The Management Accountant |May 2012 511
  8. 8. Chairperson’s Communique interface, these figures would escalate in the days to come. The role of the Committee on Banking & Insurance under the present scenario is very important and the Committee has initiated networking activities with Banks and Insurance companies, in order to open business avenues for the Practicing Members and Aruna Soman facilitate employment avenues for the members and Chairperson, Committee on Banking & Insurance students completing their final examination. Members’ Facilities & Services Representations have been made to Reserve Bank Committee of India, so that our members may partake in providing strategic guidance to ailing companies and to workDear Professional Colleagues, hand in hand with Asset Reconstruction Companies, to improve the climate of recovering bank dues. It gives me immense pleasure to address all of you Representation has also been made to providethrough ‘Management Accountant’ as chairperson of guidance on Risk Based Internal Audit and Concurrentthe Committee of Banking & Insurance. I further feel Audit of Commercial Banks. This will give ourprivileged, to also work as Chairperson of the Members an opportunity to work with them, in view of the fact that the banks may implement improvedCommittee for Members’ Facilities & Services. internal control framework for IT audit procedure. As we all know effective from 1st February, 2012 Representation has also been made to SEBI to includethe name of the institute has changed to the Institute of Cost Accountants as investment advisers, inCost Accountants of India. The Associate and Fellow accordance with its regulation of Investment Advisers.members of the Institute are now entitled to use the The Committee is also in the process of dialogue withacronym ‘ACMA’ and ‘FCMA’ after their names. With the regulators such as SEBI, RBI and IRDA to discernthis, the members have got due recognition and are avenues where the professional members can contribute,entrusted with additional responsibility to preserve and by offering their valuable services in the Stock marketenhance their work profile. The Practicing Members of and Banking and Insurance sector of the country.the Institute can now enter into a Limited Liability In this regard, the Committee has already taken thePartnership (LLP), in accordance with the LLP Act, 2008. initiative of reviving the agreement with ISACA, forThe detailed guidelines in this regard are uploaded on training our members and students, to build capabilitythe Institutes website. I request the professional in carrying out Information Systems Audits incolleagues to visit the Institute’s website regularly, Financial Institutions.which is constantly updated to serve you better. I will fall short in my responsibility if I do not The institute has written to the members to update convey my gratitude to the President of the Institutetheir changed postal addresses, contact numbers and and all my colleagues in the Council, for the confidenceemail addresses, on a regular basis, to enable the they have shown in me, by entrusting me with thisInstitute to communicate with them better and faster. task and for their cooperation and incessant support. II am delighted to inform that in the last six months, also express my deep felt appreciation towards mywe have brought down the response turnaround time team members from the department, for their sustainedof queries generated by the members to a great extent. assistance and back up.We further hope to improvise the assistance in the nearfuture, with the web-based software service, such asonline application for membership, advancement tofellowship, payment of the dues, etc. I am glad to inform you that in the last one year, Aruna Somanwe have added almost 550 practicing members, 1700 Chairperson,associate members and 320 fellow members and with Committee on Banking & Insurancethe growth of the Institute on various fronts, both in Members’ Facilities & Services Committeeterms of academic development and industrial 1st May 2012512 The Management Accountant |May 2012
  9. 9. COVER THEME Arm’s Length Price—CMA in India—a Perspective Santonu Moitra M.Com., ACMA, CS, MBA, CIA (IIA) Dy. Manager (F & A), ONGC Ltd.W ith globalisation of business and with vehicle sold in country X. The Tax Authority in country companies operating in different geogra- X will not be effected as the additional profit will be phic and geopolitical areas because of cost, reported at their end, and revenue will gain, but intax marketing efficiencies the Taxation of the country Y the Tax Authorities will be losing Taxtransaction among these different located companies revenue and will not have much profit to tax on theirhas led to the development of Transfer Pricing side of the operation or, even, there may be a loss ifRegulations and determination of Arms Length Prices. the transfer price is set at lower than cost of production.Globalisation is one reason for this interest, the rise of Further, if there is tax rate differential between X andthe multinational corporation is another and with the Y then there can be a considerable gain to the companyfact that more than 60% of world trade takes place also at the cost of Tax revenue.within multinational enterprises, the importance of This example gives the perspective why the transfertransfer pricing becomes clear. pricing regulations are necessary to protect the The present framework for Arms Length Prices was revenue of the countries.triggered mainly by US regulations in 1990 on In Indian context the provisions have been enactedintangible tangible and cost sharing. Today’s with a view to provide a statutory framework whichframework is mainly based on OECD guidelines can lead to computation of reasonable, fair andissued in 2010. The international standard that equitable profit and tax in India so that the profitsOECD Member countries have agreed should be chargeable to tax in India do not get diverted elsewhereused for determining transfer prices for tax purposes by altering the prices charged and paid in intra-is set forth in Article 9 of the OECD Model Tax group transactions leading to erosion of ourConvention as : where ‘‘conditions are made or tax revenues—CIRCULAR NO.12 OF 2001, datedimposed between the two enterprises in their 23.08.2001of CDBT.commercial or financial relations which differ fromthose which would be made between independententerprises, then any profits which would, but for thoseconditions, have accrued to one of the enterprises, but,by reason of those conditions, have not so accrued, maybe included in the profits of that enterprise and taxedaccordingly.’’ A company in X country buys gearboxes from itsown subsidiary in country Y (Y only does business with Taxation–examiningX). The price at which the company in X parent pays Whether TP = ALPits subsidiary—the transfer price—will determine howmuch profit the Y unit reports and how much local tax Circular No. 14/2001 dated 27/11/2001 : Theit pays. If the company in country X pays below normal increasing participation of multinational groups inlocal market prices, or lower than the Cost of economic activities in the country has given rise to newproduction of the unit in country Y,the unit in country and complex issues emerging from transactionsY may appear to be in financial difficulty, even though entered into between two or more enterprisesthe group as a whole shows a decent profit on the belonging to the same multinational group.The Management Accountant |May 2012 513
  10. 10. COVER THEME The profits derived by such enterprises carrying on Overview of Indian Regulatory Process forbusiness in India can be controlled by the multinational Transfer Pricing and Arms Length Transactiongroup, by manipulating the prices charged and paid Prior approvalin such intragroup transactions, thereby leading to ▲ ASSESSING ▲ Sec 92CA(1) COMMISSIONERerosion of tax revenues. This gives the rationale for Refers the case OFFICER ▲ ▲Transfer Pricing Regulations. Draft Assessment order as per ALP Determined by TPO Indian transfer pricing regulations are exhaustive in ● DETERMINES ARMS LENGTH PRICEmany respects and are broadly based on the OECD ▲ ● AS PER SEC 92 C For apparentTransfer Pricing Guidelines for Multinational Enterprises mistakes in Draftand Tax Administrations (‘OECD Guidelines’). ▲ Assessment Order TRANSFER NOTICE UNDER SEC 92CA(2) ▲ Legislation introduced effective from April 1, 2001 ▲ PRICING APPEAL ASSESSEE ▲ Sec. 92 to 92F of Income Tax Act, Rule 10A to 10E OFFICER (TPO) REPLY BY ASSESSEE ▲Income Tax Rules, 1962, Circular No 12, Aug 23 2001,Circular No 14, Dec 24 2001, Administrative guidelinesMay 20 2003. ▲ ▲ Dispute Resolution Panel CIT(A) Provisions applicable only if there is aninternational transaction(s) [Section 92B] ‘between’ two ▲▲or more associated enterprises [ Sec. 92A]. ITAT As per Sec. 92B ‘international transaction’’ meansa transaction between two or more associated Transfer Pricing Methodsenterprises, either or both of whom are non-residents, Comparable Uncontrolled Price (CUP)in the nature of purchase, sale or lease of tangible or Where the price charged for goods, services orintangible property, or provision of services, or lending property transferred in a controlled transaction isor borrowing money, or any other transaction having compared to a CUT (comparable uncontrolleda bearing on the profits, income, losses or assets of suchenterprises and shall include a mutual agreement or transaction). The CUT acts as the benchmark forarrangement between two or more associated determining the ALP. It is the most direct way inenterprises for the allocation or apportionment of, or determining the Arms Length Price (ALP) The OECDany contribution to, any cost or expense incurred or to reports prefer this method among all methods if it canbe incurred in connection with a benefit, service or be used and such comparable data is available.facility provided or to be provided to any one or more Adjustments to CUP is allowable by taxationof such enterprises. authorities which include Credit Terms, volume of In the Finance Bill 2012 it is proposed to sales, logistics and other transaction costs etc to arriveretrospectively amend the term ‘international at the ALP.transaction’ to specifically include : The various practical difficulties in applying this ● Guarantees method are that there could be differences between ● Any debt arising during the course of business controlled and uncontrolled transactions in the nature (e.g. credit period on outstanding receivables); of volume of business, geographic market, timing of ● Business reorganisations or restructuring, transactions, product life cycle, intangibles branded irrespective of whether the same has an impact vs generic products etc. Also, accurate information like on current year’s profits, income, losses or assets. quality of products, various terms of transaction etc. Intangible properties including marketing intangibles, is not available in the public domain.human assets, technology related intangibles, etc. Internal CUP This amendment will take effect retrospectively Related party ▲from 1 April 2002 and will apply in relation to FY 2001-02 onwards. manufacturer Deeming provisions [Section 92B(2)] ▲ Unrelated party Transaction between an enterprise and a person(other than an associated enterprise) shall be deemedto be a transaction between two associated enterprises, External CUPif there exists a prior agreement or the terms of such a manufacturer Related party ▲international transaction are in substance determinedbetween one of these entities and the associated Non-related manufacturer Related party ▲enterprise of the other contracting entity514 The Management Accountant |May 2012
  11. 11. COVER THEME VVF Limited vs. DCIT—(ITANo. 673 -MUM - 08) : C sells model A to X(a controlled transaction),It was held by the ITAT that the transaction of lending which, in turn, sells them to independent retailers.money by the assessee by way of interest-free foreign Sales-force Training and warranty risk are borne by Xcurrency loan to its foreign subsidiaries, should be On the other hand, C sells model B to Dcompared with a company lending in foreign currency independent company which sells to independentto unrelated party. It was observed that the ICICI Bank retailers. C trains D’s sales-force and develops traininghad advanced foreign currency loan to the assessee at material for them free of cost, and bears all the costLIBOR plus 3%. This can be taken as an "internal CUP" and bears warranty risk.as the credit rating of subsidiary merges with the credit Both Xand D is tax resident of the same countryrating of the Parent. The comparison of interest should Markets of models of machinery A & B are samenot be benchmarked with the Cash Credit @ 14% givento the Assessee. X purchased 1,000 model A from C @1,000/ machine. Resale Price Method X sold the 1,000 model A to a number of The resale price method begins with the price at independent retailers @ 1,100/.which a product that has been purchased from anassociated enterprise is resold to an independent X spent Rs. 14,000 on developing its own trainingenterprise. This price (the resale price) is then reduced material and trained its own sales force on and theby an appropriate gross margin on this price (the warranty costs are Rs. 30,000.‘‘resale price margin’’) representing the amount out For calculation of ALP on transaction between Xof which the reseller would seek to cover its selling and C :and other operating expenses and, in the light of the X selected the transaction between C and D as afunctions performed (taking into account assets used comparable uncontrolled transaction.and risks assumed), make an appropriate profit. What The gross profit margin earned by D from the resaleis left after subtracting the gross margin can be of model B to independent retailers was found to beregarded, after adjustment for other costs associated 10%.with the purchase of the product (e.g. customs duties), Sales to third parties of ¥ (1,000 model A@ 1,100) = 1,100,000as an arms length price for the original transfer ofproperty between the associated enterprises. This Purchases from C 1,000 Model A @ 800) = 800,000method is most useful where it is applied to marketing Gross Profit = 300,000operations. An appropriate resale price margin is easy Functional analysis reflects a number of differencesto determine where the reseller does not add (Training Sales-force and warranty) between thesubstantially to the value of the product. In contrast, it controlled and the selected comparable uncontrolledmay be more difficult to use the resale price method transactions, which materially affect the gross marginto arrive at an arms length price where, before resale, —hence adjustments to the ALP is required.the goods are further processed or incorporated into a Arms length Gross Margin on the basis of sales ofmore complicated product so that their identity is lost Model B machines by C to of D @10% 110000or transformed (e.g. where components are joined Add :together in finished or semi-finished goods). Adjustments for functional and risk differences : Another example where the resale price marginrequires particular care is where the reseller contributes Training costs 14,000substantially to the creation or maintenance of Warranty costs 30,000intangible property associated with the product (e.g. Total adjustments 44,000trademarks or trade names) which are owned by an Adjusted gross profit 154,000associated enterprise. In such cases, the contributionof the goods originally transferred to the value of the Adjusted transfer price of model A from C to Xfinal product cannot be easily evaluated. = X net sales of model A – Adjusted gross profit X is the subsidiary of C, which is a multinational = 1,100,000 – 154,000 = 964,000parent company. Adjusted Arms Length transfer price for sales of C C has two similar models of machinery model A & to X = 964,000/ 1,000 = 964 /model Amodel B. Cost Plus Method Both models are similar in terms of properties, CP method begins with the costs incurred by aconstruction, production processes and functions and supplier of a product or service provided to anare comparable associated enterprise, and a comparable gross mark-The Management Accountant |May 2012 515
  12. 12. COVER THEMEup is then added to those costs. This comparable gross NP margin of AE transaction established/mark up is determined by : compared with uncontrolled Transaction NP. Internal Comparable Transaction While CP and RP methods compare gross profit Where the cost plus mark up of the supplier in the margins, TNMM compares net profit margins TNMMcontrolled transaction is determined by the cost plus on a transactional basis and not on a companywidemark-up realized for these items between one party to basis.the controlled transaction and an independent Profit Split Methodenterprise in a comparable uncontrolled transaction, The Profit Split Method seeks to eliminate theor effect on profits of special conditions made or imposed External Comparable Transaction in a controlled transaction by determining the Where the cost plus mark up of the supplier in the division of profits that independent enterprises wouldcontrolled transaction is determined by the cost plus have expected had it undertaken the transaction.mark unrealized between two independent enterprises Steps for the application of the profit split method:none of which is party to the controlled transaction in The first step is to determine the total profit earneda comparable uncontrolled transaction. by the firm from a controlled transaction, not the total The Cost of Production is the starting point for this profits of the group as a whole.method. Comparability of COP is necessary forcomparison. Traditional Financial Accounting Systems This is generally the operating profit, before thedo not capture such cost, neither provides guidelines deduction of interest and taxes.for arriving at such cost leading to different bases being The second step is to split the profit between theadopted by companies. For this Cost Accounting parties based on the relative value of theirStandard (CAS) is the only imperative which gives a contributions to the controlled transactions,firm data base for such analysis .ICAI has issued such considering the functions performed, the assets used,standard and CMAs are best equipped to formulate and the risks (FAR) by each party in the controlledand certify such benchmarking which arise under the transaction, in relation to what independentCP method as a result of accounting practices parties would have received, ie benchmark withinconsistency—where the supplier in the controlled independent transactions and allocate profit on thattransaction treats a particular cost item as an indirect basis.cost (i.e. this cost item is accounted for as part of the The total profit could be allocated using one of thecost of sales), while the supplier in the selected following approaches:comparable uncontrolled transaction treats the samecost item as an operating expense (i.e. this cost item is 1. Contribution Analysis Approach : where thenot subtracted at the gross profit level). In such a case, total operating profit from a controlled transaction isand assuming that the aforementioned accounting divided between the associated enterprises basedpractice difference is the only difference between the upon the relative value of the functions performedtwo transactions, the gross profit in the comparable by each of the associated enterprises participatinguncontrolled transaction tends to be higher than the in the controlled transaction, supplemented asgross profit in the controlled transaction. much as possible by external market data that indicate Transaction Net Margin Method (TNMM) how independent enterprises would have divided profits in similar circumstances. This method was recommended by OECD inresponse to US Comparable Profits method (CPM). 2. Residual Profit Split approach : where theComparing the net profit margin relative to an operating profit of the controlled transactions isappropriate base such as costs, sales or assets realized divided between the associated enterprises.by the taxpayer in a controlled transaction with the This process is carried out in two stages:net profit margin realized by the same taxpayer, or by (a) Each of the parties to the controlled transactionan independent enterprise in a comparable is assigned a return to the basic functions that ituncontrolled transaction, NP margin with Associate performs (e.g. manufacturing or distribution).Enterprise established based on cost incurred sales Ordinarily, this basic return is to be determined byeffected, assets employed, etc. benchmarking to market returns achieved for similar NP margin in uncontrolled transaction is types of transactions by independent enterprises.calculated based on the same criteria. (b) The residual profit remaining after the first stage NP margin in uncontrolled transaction situations division would be allocated among the parties basedis adjusted to factor open market issues. on an analysis as to how this residual would have been516 The Management Accountant |May 2012
  13. 13. COVER THEMEdivided between independent enterprises. Indicators seeks to allocate the integrated profits of a transactionof the parties contributions of intangible property on the basis of the actual relative contributions of thecould be particularly useful in this context. parties to the profit in light of what comparable X and Y are two associated enterprises in two independent enterprises would have sought to achievedifferent tax jurisdictions. Both manufacture the same in comparable circumstances. Thus it seeks to establishproduct. Both these companies make expenditure for a more objective measure of each of the parties’ profit.the creation of an intangible asset which both the CAS6 also lists out the same methods for Tangiblecompanies use to promote the product. X and Y Transactions and the appropriate methods forexclusively sell products to third parties. (it is also Intangibles. CAS 6 indicates that, for intangibles, CUPassumed that intangible cost is for the first year and or Resale Price method would be appropriate. Wherethese is no prior expenditure on this intangible). It is transfer of highly valuable intangible is involved profitpresumed that Profit Split is the best applicable based method (Profit split method or Transactional Netmethod. On market analysis of uncontrolled Margin method) is more appropriate.transactions, it is seen that such transactions earn a Sec. 92C of the Income Tax Act stipulatesreturn of 10% of the Cost and that the residual profit Computation of Arms Length Price by applying theshould be split in proportion to X and Y intangible asset ‘most appropriate’ method out ofexpenditure. 1. Comparable Uncontrolled Price (CUP) X Y X+Y 2. Resale Price Method (RPM)Sales 100 300 400 3. Cost Plus Method (CPM)Cost as per CAS14 60 95 155 4. Transaction Net Margin Method (TNMM) 5. Profit Split Method (PSM)Gross Profit 40 205 245 CAS 6 issued by ICAI provides guidelines on theIntangible asset exp 10 40 50 above.Operating profit 30 165 195 As per Income Tax Act, most appropriate methodReturn on similar transaction 12 19 31 referred above shall be applied, for determination ofwith uncontrolled entities arm’s length priceResidual Profit to be split 18 146 164 Options under proviso to Section 92 C (2)Intangible expenditure basis of 32.8 131.2 164 Where more than one price is determined by theResidual Profit Split most appropriate method the ALP shall be taken to beProfit for ALP 44.80 150.20 195.00 the arithmetical mean of such prices.Additional revenue as per ALP 14.80 OR Global Formulary Apportionment Method (GFA) If the variation between the ALP so determined and price at which the international transaction has actually This method is not accepted by OECD countries as been undertaken does not exceed five per cent of thewell as Indian Taxation regulations as a valid method latter, the price at which the international transactionof arriving at ALP. has actually been undertaken shall be deemed to be A global formulary apportionment method the arm’s length price.allocates the global profits on a consolidated basis (Amended by the Finance (No. 2) Act, 2009)among the associated enterprises in different countrieson the basis of a predetermined formula. [Section 92C]. There are three essential steps to apply a global The Finance Bill 2011 had proposed that instead offormulary apportionment method : a variation of 5 percent, the allowable variation would 1. Determining the unit to be taxed in including AE be such percentage as may be notified by Central Government in this behalf. The Finance Bill 2012 has 2. Determining the global profits provided an upper ceiling of 3 percent as the tolerance 3. Establishing the formula to be used to allocate range for determination of the ALP.the global profits of the unit. This formula is to be basedon combination of costs, assets, payroll, and sales. The same shall be effective from 1 April 2013, and shall apply in relation to FY 2012-13 onwards. The GFA allocates the total profits of the groupbetween parties on the basis of an arbitrary Comparability and Benchmarking key to Transferpredetermined formula, based on weighing of relative pricelabor costs, relative capital employed, and/or other The principle of comparability is fundamental inrelative factors. By contrast, the profit split method the determination of arm’s length transfer prices. ThisThe Management Accountant |May 2012 517
  14. 14. COVER THEMEis due to the fact that the price or profit of an ➢ Assets (both tangible and intangible) employeduncontrolled transaction is used as a benchmark by each party to that transactionagainst which the price or profit of a controlled ➢ Risks borne by each party to that transaction.transaction is to be evaluated. The comparison 3. Contractual Termsconducted between controlled and uncontrolled Contractual terms play in defining, explicitly ortransactions on the degree of similarity particularly in implicitly, how the responsibilities, risks, and benefitsregard to the characteristics of the property or services are to be divided between the parties in a particulartransferred, and the functions performed in each of transaction.the transactions taking account of the assets used andrisks assumed, is very critical in arriving at the Arms Contractual terms include :Length Price, and adjustments, if any, have to be ➢ Sales or purchase volumecarried out for comparability in arriving at ALP. ➢ Working Capital In a recent case relating to Sapient Corporation ➢ Financing—direct/indirectPvt Ltd the Delhi Bench of ITAT ruled that if loss ➢ Collaterals for transactionsmaking comparables are excluded from comparison, ➢ Contract durationcomparables with superprofits will also have to be ➢ Delivery termsexcluded from comparison. The decision reteriorates ➢ Credit and payment termsthe importance of proper FAR analysis for the purpose ➢ Terms governing the provision of warrantiesof ensuring that functional comparability is the ➢ Terms governing the right to updates, orprimary basis of selection of comparable companies. modifications The OECD Transfer Pricing Guidelines describe ➢ Terms allocating the different risks, such as thethe following as the major factors determining exchange rate risk, inventory risk, etc.comparability : 4. Economic Circumstances 1. Characteristics of Property or Services Economic factors are recommended by the OECD According to the OECD Transfer Pricing Transfer Pricing Guidelines to be considered inGuidelines, the most important characteristics to be measuringexamined in analyzing this factor include, but are not ➢ market comparabilitylimited to, the following : ➢ Geographic location (a) In the case of transfers of tangible property: ➢ Size of the markets ● Physical features of the property ➢ Extent of competition in the markets and the ● Property quality and reliability, and relative competitive positions of the buyers and ● Property availability and volume of supply. sellers ➢ Credit Terms (b) In the case of provision of services: ➢ Availability of substitute goods and services ● The nature and extent of the services. ➢ Levels of supply and demand in the market as (c) In the case of intangible property: a whole and in particular regions ● Form of transaction (e.g. licensing or sale) ➢ government regulation of the market ● Type of intangible (patent, trademark, or ➢ Costs of production, including the costs of land, knowhow) labor, and capital — Duration and degree of protection, and ➢ Transport costs — Anticipated benefits from the use of the ➢ Level of the market (e.g. retail or wholesale) property. ➢ Date and time of transactions 2. Functional Analysis ➢ Business, economic and product cycles; etc. Functional analysis is an analysis of the functions 5. Business Strategiesperformed (taking into account assets used and risks Business strategies must be examined in determiningassumed) by associated enterprises in controlled comparability for transfer pricing purposes.transactions and by independent enterprises in Business strategies would take into account manycomparable uncontrolled transactions. aspects of an enterprise, such as innovation and new Three main aspects in any transaction is analysed in product development, degree of diversification, riskfunctional analysis : aversion, assessment of political changes, input of ➢ Functions undertaken by each party to a existing and planned labour laws, duration of transaction and the economic significance of arrangements, and other factors bearing upon the daily such functions conduct of business. Such business strategies may need518 The Management Accountant |May 2012
  15. 15. COVER THEMEto be taken into account when determining the (j) a record of the actual working carried out forcomparability of controlled and uncontrolled determining the arm’s length price, including detailstransactions and enterprises. of the comparable data and financial information used Documentation requirement to be fulfilled by in applying the most appropriate method, andthe company as per Sec. 92D of Income Tax Act and adjustments, if any, which were made to account forRule 10D of Income Tax Rules differences between the international transaction and Documentation requirement to be fulfilled by the the comparable uncontrolled transactions, or betweencompany as per Sec. 92D of Income Tax Act and Rule the enterprises entering into such transactions.10D of Income Tax Rules : (k) the assumptions, policies and price negotiations, (a) a description of the ownership structure of the if any, which have critically affected the determinationassessee enterprise with details of shares or other of the arm’s length price.ownership interest held therein by other enterprises. (l) details of the adjustments, if any, made to (b) a profile of the multinational group of which the transfer prices to align them with arms length pricesassessee enterprise is a part along with the name, address, determined under these rules and consequentlegal status and country of tax residence of each of the adjustment made to the total income for tax purposes.enterprises comprised in the group with whom (m) any other information, data or document,international transactions have been entered into by the including information or data relating to the associatedassessee, and ownership linkages among them. enterprise, which may be relevant for determination (c) a broad description of the business of the of the arm’s length price.assessee and the industry in which the assessee The above documentation requirements is notoperates, and of the business of the associatedenterprises with whom the assessee has transacted. mandatory where the aggregate value, as recorded in the books of account, of international transactions (d) the nature and terms (including prices) of entered into by the assessee does not exceed one croreinternational transactions entered into with each rupees.associated enterprise, details of property transferredor services provided and the quantum and the value Advance Pricing Agreement (APA) underof each such transaction or class of such transaction. Transfer Pricing Regulations in the Union Budget (e) a description of the functions performed, risks of year 2012-13assumed and assets employed or to be employed by An APA is an agreement between a taxpayer andthe assessee and by the associated enterprises involved at least one tax administration on an appropriatein the international transaction. transfer pricing methodology for a related party (f) a record of the economic and market analyses, transaction. This agreement applies over a fixed periodforecasts, budgets or any other financial estimates of time. Unilateral APA is an agreement between aprepared by the assessee for the business as a whole taxpayer and the tax administration of the countryand for each division or product separately, which may where it is subject to taxation. A bilateral or multilateralhave a bearing on the international transactions APA is between the taxpayer, the tax administrationentered into by the assessee. of the country where it is subject to taxation and one (g) a record of uncontrolled transactions taken into or more foreign tax administrations.account for analysing their comparability with the The introduction of Advance Pricing Agreementinternational transactions entered into, including a (APA) under Transfer Pricing Regulations in the unionrecord of the nature, terms and conditions relating to budget of year 2012-13 is a positive step to reduce theany uncontrolled transaction with third parties which litigation as it will be based on bilateral understandingmay be of relevance to the pricing of the international between two countries wherein it has been proposedtransactions. to be valid for a maximum of consecutive 5 years unless (h) a record of the analysis performed to evaluate there is a change in provisions of the Code having acomparability of uncontrolled transactions with the bearing on the international transaction.relevant international transaction. It is pertinent to note that unilateral APAs are not (i) a description of the methods considered for recognised by a foreign tax authority and, thereby, thedetermining the arms length price in relation to eachinternational transaction or class of transaction, the risk of double taxation would still exist, if the foreignmethod selected as the most appropriate method along tax authority does not agree with the method ofwith explanations as to why such method was so computing the arm’s-length price (ALP).selected, and how such method was applied in each However, in case of bilateral/multilateral APAs,case. all the tax authorities involved in the coveredThe Management Accountant |May 2012 519
  16. 16. COVER THEMEtransactions including the Indian and foreign tax attempt to attribute profits to a PE transfer pricingauthorities agree to the ALP of the covered transaction documen-tation should be maintained andand, thereby, the MNCs avoid the burden of double benchmarking should be done in a manner wherebytaxation. the Functions performed, Assets utilised and Risk Introduction of the APA legislation would bring assumed (FAR) of both the foreign entity and Indianabout certainty, clarity of opinion, and other benefits entity are taken into account.to corporate India. The APAs offer better assurance Tax rate differential exists between countries andon transfer pricing methods and are conducive in companies take that into account during their astuteproviding certainty and unanimity of approach. tax planning process. Improper Tax planning vis-a-vis Strategic Implications of setting of Proper Arms tax liability on transfer pricing can lead to marginsLength Price going hayware as companies in these days of intense competition operate in wafer-thin margins only. For any decision of investment the Tax liability ofthe principal outside India and the tax liability of the Role of CMA and ICAI in Transfer Pricingcompany in India needs to factor in the Transfer Pricing ICAI has issued Transfer Pricing Guidelines inregulation in force to avoid future legal tussles and 2002. The Cost Accounting Standards 1-4 issued byalso to protect the profitability envisaged in the ICAI has great relevance is arriving at ALP in Transferviability of the proposals. These needs to be examined Price :in details during assessment of the viability of the CAS No. Title Detailsproject itself along with cost management tools to fine CAS1 Classification of Cost For preparation of Cost Statementstune the tax strategy with the costing of the product CAS2 Capacity Determination For determination of capacityand transfers. CAS3 Overheads For Collection, Allocation, Bombay High Court, in case of SET Satellite Apportionment and Absorption(Singapore) Pte Ltd (218 CTR 452), in line with of overheadsthe Supreme Court decision in Supreme Court CAS3 Overheads To bring uniformity and consis-judgement in case of DIT (Intl Taxation) vs. Morgan (Revised 2011) tency in the principles andStanley and Co Inc (292 ITR 416) has held that if the methods of determining thecorrect arm’s length price is applied and paid, then Overheads with reasonablenothing further would be left to be taxed in the hands accuracyof the foreign enterprise. The Bombay High Court has CAS4 Cost of Production for To determine the assessable valuerestored the CIT(A) order in the taxpayer’s case and Captive Consumption of excisable goods used for captive consumptionheld that in case the agent is remunerated atarm’s length by the foreign principal, the tax liability All the Five methods mandated by Income Tax Act,of the foreign principal (which would arise in case it India, requires as an input detailed cost accountingis regarded to have a PE in India) would stand data/information, especially in respect of adjustmentsextinguished. to be incorporated with respect of controlled and Where the transactions are held to be at arms uncontrolled transactions to make them comparablelength, nothing further can be attributed to the PE, to arrive at the ALP. Financial Accounting system doesprovided that the transfer price takes into account all not capture the data or give the information Product-the risktaking functions of the foreign enterprise. Thus, wise, Cost poolwise,Cost driverwise, Cost centerwiseassessment of PE gets extinguished only if the neither the financial audit checks the veracity of thefollowing two conditions are cumulatively met : same, it concentrates on proper booking of expenditure The associate enterprise has been remunerated on and proper representation in Final Accounts focusedarm’s length basis, and By FAR (Functions performed, on investors.Assets utilised and Risks assumed) analysis of Indian However, the regulatory requirements, speciallyand foreign enterprise. with regards to Transfer Pricing, cannot be met by Nothing more can be attributed to PE liability of Financial Accountants. This requires proper costforeign company in India and may not be extinguished accounting system and the information generatedunless the transfer pricing takes into account the FAR needs validation by conducting Cost Audit by CMAs.analysis of Indian company as well as foreign The Revenue administration as well as the companiescompany. will find such information handy in dealing with This needs to be kept in perspective while arriving Transfer Pricing decisions.at Arms Length Price of Permanent Establishments in Presently this data is not readily available—India, otherwise the Revenue Department may could (contd. to page 527)520 The Management Accountant |May 2012
  17. 17. COVER THEME International Transfer Pricing : The Current Landscape in India Dr. Sujit Kumar Roy Pallab Pyne Associate Professor & Head of the Department of Accountancy Guest Faculty Goenka College of Commerce and Goenka College of Commerce and Business Administration, Kolkata Business Administration, KolkataIntroduction and benefits, the associated risks, the feasibility of available options and legal barriers in the host country,M ultinational corporations (MNCs) are not new phenomenon, but since the World War for example—it oversees a sequence of activities from II (1939-1945), their spectacular rise has procurement of inputs, through manufacturingconsiderably reshaped both the global economy and operations to distribution, sales and after-sales services.the world politics (the political roles played by some In addition, firms undertake activities—such as ITAmerican MNCs in the 1970s may be recalled). With functions or R&D—which support all parts of the valuethe intensifying force of globalization, the influence of chain (UNCTAD 2011).the MNCs in the world economy has further deepened Pricing Conundrumso much that 80% of the world’s industrial production One of the most difficult, and controversial as well,is said to be generated by 1,000 largest MNCs and as areas in the relationship between the MNCs and theirmuch as one third of the total US international trade is overseas subsidiaries has been the pricing issue of theconducted by and within US owned MNCS by means goods, services and technologies used in theof intercompany transactions (Truitt, 2006 : p.161). By production and distribution of cross-border transactionsome recent estimates, MNCs’ production worldwide of goods and services.generated value-added of approximately $16 trillion Indeed, the plethora of literature on the subject hasin 2010, about a quarter of global GDP, while the identified intercompany pricing of goods and servicesforeign affiliates of MNCs accounted for more than 10 as one of the most significant and perplexing issuesper cent of global GDP and one-third of world exports faced by the MNCs (Weekly 1992; O’ Connor, 1997).(UNCTAD, 2011). If we add to this figure the trade Such intercompany pricing is also used as a vehicle tothat takes place between MNCs and other unaffiliated achieve several other objectives such as:firms (which are, more often than not, non-equitymodes of international production by the MNCs), ● Moving funds internationallywhich accounted for $2 trillion in international sales ● Minimizing tariffsin 2010, then MNCs are involved in about two-thirds ● Avoiding exchange control quotasof world trade (UNCTAD, 2011; Wittendorff, 2010 ). ● Minimizing exchange risksNo doubt that these MNCs are the keystone of the ● Increasing share of profits from joint venturesglobal economic edifice and they will surely maintain ● Optimizing managerial incentives andthat position in the global village that the world is now. performance evaluation; andBecause of their unique position and core competencies ● Minimizing taxes.these MNCs are able to coordinate their activities The bare-bones of the aforesaid objectiveswithin a global value chain either through their direct influencing MNC pricing policy, more specificallysupervision and control—leading to cross border FDI referred to as transfer pricing issues’, are well-—or through non-equity mode of production in a discussed in OConnor (1997). For example, O’ Connorcontractual arrangement but nonetheless exercising explains that, if a MNC wants to move fund out of arelative bargaining power over those host-country country, it can charge higher price to its foreignfirms. affiliate, or can do the opposite when the objective is While the ultimate ownership and control to supply fund to the affiliate. Similarly, affiliatesconfiguration of a global value chain is the outcome of wishing to pay lower import duty may follow lowa set of strategic choices by the MNC—the relative costs mark-up policy. If the MNC under-prices the shipmentThe Management Accountant |May 2012 521

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