Article by ca. sudha g. bhushan

Inside
This Issue
The
Management Accountant
Official Organ of the Institute of Cost Accountants of India established in year 1944 (Founder
member of IFAC, SAFA and CAPA)
Volume 47 No. 5 May 2012
C O N T E N T S
0507 EDITORIAL Case Study
0554 Sustainable Growth in Indian Jute Industry—An
0508 PRESIDENT’S COMMUNIQUE Exploratory Study by Ashim Paul
0558 Diagnosing BSNL As A Business—Performance
0512 CHAIRPERSON’S COMMUNIQUE Analysis of A Fully Owned Government Company—
A Case Study of Bharat Sanchar Nigam Ltd.
Cover Theme by John Thomas & Ramesh Damarla
0513 Arm’s Length Price—CMA is India—a Perspective Human Resource Management
Dr. Santonu Moitra
0565 Organization Development : An Orientation to
0521 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. Phadke
0535 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 Masood
0538 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 Gangopadhyay
0540
Agreements : Coping With Treaty Boomerangs Financial Reporting
by P. Ravindran 0579 ‘Crime and Punishment’ : An introspection into two
infamous financial reporting frauds across the world
0544 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 at
0549 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 News
0552 Is the Union Budget of India (2012-2013) Realistic
and Achievable? 0617 Letters to Editor
by Dr. Dilip Kumar Datta 0622 Book Review

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The Management Accountant |May 2012 505

INSTITUTE UPDATES

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PRESIDENT
M. Gopalakrishnan
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506 The Management Accountant |May 2012

From the Editor’s Desk

The term ‘arm’s length’ has been defined in the Kohler's 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, arm's length purchase’’. It is also
suggested in the said dictionary that transactions between affiliated companies are
not ordinarily regarded as being at arm's 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 arm's 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 arm's known as the arm's 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. Arm's 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 arm's 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.


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 management's 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 Government's 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 drawing



from the experiences of the past and the current thinking the Central Council Members CMA. Dr.Sanjiban
on the subject. Bandyopdhayaya and CMA. Manas Kr. Thakur were able
Members may recall that the Institute has been made a to have detailed interaction with members and chapter
member 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 Corporate
on 20th April, 2012 at New Delhi. The activities of the Affairs, the Indian Institute of Corporate Affairs, moved
Directorate of Advanced Studies started off in full swing into their state-of-art new premises at Manesar, which
with the Board of Advanced Studies holding its first was inaugurated by the Honourable Prime Minister
meeting on 7th April, 2012 followed by the next meeting Dr.Manmohan Singh ji. It was heartening to note the
on 20th April 2011. This has accelerated the starting of Prime Minister in his speech highlighting the role of
the Advanced Courses that have been planned by the professional bodies along with the corporate sector in the
Institute. The details have been given elsewhere in this growth of the Indian economy.
message. I was happy to inaugurate the new extended conference
The Council meeting held on 31stMarch 2012, also took hall by the Lucknow Chapter on 21st April 2012, along
some key decisions on holding of conferences. It was with the Vice President. We had very good interaction
decided that the various national conferences will be held with the large number of members present on the
in all the four regions so that each region gets an occasion in which the developmental works that can
opportunity to hold at least one national event per year. taken up for the profession were discussed.
The National Cost Convention, National Practitioner's Student’s matters
Convention, National Student’s Convention and the Studies
National Regional Council and Chapter's Convention will
To facilitate the student community, the Studies
be held in each of the four regions. It was also decided
Directorate already started a new logistics system
that each Region will hold one Regional Conference per
whereby, the students on the registration day itself will
year in a city as decided by the Regional Council, instead
be provided with the requisite study material. Although
of multitude of Regional Conferences being held in
this process has taken off well, I find that many chapters
various cities in some Regions. The First Foundation Day
are still following the old manual system, in spite of the
of the Institute will be held at New Delhi on 19th May
continuous communication from the Directorate of
2012, which falls on the day on which the Act was passed
Studies about implementation of the IEPS system for
by the Parliament.
student registration. This is putting lot of students into
As a strong believer in embracing best practice and problems as some of the chapters are accumulating the
installing systems in all operations of the Institute, sincere applications and completing the registrations in one
effort is on to install new system driven operations and go in the last minute. I request the Regional Councils
having standard operating practice in place. A and Chapters to co-operate with the Directorate of
comprehensive guideline is almost in its final shape. Studies so that the students at large are benefitted by the
As the Institute's operations are expanding, new recruits initiative.
are taking place in various departments. I hope that with Examination
the combinations of the experience of the senior
The Examination Directorate is busy in making all
executives and the enthusiasm of the new blood Institute
arrangement for the ensuing June 2012 term of
will thrive further in the right direction.
examination all over India and overseas centers. This
I am also happy to inform you that myself and Vice time, for further strengthening the process of conduct of
President, Shri Rakesh Singh were invited to attend the examination, photo attendance sheet along with photo
1st meeting of the reconstituted Quality Review Board admit card will be in place which will streamline the
of the Institute, held on 10th April 2012 under the examination process further.
Chairmanship of Shri R.S Sharma, Ex-CMD, ONGC. We Technical Directorate
assured that the Institute shall provide full support for
I am happy to note that the CASB in its 52nd meeting
the 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 9th
The meeting organized on 11th April 2012, jointly by meeting held on 17th April has cleared the CAAS-320 on
Confederation of Indian Industry and our Institute, was Planning an Audit of Cost Statements and CAAS-340 on
a good event showcasing the benefits of institute industry Audit Documentation. Both the drafts are likely to be
partnership. Myself and Vice President accompanied by discussed by the Council in its forthcoming meeting.



The Technical Directorate Extension Centres have started Central Government has issued revised version of Form
their activities in right earnest and the meeting of CFOs 23C and Form 23D with effect from 21st April, 2012. Prior
from various industries was organised on 25th April, to revised version, the companies who would like to
2012 at Chennai. Myself, Vice President, Shri. B. R. appoint same cost auditor for multi products/ units were
Prabhakar 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 single
Chennai) used the meet to trigger Special Interest Group Form 23C if a company wants to appoint one and the
focusing on sector specific issues, which was welcomed same cost auditor for the multi products/ units. Such
by the CFOs present. filing would facilitate cost accountant appointed as cost
Training and Placement Directorate auditor for all the products of same "company" to be
Placement counted as one "Company" for the purpose of limit under
I 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 to
CMAs has been successfully completed in all the four Central Government would facilitate the one and same
Regions during the month of April. Corporate like TCS, cost auditor to furnish the information of his/her
HCL 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 along
India, ONGC and other Corporate like Wipro, Saint with instructions for filing up these forms are hosted on
Gobain, Pidilite, CIPLA, Amtek, Accenture, Mukund, the Institute website and MCA21 website.
Suzlon and Nestle India visited our campus to find their CEP-I Directorate
future managers. Some more Banks/Corporate have also I am pleased to inform that well known international
expressed 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 the
placement program a success goes to the integrated Institute in order to help the Corporates to update their
approach adopted by Placement Directorate under the knowledge on the Revised Schedule VI to the Companies
guidance of Chairman-Members in Industry Committee Act 1956. As expected, Dr.Ghosh was able to impart a
and the Regional Councils and I compliment them for
practical approach to the concept, which has triggered
their efforts.
the demand for more such workshops in future.
Training
I request the members to go thru the calendar of
I have already shared the news of the tie up we have Management Development Programmes for the year
made with Food Corporation of India for engaging cost 2012-13 which has been brought out by the Directorate
trainees. Many more Corporate have expressed their incorporating the new topics and other contemporary
interest to absorb our Intermediate qualified students as topics for up-dation of the CMA professionals. The same
Trainees. While nearly 500 companies have already is being published in the Journal for the information and
been compiled for Training our students, many use of our members and others.
Corporate giants like MMTC, NBCC, NHPC and Chennai
CEP-2 Directorate
Metro Water have recruited Intermediate qualified
students as Trainees in the recent months. Majority of I am happy that the CEP-2 Directorate is planning to bring
the students undergoing Training are enrolled with soon the webinars of some of the technical sessions of
Practicing Cost Accountants. With the scope for practice the eminent faculty members for the benefit of our
expanding, I am sure more and more students would members and students. The Directorate had discussions
enroll with Practicing Members. As the Industry is with many Government Departments and other
nowadays 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 Directorate
future.
I am glad to inform you that the scheme of Benevolent
Professional Development Directorate Fund is being redesigned for providing more benefit to
As all of you are aware, the Ministry of Corporate Affairs the members of the Fund. For this purpose, the Life
Cost Audit Branch vide General Circular No. 15/2011 Membership fee for the Benevolent Fund has been raised
dated 11th April, 2011 changed the procedure for to Rs. 2500/- (one-time payment) from the existing fee of
appointment of cost auditors by the companies. The Rs. 2000/-. For the purpose of obtaining benefit from



the Fund, a member should ensure to pay his up to date met twice in order to finalize and launch two of its initial
Associate/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 and
full advantage of the membership to the Benevolent (II) Treasury and Financial Risk Management
Fund.
The above two courses are expected to be launched
Journal Directorate soon and the details on the courses shall also soon be
I am happy to share that ‘The Management Accountant’ made available to interested candidates. It has been
journal 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 and
members. This has improved the external look and get other allied disciplines, that enjoy market demand and
up of the journal significantly and is now comparable scope can be launched for our members in the future. I
with some of the best of the journals in the country. I am glad that best of the minds from academia and
complement the Chairman and the members of the industry comprising the Advanced Studies Board are
Journal Committee for this. The use of ‘map litho’ paper putting their efforts and experience in designing these
of 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 for
the qualitative aspect of the journal by inviting practical Budh Purnima and other festivals during the month,
articles from corporate managers, industry experts and
practicing members is bearing fruition. As members can Sincerely yours,
see that the April 2012 journal has 90% of the coverage
from the practical point of view. I request all subject
matter experts in various industries to continue to
contribute to the knowledge base of one and all through
the official organ of the Institute. CMA M. Gopalakrishnan
President
Advanced Studies Directorate The Institute of Cost Accountants of India
In the month of April, the Board of Advanced Studies 1st May 2012


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 work
Dear 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 provide
through ‘Management Accountant’ as chairperson of guidance on Risk Based Internal Audit and Concurrent
the Committee of Banking & Insurance. I further feel Audit of Commercial Banks. This will give our
privileged, to also work as Chairperson of the Members an opportunity to work with them, in view
of the fact that the banks may implement improved
Committee 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 include
the name of the institute has changed to the Institute of Cost Accountants as investment advisers, in
Cost 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 with
acronym ‘ACMA’ and ‘FCMA’ after their names. With
the regulators such as SEBI, RBI and IRDA to discern
this, 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 market
enhance 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 the
Partnership (LLP), in accordance with the LLP Act, 2008.
initiative of reviving the agreement with ISACA, for
The detailed guidelines in this regard are uploaded on
training our members and students, to build capability
the Institute's website. I request the professional
in carrying out Information Systems Audits in
colleagues 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 Institute
their changed postal addresses, contact numbers and
and all my colleagues in the Council, for the confidence
email addresses, on a regular basis, to enable the
they have shown in me, by entrusting me with this
Institute to communicate with them better and faster. task and for their cooperation and incessant support. I
I am delighted to inform that in the last six months, also express my deep felt appreciation towards my
we have brought down the response turnaround time team members from the department, for their sustained
of queries generated by the members to a great extent. assistance and back up.
We further hope to improvise the assistance in the near
future, with the web-based software service, such as
online application for membership, advancement to
fellowship, payment of the dues, etc.
I am glad to inform you that in the last one year, Aruna Soman
we have added almost 550 practicing members, 1700 Chairperson,
associate members and 320 fellow members and with Committee on Banking & Insurance
the growth of the Institute on various fronts, both in Members’ Facilities & Services Committee
terms of academic development and industrial 1st May 2012


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 in
tax marketing efficiencies the Taxation of the country Y the Tax Authorities will be losing Tax
transaction among these different located companies revenue and will not have much profit to tax on their
has led to the development of Transfer Pricing side of the operation or, even, there may be a loss if
Regulations 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 and
the multinational corporation is another and with the Y then there can be a considerable gain to the company
fact 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 transfer
transfer 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 enacted
intangible tangible and cost sharing. Today’s with a view to provide a statutory framework which
framework is mainly based on OECD guidelines can lead to computation of reasonable, fair and
issued in 2010. The international standard that equitable profit and tax in India so that the profits
OECD Member countries have agreed should be chargeable to tax in India do not get diverted elsewhere
used 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 our
Convention as : where ‘‘conditions are made or tax revenues—CIRCULAR NO.12 OF 2001, dated
imposed between the two enterprises in their 23.08.2001of CDBT.
commercial or financial relations which differ from
those which would be made between independent
enterprises, then any profits which would, but for those
conditions, have accrued to one of the enterprises, but,
by reason of those conditions, have not so accrued, may
be included in the profits of that enterprise and taxed
accordingly.’’
A company in X country buys gearboxes from its
own subsidiary in country Y (Y only does business with
Taxation–examining
X). The price at which the company in X parent pays Whether TP = ALP
its subsidiary—the transfer price—will determine how
much profit the Y unit reports and how much local tax Circular No. 14/2001 dated 27/11/2001 : The
it pays. If the company in country X pays below normal increasing participation of multinational groups in
local market prices, or lower than the Cost of economic activities in the country has given rise to new
production of the unit in country Y,the unit in country and complex issues emerging from transactions
Y may appear to be in financial difficulty, even though entered into between two or more enterprises
the group as a whole shows a decent profit on the belonging to the same multinational group.


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The profits derived by such enterprises carrying on Overview of Indian Regulatory Process for
business in India can be controlled by the multinational Transfer Pricing and Arms Length Transaction
group, by manipulating the prices charged and paid Prior approval
in such intragroup transactions, thereby leading to

▲
ASSESSING

▲
Sec 92CA(1)
COMMISSIONER
erosion 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 PRICE
many respects and are broadly based on the OECD

▲
● AS PER SEC 92 C
For apparent
Transfer Pricing Guidelines for Multinational Enterprises mistakes in Draft
and 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 guidelines
May 20 2003. ▲
▲
Dispute Resolution Panel CIT(A)
Provisions applicable only if there is an
international transaction(s) [Section 92B] ‘between’ two ▲▲
or more associated enterprises [ Sec. 92A]. ITAT
As per Sec. 92B ‘international transaction’’ means
a transaction between two or more associated Transfer Pricing Methods
enterprises, 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 or
intangible property, or provision of services, or lending
property transferred in a controlled transaction is
or borrowing money, or any other transaction having
compared to a CUT (comparable uncontrolled
a bearing on the profits, income, losses or assets of such
enterprises and shall include a mutual agreement or transaction). The CUT acts as the benchmark for
arrangement between two or more associated determining the ALP. It is the most direct way in
enterprises for the allocation or apportionment of, or determining the Arms Length Price (ALP) The OECD
any contribution to, any cost or expense incurred or to reports prefer this method among all methods if it can
be 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 taxation
of 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 arrive
retrospectively 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 deemed
to be a transaction between two associated enterprises, External CUP
if there exists a prior agreement or the terms of such a
manufacturer Related party
▲

international transaction are in substance determined
between one of these entities and the associated
Non-related manufacturer Related party
▲

enterprise of the other contracting entity


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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 X
currency loan to its foreign subsidiaries, should be On the other hand, C sells model B to D
compared with a company lending in foreign currency independent company which sells to independent
to unrelated party. It was observed that the ICICI Bank retailers. C trains D’s sales-force and develops training
had advanced foreign currency loan to the assessee at material for them free of cost, and bears all the cost
LIBOR 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 country
rating of the Parent. The comparison of interest should
Markets of models of machinery A & B are same
not be benchmarked with the Cash Credit @ 14% given
to 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 an
associated enterprise is resold to an independent X spent Rs. 14,000 on developing its own training
enterprise. This price (the resale price) is then reduced material and trained its own sales force on and the
by 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 X
of 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 a
functions 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 resale
is left after subtracting the gross margin can be of model B to independent retailers was found to be
regarded, 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) = 1,100,000
as an arm's length price for the original transfer of
property between the associated enterprises. This Purchases from C 1,000 Model A @ 800) = 800,000
method is most useful where it is applied to marketing Gross Profit = 300,000
operations. An appropriate resale price margin is easy Functional analysis reflects a number of differences
to determine where the reseller does not add (Training Sales-force and warranty) between the
substantially to the value of the product. In contrast, it controlled and the selected comparable uncontrolled
may be more difficult to use the resale price method transactions, which materially affect the gross margin
to arrive at an arm's 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 of
more complicated product so that their identity is lost Model B machines by C to of D @10% 110000
or 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 margin
requires particular care is where the reseller contributes Training costs 14,000
substantially to the creation or maintenance of Warranty costs 30,000
intangible property associated with the product (e.g. Total adjustments 44,000
trademarks or trade names) which are owned by an
Adjusted gross profit 154,000
associated enterprise. In such cases, the contribution
of the goods originally transferred to the value of the Adjusted transfer price of model A from C to X
final 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 = 964,000
parent 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 A
model B. Cost Plus Method
Both models are similar in terms of properties, CP method begins with the costs incurred by a
construction, production processes and functions and supplier of a product or service provided to an
are comparable associated enterprise, and a comparable gross mark-


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up 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 TNMM
controlled transaction is determined by the cost plus on a transactional basis and not on a companywide
mark-up realized for these items between one party to basis.
the controlled transaction and an independent Profit Split Method
enterprise in a comparable uncontrolled transaction, The Profit Split Method seeks to eliminate the
or 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 would
controlled 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 earned
a 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 for
comparison. Traditional Financial Accounting Systems This is generally the operating profit, before the
do 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 the
adopted by companies. For this Cost Accounting parties based on the relative value of their
Standard (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 controlled
and certify such benchmarking which arise under the transaction, in relation to what independent
CP method as a result of accounting practices parties would have received, ie benchmark with
inconsistency—where the supplier in the controlled independent transactions and allocate profit on that
transaction 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 the
cost of sales), while the supplier in the selected following approaches:
comparable uncontrolled transaction treats the same
cost item as an operating expense (i.e. this cost item is 1. Contribution Analysis Approach : where the
not subtracted at the gross profit level). In such a case, total operating profit from a controlled transaction is
and assuming that the aforementioned accounting divided between the associated enterprises based
practice difference is the only difference between the upon the relative value of the functions performed
two transactions, the gross profit in the comparable by each of the associated enterprises participating
uncontrolled transaction tends to be higher than the in the controlled transaction, supplemented as
gross 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 in
response to US Comparable Profits method (CPM). 2. Residual Profit Split approach : where the
Comparing the net profit margin relative to an operating profit of the controlled transactions is
appropriate 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 transaction
an independent enterprise in a comparable is assigned a return to the basic functions that it
uncontrolled 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 by
effected, 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 based
is adjusted to factor open market issues. on an analysis as to how this residual would have been


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divided between independent enterprises. Indicators seeks to allocate the integrated profits of a transaction
of the parties' contributions of intangible property on the basis of the actual relative contributions of the
could 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 achieve
different tax jurisdictions. Both manufacture the same in comparable circumstances. Thus it seeks to establish
product. 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 Tangible
companies use to promote the product. X and Y Transactions and the appropriate methods for
exclusively sell products to third parties. (it is also Intangibles. CAS 6 indicates that, for intangibles, CUP
assumed that intangible cost is for the first year and or Resale Price method would be appropriate. Where
these is no prior expenditure on this intangible). It is transfer of highly valuable intangible is involved profit
presumed that Profit Split is the best applicable based method (Profit split method or Transactional Net
method. 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 stipulates
return of 10% of the Cost and that the residual profit Computation of Arm's Length Price by applying the
should be split in proportion to X and Y intangible asset ‘most appropriate’ method out of
expenditure.
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 the
Intangible asset exp 10 40 50
above.
Operating profit 30 165 195
As per Income Tax Act, most appropriate method
Return on similar transaction 12 19 31 referred above shall be applied, for determination of
with uncontrolled entities arm’s length price
Residual 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 the
Residual Profit Split most appropriate method the ALP shall be taken to be
Profit 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 the
well as Indian Taxation regulations as a valid method latter, the price at which the international transaction
of 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 countries
on 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 of
formulary 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 based
on 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 group
between parties on the basis of an arbitrary Comparability and Benchmarking key to Transfer
predetermined formula, based on weighing of relative price
labor costs, relative capital employed, and/or other The principle of comparability is fundamental in
relative factors. By contrast, the profit split method the determination of arm’s length transfer prices. This


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is due to the fact that the price or profit of an ➢ Assets (both tangible and intangible) employed
uncontrolled transaction is used as a benchmark by each party to that transaction
against 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 Terms
conducted between controlled and uncontrolled
Contractual terms play in defining, explicitly or
transactions on the degree of similarity particularly in
implicitly, how the responsibilities, risks, and benefits
regard to the characteristics of the property or services
are to be divided between the parties in a particular
transferred, and the functions performed in each of
transaction.
the transactions taking account of the assets used and
risks assumed, is very critical in arriving at the Arms Contractual terms include :
Length Price, and adjustments, if any, have to be ➢ Sales or purchase volume
carried out for comparability in arriving at ALP. ➢ Working Capital
In a recent case relating to Sapient Corporation ➢ Financing—direct/indirect
Pvt Ltd the Delhi Bench of ITAT ruled that if loss ➢ Collaterals for transactions
making comparables are excluded from comparison, ➢ Contract duration
comparables with superprofits will also have to be ➢ Delivery terms
excluded from comparison. The decision reteriorates ➢ Credit and payment terms
the importance of proper FAR analysis for the purpose ➢ Terms governing the provision of warranties
of ensuring that functional comparability is the ➢ Terms governing the right to updates, or
primary basis of selection of comparable companies. modifications
The OECD Transfer Pricing Guidelines describe ➢ Terms allocating the different risks, such as the
the 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 in
Guidelines, the most important characteristics to be measuring
examined in analyzing this factor include, but are not ➢ market comparability
limited 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 Strategies
performed (taking into account assets used and risks Business strategies must be examined in determining
assumed) by associated enterprises in controlled comparability for transfer pricing purposes.
transactions and by independent enterprises in Business strategies would take into account many
comparable 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, risk
functional 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 need


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to be taken into account when determining the (j) a record of the actual working carried out for
comparability of controlled and uncontrolled determining the arm’s length price, including details
transactions and enterprises. of the comparable data and financial information used
Documentation requirement to be fulfilled by in applying the most appropriate method, and
the company as per Sec. 92D of Income Tax Act and adjustments, if any, which were made to account for
Rule 10D of Income Tax Rules differences between the international transaction and
Documentation requirement to be fulfilled by the the comparable uncontrolled transactions, or between
company 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 determination
assessee 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 arm's length prices
assessee enterprise is a part along with the name, address, determined under these rules and consequent
legal 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 associated
assessee, 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 not
operates, and of the business of the associated
enterprises 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 crore
international transactions entered into with each
rupees.
associated enterprise, details of property transferred
or services provided and the quantum and the value Advance Pricing Agreement (APA) under
of 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 2012-13
assumed and assets employed or to be employed by An APA is an agreement between a taxpayer and
the assessee and by the associated enterprises involved at least one tax administration on an appropriate
in 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 period
forecasts, budgets or any other financial estimates of time. Unilateral APA is an agreement between a
prepared by the assessee for the business as a whole taxpayer and the tax administration of the country
and for each division or product separately, which may where it is subject to taxation. A bilateral or multilateral
have a bearing on the international transactions APA is between the taxpayer, the tax administration
entered 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 Agreement
international transactions entered into, including a (APA) under Transfer Pricing Regulations in the union
record of the nature, terms and conditions relating to budget of year 2012-13 is a positive step to reduce the
any uncontrolled transaction with third parties which
litigation as it will be based on bilateral understanding
may be of relevance to the pricing of the international
between two countries wherein it has been proposed
transactions.
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 a
comparability 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, the
determining the arm's length price in relation to each
international transaction or class of transaction, the risk of double taxation would still exist, if the foreign
method selected as the most appropriate method along tax authority does not agree with the method of
with 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 covered


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transactions including the Indian and foreign tax attempt to attribute profits to a PE transfer pricing
authorities agree to the ALP of the covered transaction documen-tation should be maintained and
and, thereby, the MNCs avoid the burden of double benchmarking should be done in a manner whereby
taxation. the Functions performed, Assets utilised and Risk
Introduction of the APA legislation would bring assumed (FAR) of both the foreign entity and Indian
about 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 and
on transfer pricing methods and are conducive in companies take that into account during their astute
providing 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 margins
Length 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 of
the principal outside India and the tax liability of the Role of CMA and ICAI in Transfer Pricing
company in India needs to factor in the Transfer Pricing ICAI has issued Transfer Pricing Guidelines in
regulation in force to avoid future legal tussles and 2002. The Cost Accounting Standards 1-4 issued by
also to protect the profitability envisaged in the ICAI has great relevance is arriving at ALP in Transfer
viability of the proposals. These needs to be examined Price :
in details during assessment of the viability of the CAS No. Title Details
project itself along with cost management tools to fine
CAS1 Classification of Cost For preparation of Cost Statements
tune the tax strategy with the costing of the product
CAS2 Capacity Determination For determination of capacity
and 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 overheads
the 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 and
Stanley and Co Inc (292 ITR 416) has held that if the methods of determining the
correct arm’s length price is applied and paid, then Overheads with reasonable
nothing further would be left to be taxed in the hands accuracy
of the foreign enterprise. The Bombay High Court has CAS4 Cost of Production for To determine the assessable value
restored the CIT(A) order in the taxpayer’s case and Captive Consumption of excisable goods used for
captive consumption
held that in case the agent is remunerated at
arm’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 accounting
is regarded to have a PE in India) would stand data/information, especially in respect of adjustments
extinguished. to be incorporated with respect of controlled and
Where the transactions are held to be at arm's uncontrolled transactions to make them comparable
length, nothing further can be attributed to the PE, to arrive at the ALP. Financial Accounting system does
provided 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 centerwise
assessment of PE gets extinguished only if the neither the financial audit checks the veracity of the
following 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 focused
arm’s length basis, and By FAR (Functions performed, on investors.
Assets utilised and Risks assumed) analysis of Indian However, the regulatory requirements, specially
and 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 cost
foreign company in India and may not be extinguished accounting system and the information generated
unless 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 companies
company. 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)


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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, Kolkata

Introduction 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 manufacturing
considerably 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 IT
American MNCs in the 1970s may be recalled). With functions or R&D—which support all parts of the value
the intensifying force of globalization, the influence of chain (UNCTAD 2011).
the MNCs in the world economy has further deepened Pricing Conundrum
so 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 their
much as one third of the total US international trade is overseas subsidiaries has been the pricing issue of the
conducted by and within US owned MNCS by means goods, services and technologies used in the
of intercompany transactions (Truitt, 2006 : p.161). By production and distribution of cross-border transaction
some recent estimates, MNCs’ production worldwide of goods and services.
generated value-added of approximately $16 trillion
Indeed, the plethora of literature on the subject has
in 2010, about a quarter of global GDP, while the
identified intercompany pricing of goods and services
foreign affiliates of MNCs accounted for more than 10
as one of the most significant and perplexing issues
per 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 to
that takes place between MNCs and other unaffiliated
achieve several other objectives such as:
firms (which are, more often than not, non-equity
modes of international production by the MNCs), ● Moving funds internationally
which accounted for $2 trillion in international sales ● Minimizing tariffs
in 2010, then MNCs are involved in about two-thirds ● Avoiding exchange control quotas
of world trade (UNCTAD, 2011; Wittendorff, 2010 ). ● Minimizing exchange risks
No doubt that these MNCs are the keystone of the ● Increasing share of profits from joint ventures
global economic edifice and they will surely maintain ● Optimizing managerial incentives and
that position in the global village that the world is now. performance evaluation; and
Because of their unique position and core competencies ● Minimizing taxes.
these MNCs are able to coordinate their activities The bare-bones of the aforesaid objectives
within a global value chain either through their direct influencing MNC pricing policy, more specifically
supervision 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 O'Connor (1997). For example, O’ Connor
contractual arrangement but nonetheless exercising explains that, if a MNC wants to move fund out of a
relative bargaining power over those host-country country, it can charge higher price to its foreign
firms. affiliate, or can do the opposite when the objective is
While the ultimate ownership and control to supply fund to the affiliate. Similarly, affiliates
configuration of a global value chain is the outcome of wishing to pay lower import duty may follow low
a set of strategic choices by the MNC—the relative costs mark-up policy. If the MNC under-prices the shipment


Article by ca. sudha g. bhushan

Article by ca. sudha g. bhushan

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