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Transfer Pricing Analysis and
Recent Experiences and
Judgment
BCASsp . a e
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ac groun
Case Study
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Presently five rounds of audit have been completed
TNMM is most commonly used by the taxpayers
Precedents set in earlier ears enerall followed
Emphasis has been laid on Documentation andEconomic Analysis
Legal precedents available on transfer pricing MentorGraphics, Morgan Stanley, Development Consultant
, , - , , ,Instrumentarium Corporation, Vanenburg etc.
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ase u y
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Case Study
ABC
International
Inc. China
ABC
International EndCustomer
Sale of BTS
Equipment
Outside
Purchase of
Mobile Phone
Instruments
Sale of BTS Equipment
& Providing Installation
& Commissioning
services
Installation &
Commissioning
of BTS
Equipment onMobile Towers
India
End
Customer
ABC India
Ltd.Sale of Mobile
Phone
Instruments
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Facts
ABC India Ltd. is engaged into manufacturing of BTS
Equipment, installation and commissioning of such BTS
e ui ment and tradin of Mobile Phone E ui ments
ABC India sells the BTS Equipment to end customersthrough its Associated Enterprise (AE) in various countries
of BTS Equipment and installation and commissioning of
such BTS Equipment
cost plus 10 per cent. Installation and commissioning cost is
also charged at cost plus 10 per cent
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Facts
Technical staff is deputed at the end clientsplace for installation and commissioning of
For deputation of technical staff, followingcosts are recovered at cost lus 10 er centmark-up:
Travel Cost;
Actual expenses incurred for installation andcommissioning of BTS Equipments;
a ary cos o emp oyees on as s o an- aysABC India also imports Mobile Phone
E ui ments from ABC International China
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Factso ow ng are e n erna ona ransac on
entered into by ABC India Ltd. with its AEs
Sr. No. Name of the Nature of Amount (`)
(`
in 000s)
ransac on
1 ABC
International
Sale of BTS
Equipment
104,500
2 ABC
International
GMBH
Commissioni
ng and
Installation
8,250
Charges
3 ABC
International
Purchase of
Mobile
48,580
China Ltd. Phone
Equipments
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Facts
ABC International GMBH sold the BTS Equipmentsat import cost plus 4 per cent mark-up
ABC International GMBH provided installation and
mark-up
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Consolidated P&L(` in 000s)
Opening Stock
BTS Equipment 1,250
Mobile Phones 15,250
Sales
BTS Equipment 104,500
Mobile Phones 68,250
Purchase of Mobile Phone 48,580
Installation & Comm. 8,250
,
Salary, TA, etc. 7,500
Other operating
BTS Equipment 1,000
Mobile Phones 8,200
Expense 4,950
Interest Paid 780
Interest Income 80
e ro ,
Total 190,280
Total 190,280
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Economic Analysis ?
Business
Function
Intangibles/
RisksManagement
Structure/
Processes
Economic Analysis
Economic
ProfilingComparable
Strategy
Most
Appropriate
Method
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FAR Analysis Manufacturing Segment
Activities performed ABC India ABC
International
unc ons er orme
Development of global strategy / brandingfor the manufacture and sale of Groups
x
R&D activities x
Inventory Management
Selling & Distribution activities
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FAR Analysis Manufacturing Segment
Assets ABC India ABC
ssets emp oye
Internat ona
Manufacturing Facilities x
Technical know-how x
Trademarks x
are ous ng ac t es
Human Resources
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FAR Analysis Manufacturing Segment
Risks ABC India ABC
International
s s ssume
Market risk
Legal risk
Inventory risk
Forei n exchan e fluctuation risk x
Credit risk
ABC India can be characterised as a full fledged
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pertaining to manufacturing of BTS Equipments
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FAR Analysis Trading Segment
Activities performed ABC India ABC
unct ons er orme
ChinaEstimation of demand x
Manufacture of goods x
Customs clearance formalities x
Marketing activities
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Assets employed
Assets ABC India ABCInternational
China
Fixed Assets
Human Resources
Trademarks and brand
names
x
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FAR Analysis Trading Segment
Risks ABC India ABC
International
s s ssume
China
Market risk
Inventory risk
Forei n exchan e fluctuation x
risk
Credit risk x
n a can e c arac er se as a u e ge ra er
not owning significant intangibles in respect of trading
of Mobile Phone Equipments
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. .
Mentor Graphics (Noida) Pvt. Ltd. Vs DCIT (109 ITD 101)
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.
Slicing Based"
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Which Way forward?
anu ac ur nganu ac ur ng
Understanding the
Business Model of
the Com an
Installation
& Commissioning
TradingTrading
OperatingOperating
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ncomencome
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Aggregation vs. Segregation
Manufacturing, Installation and Commissioning:
Installation and Commissioning of the BTS Equipment is
Trading of Mobile Phone Equipment: Trading of Mobile Phone Equipment is a separate activity
an s no nex r ca y n e o e sa e o
Equipment.
Development Consultants (P.) Ltd. vs DCIT (23 SOT 455)
Global Vantedge vs. DCIT (37 SOT 1)
n a . t . vs. p tt ng oConsolidated Accounts into Manufacturing & Trading Segments
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Segment Analysis
Based on the business functions of ABC India, the
business can be divided into the following segments:
Manufacturing Segment This involves manufacturing of BTS
Equipments. The international transactions in this segment
include export of BTS Equipments
Installation and commissioning of BTS Equipment
Trading Segment This involves purchase and resale of Mobile
Phone Equipment. The international transactions in this.
Benchmarking of
InternationalTransactions
Which Way
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Forward?
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Split P&L Account
Tested Party P&L A/c Manufacturing Segment Tested Party P&L A/c Trading Segment
(` in 000s)(` in 000s)
Opening Stock 1,250
Manufacturing
Cost 94 750
Sale of BTS 104,500
Installation &
Commissionin 8 250
Opening Stock 15,250
Purchases 48,580
Sales 68,250
Closing Stock 8,200
Salary, TA, etc. 7,500
Net Profit 10,250
Closing Stock 1,000
,
Total 76,450
Operating Expense
Total 76,450
Gross Profit 12,620
Total 113,750 Total 113,750
4,950
Interest Paid 780
Interest Income 80
,
Total 12,700 Total 12,700
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Transaction Based Methods
Profit Based Methods
(CUP)
Resale Price
Cost Plus
Profit Split-Comparable
-Residual
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CUP Method
Product/Service EconomicConditions
Contractual terms
e o e compar son a mos mposs e Hence, CUP is rejected as most appropriate
method
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Resale Price Method
Determine the gross profit margin
transactions
2
Subtract the appropriate gross
margin from the applicableresa e pr ce
3The remainder will be the
arms length price with the
controlled entity
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Resale Price Method- Trading
XYZ ABC Parent
Expenses = 17
India Company
Revenue=20
Independent
rans er pr ce
using
RP Method
distributors
margin-12%
s r u orRevenue 20
Less Cost 17
Retail
Independent
DistributorMargin = 3Price
Unknown
i.e.3 divided by
20
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Cost Plus Method
Transfer Price is determined by adding appropriate
gross pro mar -up o con ro e se er s cos s o
producing the property or provision of service
Indian disclosure norms are not uniform forclassifying expenses that should come before GP
and after GP. Hence exact matching of GP with the
comparables will not be possible.
Hence, C+ is not selected as the most appropriatemethod for manufacturing and installation and
perspective
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Profit Split Method
Compares allocation of profit (loss) to allocation
Applicability
-
- Multiple interrelated International Transactions
Relies on market data
Few taxpayers qualify for this method - difficult to get
a comparable
Rejected as the Most Appropriate Method
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CostStructures
Comparability
Factors
Risks
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Determine arms length price by comparing financial
results of tested party and selected uncontrolled
parties
Apply Profit Level Indicators (PLIs)
TNMM is selected as the most appropriate method for
benchmarking the international transaction of import
o o e one qu pmen s
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Selection of Tested Party
OCED: The choice of the tested party should be consistent with thefunctional analysis of the transaction. As a general rule, the tested party is
the one to which a transfer pricing method can be applied in the most
reliable manner and for which the most reliable comparables can be found,
i.e.it will most often be the one that has the less complex functionalanalysis.
tested party
Manufacturing, Installation & Commissioning Activity:simpler entity and reliable internal comparable data available).
Trading of Mobile Phone Equipments: ABC India Ltd(assessee selected as the tested party being entity with simpler entity
and external reliable comparable data is available)
Ranbaxy Laboratories Ltd. vs. ACIT [299 ITR (AT) 175]
Development Consultants (P.) Ltd. vs DCIT (23 SOT 455)
Global Vantedge vs. DCIT (37 SOT 1)
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Selection of the Most Appropriate Method
Manufacturin Activit :
As discussed earlier, CPM is selected as themost appropriate method by benchmarking
ore gn AE
Trading Activity:
ec n ca y s app ca e;
But in view of lack of availability of data for
com utation of ross rofit mar in
TNMM is selected as the most appropriate
method.
D t i ti f A L th P i
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Determination of Arms Length Price
Manufacturing Activity AE has sold BTS System to End Customer at import cost plus 4
percent mark-up
Sale Price to End Customer
Particulars (` in 000s) (` in 000s)
Sale Price to End Customer by AE
BTS Equ pment 108,680
Installation & Commissioning 8,580 117,260
Import Price to AE
qu pment ,
Installation & Commissioning 8,250 112,750
Variation 4510
ar a on as o n erna ona ransac on
Since the variation between the international transaction and final price to end
customer is less than 5 %, international transaction of sale of BTS Equipment is at
arm s engt
ACIT vs. MSS India Pvt. Ltd (2009-TIOL-416-ITAT-PUNE)
D t i ti f A L th P i
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Determination of Arms Length Price
Trading Activity
Search for Comparable Companiesa a ase se rowess
Issues faced in case of the use of Comparable data
Comparable contemporaneous data not available
Whereas the Tax Department insists on same year data only
Limitations of databases such as inadequate information, etc.
Philips Software Pvt. Ltd. vs. ACIT (26 SOT 226) Use ofcontemporaneous data
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Search Process Trading Segment
Search criteria No. of companiespassing the criteria
Industry classification Telephones and Mobile Phones
Companies having Trading Sales / Total Sales > 90% 12
ccep compan es av ng ar e ng ver semen
Cost / Sales > 2.5%
Rejected companies making losses consistently 1
Select Companies not having significant related party
transactions
4
Arithmetic mean of Operating Profit / sales of comparable
companies is 8.59%
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Philips Software Centre Pvt Ltd vs ACIT(26 SOT 226)
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Determination of the Arms Length Price
Selection of PLI
Operating profit margin (on sales) was considered as anappropriate PLI for comparing the operating marginearned by ABC India for Trading activities with that of
compara es n respec ve us nesses
Where, Operating Profit Margin (on sales) is computed as= Operating Profits / Operating Income
pera ng ro = pera ng ncome pera ngcost
Operating income = Total income Non operatingincomes like rofit on sale of fixed assets and
investments, income from investments, etc. Operating costs = Total costs- Non operating costs like
Preliminary expenses w/off + Loss on sale of
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, .
Determination of the Arms Length Price
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Tested Party P&L A/c Trading Segment
Determination of the Arm s Length Price(` in 000s)
Opening Stock 15,250
Purchases 48,580
Sales 68,250
Closing Stock 8,200
Gross Profit 12,620
Total 76,450Total 76,450
Operating Expense 4,950
Interest Paid 780
Net Profit 6 970
Gross Profit 12,620
Interest Income 80
Total 12,700Total 12,700
O Profit = NP - Interest Income + Interest
Paid = 6,970 80 + 780 = 7,670Op Profit / Sales = 7670 / 68250 * 100 = 11.24%
p ro a es es e
Party) = 11.24%Op Profit / Sales
(Comparable Companies) =
8.59%
Since the Operating margin of ABC India is more than the operating margin of
comparable companies, the transaction of import of Mobile Phones is at arms length
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THANK YOU
QUESTIONS
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