Method of Computation – Resale Price Method (RPM), Cost Plus Method (CPM), Transactional Net Margin Method (TNMM) and Profit Split Method (PSM)“INTENSIVE WORKSHOP ON TRANSFER PRICING “Organized by J.B. Nagar CPE Study Circle jointly with WIRC
Prakash Kotadia26 October 2012
Method of Computation – RPM, CPM, TNMM and PSM
CONTENTS
Page 2
Overview
Resale Price Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method
Most Appropriate Method
Method of Computation – RPM, CPM, TNMM and PSM
BACKGROUND
• Any income arising from an international transaction between the AEs should be computed having regard to the ALP
• ALP is the price applied or proposed to be applied in a transaction between persons other than AEs in uncontrolled transactions
• Due to special relationship between AEs, transfer price may be different than the price that would have been agreed between unrelated parties and hence, TP Regulations
Page 3
Method of Computation – RPM, CPM, TNMM and PSM
COMPARABILITY
• All the prescribed methods require comparables
• Transfer Price is set or defended using data from comparable companies
• Comparables should be independent and operate in uncontrolled environment
• Factors used in judging comparability- Nature of transactions- Functions performed- Assets employed- Risks Assumed- Contractual terms- Economic and market conditions
Page 4
Method of Computation – RPM, CPM, TNMM and PSMPage 5
PRESCRIBED METHODS
Methods for computing
ALP
Traditional Profit Based
CUP RPM CPM PSM TNMM New Method – CBDT Notification 18/2012
Method of Computation – RPM, CPM, TNMM and PSM
OECD GUIDELINES 2010
• Where traditional method and profit based method can be applied in an equally reliable manner, the traditional method is preferable to the profit based method
• Traditional methods cannot be applied to every possible situation
• Mere difficulty in obtaining data for application of traditional methods should not be the sole criteria for adopting profit based methods in determining ALP
• Profit based methods are more appropriate in situations- where each of the parties make valuable and unique contribution in
relation to the controlled transaction or when the transactions are highly inter-related;
- where reliable data for application of traditional methods is not available
Page 6
Method of Computation – RPM, CPM, TNMM and PSMPage 7
RESALE PRICE METHODTRANSACTIONAL NET MARGIN METHODRESALE PRICE METHOD
Method of Computation – RPM, CPM, TNMM and PSM
RPM
• Compares the resale gross margin earned by AE with the resale gross margin earned by comparable independent entity
• An arm’s length gross margin should be sufficient for a reseller to cover its operating expenses and make an appropriate operating profit considering its functions and risks
• RPM can be applied only in cases where the tested party has purchased goods/services from AE and resold to non-AE. If goods/services are purchased from non-AE and sold to AE by the tested party, then RPM cannot be applied
- Gharda Chemical Ltd Vs. DCIT (Mumbai ITAT) - 2009-TIOL-790-ITAT-MUM
Page 8
RPM generally applied to marketing operations (distributor not adding significant value to the product)
Method of Computation – RPM, CPM, TNMM and PSMPage 9
RPMSteps• Identify the third party selling price/fee for products/services purchased
/procured from AEs
• Reduce the comparable uncontrolled Gross Profit Margin in similar products /services
• Reduce the expenses incurred for procuring products/services
• Adjust for functional and other differences, if any
• The adjusted price is the ALP
Method of Computation – RPM, CPM, TNMM and PSMPage 10
RPM• Foreign manufacturer has WOS in
India as its distributor for Product A in India
• Foreign manufacturer has also appointed third party distributor for Product B in India
• GP Margin of third party distributor from sale of Product B – 30%
• Market price of Product A in India – 600
• Transfer Price for sale of Product A by the foreign manufacturer to its AE in India = Resale Price x (1 – 30%)600 x 70% = 420
Foreign Manufacture
r
Indian WOS – AE - Distributor
Third Party Distributor
Sales = 500COGS =
350
End Customer in
India
End Customer in
IndiaGP Margin =
30%
Product - BProduct - A
Resale Price =
600
Method of Computation – RPM, CPM, TNMM and PSM
RPMApplicability of RPM when foreign AE is a distributor and selected as tested party• Foreign benchmarking is required to be done treating AE as tested party
• Even though the tax department has recently started accepting foreign benchmarking but insist on providing robust documentation to prove functional similarity and reliability of data
• Assessee should be able to prove the close functional comparability between the AE and comparables and should be able to prove the reliability of the data
Page 11
Method of Computation – RPM, CPM, TNMM and PSM
RPMStrengths• Product differences are less significant, i.e. are less likely to have material
effect on profit margins than on price
• Fewer comparability adjustments needed to account for product differences, because focus is on functions performed
• OECD Guidelines
“the facts may indicate that a distribution company performs the same functions (taking into account assets used and risks assumed) selling toasters as it would selling blenders and hence in a market economy there should be a similar level of compensation for the two activities…”
Page 12
Method of Computation – RPM, CPM, TNMM and PSM
RPMWeaknesses• Gross profit margins may be affected by management efficiency etc., which
may have an impact on profitability but not on the price of the goods or services
• Accounting consistency important for comparability purposes
• Resale price method difficult to use when - goods are further processed before resale, or - reseller contributes substantially to creation or maintenance of
intangible associated with the product (e.g. trademarks)
Page 13
Method of Computation – RPM, CPM, TNMM and PSM
RPM Case Study • L India is 100% subsidiary of L Ltd.,
France• L India engaged in manufacturing and
distribution of cosmetics • L India’s business was accordingly
segregated between manufacturing and distribution
• L Ltd. benchmarked manufacturing and distribution segments separately
• For distribution segment i.e. international transaction of purchase of finished goods, L India applied RPM benchmarking the gross margin at 40.80% against comparables’ margin of 14.85%
• The TPO rejected RPM and applied TNMM. An adjustment was made on the basis of operating margin of comparables at 0.36% against L India’s loss of (-) 19.84%
Page 14
L Ltd. France
L India
Manufacturing of
cosmetics
Distribution of cosmetics
Purchase of finished goods
and raw materials
Method of Computation – RPM, CPM, TNMM and PSMPage 15
RPM Case Study • L India’s contentions
– As per OECD guidelines and guidance note issued by ICAI, RPM is the MAM in case of distribution and marketing activities especially when goods are purchased from AE and resold to unrelated parties
– Net losses in the distribution segment incurred only for 3 years and thereafter L India started earning profits
– Certificates from AE confirming profit margin only at 2%
• Ruling– RPM is appropriate for distribution– Losses on account of business
strategy– No motive to shift profits in view of
low margin earned by AE
L Ltd. France
L India
Manufacturing of
cosmetics
Distribution of cosmetics
Purchase of finished goods
and raw materials
Method of Computation – RPM, CPM, TNMM and PSM
RPMPractical Issues • Minor functional difference affect gross profit margins
- In RPM, the comparability is at the Gross margin level and hence, RPM requires a high degree of functional comparability rather than product comparability. Hence, a detailed analysis showing the close functional comparability and risk profile of the tested party and comparables should be clearly brought out in the TP Study to justify comparability at gross profit level under RPM
- Axalto Cards & Terminals India Ltd (2010-TII-37-ITAT-DEL-TP)
• Difficulties in determination of costs- Finding correct data of gross margin in the public domain- Categorization of expenses as COGS or operating expenses- Adjustments on account of economies of scale, operational efficiencies, accounting
policies etc. - Benchmarking limited risk distributor
Page 16
COST PLUS METHOD
Method of Computation – RPM, CPM, TNMM and PSMPage 17
TRANSACTIONAL NET MARGIN METHODCOST PLUS METHOD
Method of Computation – RPM, CPM, TNMM and PSM
CPM
• Compares the gross profit on costs earned by the tested party with the gross profit on costs earned by comparable independent entity
• “Cost Plus method” is different from “Cost Plus Pricing mechanism”- For instance: A captive service provider in India may charge Cost plus
15% mark up from its AE but may use TNMM to justify its international transactions
Page 18
CPM generally applied to Contract Manufacturer, in particular of semi-finished goods, Contract R&D Service Provider, Captive Service Provider
Method of Computation – RPM, CPM, TNMM and PSM
CPMSteps• Identify the direct and indirect costs of production incurred in transactions
undertaken by the tested party
• Identify the normal gross profit in comparable uncontrolled transactions
• Adjust the normal gross profit (as computed above) to account for functional and other differences
• Add the adjusted gross profit (as computed above) to the costs identified in first step
• The sum so arrived above is taken as ALP
Page 19
Method of Computation – RPM, CPM, TNMM and PSM
CPMStrengths• Product differences are less significant, i.e. are less likely to have material
effect on profit margins than on price
• Less product comparability required compared with CUP method
• Fewer comparability adjustments needed compared with the CUP method to account for product differences, because focus is on functions performed
Page 20
Method of Computation – RPM, CPM, TNMM and PSM
CPMWeaknesses• In practice, often difficult to determine appropriate cost basis
• Costs incurred may not always be determinant of profit level
• Not always discernible link between level of costs incurred and a market price
• Accounting consistency important for comparability purposes
Page 21
Method of Computation – RPM, CPM, TNMM and PSM
CPM VS TNMM
In the case of manufacturer, whether CPM should be selected as the Most Appropriate Method instead of TNMM?
• Facts of various judicial precedents suggest that the assessees engaged in manufacturing activity have been following CPM. However, they could not justify the same before TPO due to functional differences, difference in terms and conditions, inadequate documentation, etc and hence, the TPO rejected CPM and followed TNMM
• Diamond Dye Chem Ltd. vs. DCIT (2010-TII-20-ITAT-MUM-TP)Where reliable cost data for the product manufactured is available, CPM must be followed
• It may be advisable that in case of manufacturer, CPM should be preferred over TNMM subject to availability of the reliable data necessary for the application of CPM and a close degree of comparability of the functions performed, assets employed and risks assumed by the tested party and the comparables.Page 22
Method of Computation – RPM, CPM, TNMM and PSMPage 23
CPMCase Study
• Foreign manufacturer has WOS in India• Indian WOS manufactures and supplies semi
finished goods to its foreign AE• Comparable companies in India selling similar
products earn an average mark-up on cost of 20%Foreign AE
Indian WOS –
Manufacturer
Supply of semi
finished goods
ALP of international transaction of Indian WOS
Particulars Amount
Cost of raw materials 200
Other direct and indirect production costs 100
Total cost base 300
Mark-up on costs (20% - tested in CPM – determined from uncontrolled comparables
60
Transfer Price 360
Overheads and other operating expenses
40
Operating Profit 20
PROFIT SPLIT METHOD
Method of Computation – RPM, CPM, TNMM and PSMPage 24
TRANSACTIONAL NET MARGIN METHODPROFIT SPLIT METHOD
Method of Computation – RPM, CPM, TNMM and PSM
PSM
• PSM calculates the combined operating profits resulting from all intercompany transactions based on the relative value of each AE’s contribution to the operating profits
• The contribution made by each party is ascertained on the basis of FAR of each AE
• PSM may be applicable mainly in international transactions involving- transfer of unique intangibles; or - in multiple inter-related international transactions which cannot be
evaluated separately
• It works on an assumption that independent parties would split the combined profits in proportion to the value of their relative contributions
Page 25
Method of Computation – RPM, CPM, TNMM and PSM
PSMSteps• Determine the combined net profit of AEs arising out of international
transactions
• Evaluate relative contributions by each AE on the basis of FAR of each AE
• Split the combined net profit amongst AEs in proportion to their relative contributions
• Profit thus apportioned to the tested party is used to arrive at ALP
Page 26
Method of Computation – RPM, CPM, TNMM and PSM
PSMStrengths • Offers solution for highly integrated operations for which one-sided method
would not be appropriate
• Offers solutions where both the parties to the transaction contribute unique intangibles
• Offers flexibility since it takes into account specific, possibly unique, facts and circumstances of the AEs which are absent in the case of independent third parties by adopting arm’s length approach
• The two-sided approach in PSM ensures that neither party to the controlled transaction is left with an extreme and improbable profit result
Page 27
Method of Computation – RPM, CPM, TNMM and PSM
PSMWeaknesses • Difficult to apply in practice
• AEs and Tax authorities face difficulties in accessing information from foreign affiliates
• It may be difficult to measure combined costs and revenue for all AEs, as it may require stating of books and records on common basis as regards- Accounting practices- Different currencies, etc.
• It may be difficult to identify the operating expenses associated with the international transactions and AE’s other activities
Page 28
PSM is not widely used in practice
Method of Computation – RPM, CPM, TNMM and PSM
PSMDetermination of ALP Allocation of the combined profit can be done by any one of the following ways
• Contribution Approach / Analysis- Capital Investment Approach / Analysis- Compensation Approach- Bargaining Theory Approach- Survey Approach
• Residual Approach / Analysis
Page 29
Method of Computation – RPM, CPM, TNMM and PSM
PSMDetermination of ALP
Contribution Approach / Analysis
• The combined profit i.e. the total profit from the controlled transactions would be divided between the AEs based on
- the reasonable approximation of the division of the profits under the arm’s length condition prevailing in similar transactions and
- the relative value of the functions performed after taking into account assets employed and risks assumed by each AE, i.e. FAR analysis of each AE
Page 30
Determination of contribution of each AE should be economically justified and not on Global Apportionment Formula
Method of Computation – RPM, CPM, TNMM and PSM
PSMDetermination of ALP
Residual Approach / Analysis
• Under the residual approach, the combined profits of the controlled transactions are allocated in two stages
- Towards the basic return appropriate for the type of transactions (which would be without considering the contribution of intangibles or unique product)
- The residual profit must be split between enterprises in their relative contribution (which is generally based on contribution of intangibles possessed by AEs)
Page 31
Method of Computation – RPM, CPM, TNMM and PSM
PSMDetermination of ALP Factors to be kept in mind• The combined profit to be split (including losses) should be only that profit
arising from controlled transactions under review
• Allocation of combined profit between AEs should be consistent with the FAR Analysis of each AE and should be based on the factors agreeable between the third parties
• Criteria or allocation keys used to split the profit should be reasonably independent of the transfer pricing policy formulation and should be reasonably supported by reliable comparable data
• In practice, common allocation keys used are assets (operating assets, fixed assets, intangible assets, etc.) or capital employed or costs (relative spending and/or investment in key areas such as research and development, engineering, marketing, etc.)Page 32
Method of Computation – RPM, CPM, TNMM and PSM
PSMDetermination of ALP
Factors to be kept in mind
• Asset based or capital based allocation keys can be used where there is a strong correlation between tangible or intangible assets or capital employed and creation of value in the context of the controlled transaction
• Cost based allocation keys can be used where there is a strong correlation between relative expenses incurred and relative value added
• Other allocation keys can be based on incremental sales, headcounts, time spent by certain group of employees, number of servers, data storage, floor space, etc.
Page 33
Method of Computation – RPM, CPM, TNMM and PSM
PSMCase Study • Government of Germany is the sole
telecom operator in Germany• XYZ Germany, pursuant to its
Agreement with the German Government in 1997, was to provide BTS Equipment to the Government for the period of 25 years
• XYZ Germany enjoys the monopoly (due to its early entry in German Market and expertise in delivering BTS Equipment) in the German Market - the sole customer being the German Government
• XYZ Germany owns the brand name under which the BTS Equipments are sold to the German Government
• In view of the above, determination of the ALP treating XYZ Germany as the tested party is ruled outPage 34
XYZ Germany
Government of
Germany
XYZ India
Sells the BTS Equipment manufactured by XYZ India under the brand name XYZ
Germany
Sells Manufactured BTS Equipment for Mobile
GSM Network
Method of Computation – RPM, CPM, TNMM and PSMPage 35
PSMCase Study
• XYZ India, WOS of XYZ Germany, manufactures the BTS Equipments by application of highly complicated technical know-how developed by it in-house
• ABC India is the only company in India which manufactures such BTS equipments, but entire transaction of ABC India is with its related party (Uncontrolled comparable is not available)
• CUP method, CPM and TNMM cannot be selected as the MAM due to lack of availability of comparable data; and RPM is not applicable based on the facts of the case
• On account of presence of valuable intangibles with XYZ India (viz. technical knowhow) and XYZ Germany (viz. Product Brand name), PSM was considered as the MAM
XYZ Germany
Government of
Germany
XYZ India
Sells the BTS Equipment manufactured by XYZ India under the brand name XYZ
Germany
Sells Manufactured BTS Equipment for Mobile
GSM Network
Method of Computation – RPM, CPM, TNMM and PSM
PSMCase Study
Financial Results of XYZ India and XYZ Germany
Page 36
XYZ India
Particulars
Amount
Particulars
Amount
COGS 250 Sales 460
Other Op. Expenses
150
Net Profit 60
Total 460 Total 460
XYZ Germany
Particulars
Amount Particulars
Amount
Purchases 460 Sales 700
Other Op. Expenses
140
Net Profit 100
Total 700 Total 700
Method of Computation – RPM, CPM, TNMM and PSM
PSMCase Study
Allocation of Profits to Routine Contributions• The total profits of 160 is required to be allocated between XYZ India and XYZ
Germany on the basis of their manufacturing and distribution functions respectively
• Based on the benchmarking study conducted from the data available in public domain in India in relation to manufacturing of Communication Equipments, a profit margin of 8% on total cost was considered to be at arm’s length
• Based on the benchmarking study conducted from the data available in public domain in Germany in relation to distribution of communication equipments, a profit margin of 4% on sales was considered to be at arm’s length
• Accordingly, 32 (8% of 400) and 28 (4% of 700) was attributed to manufacturing and distribution functions performed by XYZ India and XYZ Germany respectively
Page 37
Method of Computation – RPM, CPM, TNMM and PSM
PSMCase Study Allocation of Residual Profits• The residual consolidated profit of 100 (160-32-28) will have to be allocated
between XYZ India and XYZ Germany on the basis of their relative value of intangibles
• Valuation of intangible was conducted for the technical know-how owned by XYZ India based on income approach and was valued at 250 with expected life of the know-how to last for 10 years
• Valuation of intangible was conducted for the brand name owned by XYZ Germany based on income approach and was valued at 1,000 with expected life of the brand name to last for residual 10 years (i.e. till the expiry of the contract with the German Government)
• Hence, the consolidated residual value of profits was allocated between XYZ India and XYZ Germany in the ratio of 1:4
• Accordingly, the balance profit of 100 was allocated between XYZ India and XYZ Germany in the proportion of 20 and 80 respectively
Page 38
Method of Computation – RPM, CPM, TNMM and PSM
PSMCase Study Summary of Distribution of Consolidated Profits
Page 39
Profit Attribution XYZ India
XYZ German
y
Total
Consolidated Net Profit (a) 160
Less: Attributed towards respective Routine Contributions
(b) 32 28 60
Residual Profits (c = a – b) 100
Attribution towards relative intangibles
(d) (1:4) 20 80 100
Total Profit Attribution (e = b + d)
52 108 160Since actual profit earned by XYZ India is more than the Attributed
Profit (60 > 52), the transactions entered into by XYZ India with XYZ Germany are at
arm’s length
Method of Computation – RPM, CPM, TNMM and PSMPage 40
TRANSACTIONAL NET MARGIN METHODTRANSACTIONAL NET MARGIN METHOD
Method of Computation – RPM, CPM, TNMM and PSM
TNMM• Under TNMM, ALP is determined by comparing
- the net profit margin of the tested party - from controlled transaction - with net profit margin earned from comparable uncontrolled transactions (Internal
TNMM) or - with net profit margin of an unrelated party engaged in a comparable uncontrolled
transaction (External TNMM)
• TNMM compares net margins by using certain ratios (PLIs) to express net profit as a % of a given base which commonly include operating cost, operating income, total assets, value added expenses, etc.
• TNMM is similar to RPM and CPM to the extent that it involves a comparison of margins earned in a controlled situation with margins earned from comparable uncontrolled situations
• However, TNMM differs from RPM and CPM to the extent that it involves comparison of margins at net profit level as against at gross profit level
Page 41
Method of Computation – RPM, CPM, TNMM and PSMPage 42
TNMMSteps
Perform FAR Analysis of all entities engaged in controlled transactions
Choose a Tested Party(generally, the simpler
Entity)
Characterize the TestedParty (based on FAR
Analysis)
Indentify uncontrolledTransactions or
comparables
Select PLI and determine operating Margin
of comparables
Determine arm’s Length Operating Margin after
Making Adjustments, if any
Compare adjusted marginof comparables with tested party’s margin
Determine whether controlledtransactions are at ALP
Method of Computation – RPM, CPM, TNMM and PSM
TNMMStrengths• Requires comparability at a Broad functional level - Product differences are
acceptable provided such difference does not materially affect the margin
• Operating profit margins are less affected by transactional differences as is the case with price in case of application of CUP Method
• Need to examine a financial indicator of only one of the AE (i.e. the tested party)
• No need to restate the books and records for all participants on a common basis or to allocate costs as is the case with PSM
• The differences in functions performed between enterprises are often reflected in variation in operating expenses. Consequently enterprises may have wide range of gross profit margins but it may still earn broadly similar level of net profitsPage 43
Method of Computation – RPM, CPM, TNMM and PSM
TNMMWeaknesses • Requires information on uncontrolled transaction which may not be available
at the time of entering into controlled transaction
• Difficulty in ascertaining revenue and operating expenses (i.e. segmental results) related to the controlled transactions to establish the net profit indicator
• Difficulty in making reasonable accurate adjustments in cases where factors like difference in working capital, risk assumed, etc. have influence on the net margins of the taxpayers vis-à-vis third parties
• Difficulty in determining the corresponding adjustment, particularly where the controlled transactions are both on the purchase as well as sales side
Page 44
Method of Computation – RPM, CPM, TNMM and PSM
TNMMTested Party • The following parameters are used for selection of the tested party
- Should be least complex (functionally) entity
- Availability of reliable comparable data that requires fewest and most reliable adjustments
- Should ideally not own any intangibles
Page 45
The reasons for selection of tested party should be adequately documented in the TP Study
Method of Computation – RPM, CPM, TNMM and PSM
TNMMPLI• PLIs are the ratios that measure the relationship between the profits and
other attributes like costs or sales or resources like capital employed or assets employed to establish ALP
• Most commonly used PLIs in TNMM are:- Operating Margin (Operating Profit to Operating Cost or Operating Income)- Return on Assets or Capital Employed (Operating Profit to Operating Assets
or Capital Employed)
• Operating Margin is calculated by eliminating extra-ordinary income or expenses and non operating income and expenses like interest, loss on sale of fixed assets, etc. from the net profit
Page 46
Method of Computation – RPM, CPM, TNMM and PSM
TNMMPLI
Page 47
PLI Formula Typical Applicability
Operating Margin on Operating Income
OP/OI When amount payable to AE for purchase from AE or services received from AE
Operating Margin on Operating Cost
OP/OC When amount receivable from AE for exports to AE or services rendered to AE
Return on Assets OP/Operating Assets Capital Intensive Manufacturers
Berry Ratio GP/VAE Intermediary activities
Method of Computation – RPM, CPM, TNMM and PSM
TNMMPLI
Indian TP regulations
• Net profit margin realized by an enterprise from an international transaction entered into with its AEs has to be compared with the net profit margin realized by an enterprise from a comparable uncontrolled transaction or by an unrelated enterprise from a comparable uncontrolled transaction
• In the absence of any clarification on what constitutes the net margin, it is normally understood as “NPBT / Sales” or “NPBT / Cost” as the case may be
Page 48
Method of Computation – RPM, CPM, TNMM and PSM
TNMMPLI
OECD Guidelines
• TNMM examines the net profit relative to an appropriate base (for example costs, sales, assets) that a taxpayer realizes from a controlled transaction
• Net profit from a controlled transaction (i.e. international transaction) should constitute only those items, which are- Directly or indirectly related to international transaction; and- Operating in nature
• Accordingly, net profit margin is understood as Operating Profit
Page 49
Method of Computation – RPM, CPM, TNMM and PSM
TNMMPLI
Judicial Precedents• One View:
TNMM requires comparison of Net Profit Margin and not operating margins - Addl. CIT vs. M/s Tej Diam (2010-TII-27-ITAT-MUM-TP);- UCB India Pvt. Ltd. vs. ACIT (121 ITD 131)(Mum); - ACIT vs. M/s Twinkle Diamond (2010-TII-09-ITAT-MUM-TP)- Symantec Software Solutions Pvt. Ltd. vs. ACIT (2011-TII-60-ITAT-MUM-TP)
• Contrary View:Net Margin i.e. only operating income and operating expenses for relevant business activity to be considered - TNT India Private Ltd. vs. ACIT [ITA No. 1442(BNG) / 08]- M/s Marubeni India Pvt. Ltd. vs. Addl. CIT (2011-TII-36-ITAT-DEL-TP)- M/s DHL Express (India) Pvt. Ltd. vs. ACIT (2011-TII-59-ITAT-MUM-TP)
Page 50
Method of Computation – RPM, CPM, TNMM and PSMPage 51
TNMM Case Study
• G India was engaged in facilitating sourcing of apparel from India for its AEs
• The primary activity of G Ltd comprised of assistance in identifying vendors, assistance to vendors in procurement of apparel, inspection and quality control and coordination with vendors to ensure delivery of goods to AEs
• The technical and intellectual inputs for discharge of above services were provided by AEs
• G India adopted TNMM to benchmark the service fee determined at cost plus 15% mark up from AE
• TPO disregarded FAR of G India, observed that G India was not limited risk support provider and held that G India ought to have earned a commission of 5% on FOB of goods procured for AEs
G Ltd. USA and its group
companies
G India
Cost plus 15%
Third party vendors
Sourcing Services
Sale of goods
Method of Computation – RPM, CPM, TNMM and PSMPage 52
TNMM Case Study
Ruling• G India is a limited risk procurement
service provider, no intangibles were developed by G India
• G India’s roles and responsibilities were well defined by its agreement with AEs
• G India had no role to play in the end customer pricing and therefore there was no question of location savings. The intent of sourcing from India was to provide lower cost to end customers
• The application of PLI on the basis of commission of FOB value would give absurd results. The PLI should be in consonance to FAR of G India. Accordingly application of cost plus was the most appropriate PLI
G Ltd. USA and its group
companies
G IndiaThird party
vendors
Sale of goods
Cost plus 15%
Sourcing Services
Method of Computation – RPM, CPM, TNMM and PSMPage 53
TRANSACTIONAL NET MARGIN METHODMOST APPROPRIATE METHOD
Method of Computation – RPM, CPM, TNMM and PSM
MOST APPROPRIATE METHOD
• Indian TPR does not provide any hierarchy or priority for selection of MAM
• MAM is that method which, under the facts and circumstances of the transaction under review, provides the most reliable measure of an arm’s length result
• Each method needs to be tested on its merits depending on the nature of international transaction, availability of reliable comparable data, extent to which reasonable adjustments can be made, etc.
Page 54
Method of Computation – RPM, CPM, TNMM and PSM
MOST APPROPRIATE METHOD
Page 55
Method PLI Degree of
comparability
required is
With respect to
CUP Price Very High Similar products & surrounding conditions
RPM GP/Sales High Similar FAR and engaged in distribution of products
CPM GP/Direct and Indirect Cost of Production
High Similar FAR and engaged in manufacture, assembly or production of tangible products or provision of services
PSM OP/Assets or Capital Employed or Cost
Moderate Similar FAR and involving transfer of unique intangible or multiple inter related international transactions
TNMM OP/OC or OI or operating assets or capital employed
Moderate Similar FAR and applied when other methods fail to be applied
Method of Computation – RPM, CPM, TNMM and PSM
ISSUES IN SELECTING THE MOST APPROPRIATE METHOD• Can ALP be determined without following any method as MAM
- It is mandatory for the assessee to follow one of the prescribed method and demonstrate the arm’s length nature of the international transaction - DCIT vs. M/s Starlite (2010-TII-28-ITAT-MUM-TP)
- TPO can not follow the method which is not authorized under the IT Act or Rules - CA Computer Associates Pvt. Ltd. vs DCIT (2010-TIOL-68-ITAT-
MUM)- Nimbus Communications Ltd. vs. ACIT (2010-TII-21-ITAT-MUM-
TP)
- However, in view of New Method prescribed by CBDT Notification 18/2012 , it would be possible to apply a method other than the prescribed onesPage 56
Method of Computation – RPM, CPM, TNMM and PSM
GLOSSARY
Page 57
Abbreviation Term Abbreviation Term
AE(s) Associated Enterprise(s) PSM Profit Split Method
ALP Arm’s Length Price RPM Resale Price Method
BTS Base Transceiver Station TNMM Transactional Net Margin Method
COGS Cost of Goods Sold TPO Transfer Pricing Officer
CPM Cost Plus Method TPR Transfer Pricing Regulations
CUP Method Comparable Uncontrolled Price Method VAE Value Added Expenses
FAR Analysis Functions, Assets and Risk Analysis
ICAI The Institute of Chartered Accountants of India
IT Act The Income Tax Act, 1961
MAM Most Appropriate Method
NPBT Net Profit Before Tax
OECD Organisation for Economic Co-operation and Development
OECD Guidelines
Transfer Pricing Guidelines issued by OECD in July 2010
PLI Profit Level Indicator
Method of Computation – RPM, CPM, TNMM and PSMPage 58
Method of Computation – RPM, CPM, TNMM and PSM
PRAKASH KOTADIAPartner, Tax & Regulatory ServicesBDO Consulting Pvt. Ltd.Direct +91 22 6672 9790Mobile+ 91 98213 [email protected]
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Method of Computation – RPM, CPM, TNMM and PSMPage 60
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