transfer pricing
TRANSCRIPT
Management Control System
Assignment on Transfer Pricing Mechanism
ITM Business School, Kharghar
Submitted To: Submitted By:
Prof. Bharat Shah Dhara Badiani
Roll No. –KHR200PGDMF012
Batch – A
Transfer Pricing
Concept of Transfer Pricing:
In divisionalised companies, where profits or investment centers are created, there is likely to be
interdivisional transfer of goods, or services and these internal transfers create the problem of transfer
pricing. A transfer price is that notional value at which goods and services are transferred between
divisions in a decentralized organisation. Transfer prices are normally set for intermediate products
which are goods and services that are supplied by the selling division to the buying division. It can be
said that the problem of suitable transfer prices arises only when divisions do business with one
another. Thus in managerial accounting, when different divisions of a multi-entity company are in charge
of their own profits, they are also responsible for their own "Return on Invested Capital". Therefore,
when divisions are required to transact with each other, a transfer price is used to determine costs.
Principles of Transfer Pricing:
There should be common management
There should be an existence of intermediate product
Objectives of Transfer Pricing:
If two or more profit centers are jointly responsible for product development, manufacturing and
marketing, each should share in the cost and the revenue that is generated when the product is finally
sold. A question arises as to how the transfer of goods and services between divisions should be priced.
The price charged to the interdivisional transfer of goods is revenue to the selling division and cost to
the buying division. Therefore the price charged will effect the profit of both the divisions; benefit
(revenue) to one division can be created only at the expense of other division. The transfer prices, thus
can have impact on the evaluation of each division’s performance and measures applied for such
measurements of performance. While determining transfer prices a number of criteria (objectives)
should be fulfilled.
Transfer prices should help in the accurate measurement of divisional performance
(profitability) measurement.
Transfer prices should help goal congruence to take place, which in effect means that the
objectives of divisional managers are compatible with the objectives of overall company.
Transfer prices should ensure that divisional autonomy and authority is preserved. The main
purpose of decentralization is to enable divisional managers to exercise greater autonomy and
to measure the overall results achieved on a profit centre or investment centre. It is therefore
not proper to give divisional managers authority by one hand placing them in charge of
divisional operations and to remove that authority by dictating transfer prices that affect the
performance of the division.
To provide each division with relevant information required to make optimal decisions for the
organisation as a whole.
A transfer pricing system, if properly established, can check multinational companies and
international groups which may try to manipulate transfer prices between countries in order to
minimize the overall tax burden.
Three Decisions
A transfer pricing situation usually involves three questions or decisions.
1. Should the transfer take place? This is essentially a (Make or Buy) question. Should the company make the item or outsource, i.e., purchase it on the outside market? This is a relevant cost problem (also referred to a differential or incremental cost). The key is which costs will be different under the two alternatives, i.e., make inside and transfer, or buy from outside the company?
2. If the answer to question one is yes, then what transfer price should be used?
3. Should the central office interfere in establishing the transfer price?
Requisites of a sound transfer pricing system:
It should be simple to understand and easy to operate.
It should enable fixation of fair transfer prices for the output transferred or service rendered. A
divisional manager who considers the transfer price to be unfair to the division may be
demotivated.
Ideally the divisional managers / business unit should be given the autonomy and freedom, to
sell a small portion of its production to customers outside the organisation or to buy small
quantities from sources outside it. Frequently the divisional managers may have restrictions in
this regard.
The business unit/ divisions should have free access to various sources of market information.
There should be a negotiation for transfer prices between the business unit / divisional
managers of the selling and the buying unit / division. Negotiated transfer prices are far more
better than the prices imposed by the top management.
Sound transfer pricing ground rules should be framed to guide negotiations between business
unit / divisional managers. These rules will provide consistency and also minimize
interdepartmental conflicts.
Top management should discourage prolonged arguments between business units / divisional
managers.
Methods of Transfer Pricing:
Broadly, there are three bases available for determining transfer prices, but many options are also
available within each base. These methods are:
1. Market Prices
2. Cost based Prices
a. Variable Cost
b. Actual full Cost
c. Full Cost Plus Profit Margin
d. Standard Full Cost
e. Opportunity Cost
3. Negotiated Prices
4. Dual Prices
Market Bases Prices:
Market price refers to a price in an intermediate market between independent buyers and sellers. When there is a competitive external market for the transferred product, market prices work well as transfer prices.
When transferred goods are recorded at market prices, divisional performance is more likely to represent the real economic contribution of the division to total company profits. If the goods cannot be bought from a division within the company, the intermediate product would have to be purchased at the current market price from the outside market. Therefore in this case managers of both the divisions are indifferent between trading with each other or with outsiders.
Market- based prices are based on the opportunity cost concepts. The opportunity cost approach signals that the correct transfer price is the market price. Since selling divisions can sell all that it produces at the market price, transferring internally at a lower price would make the division worse off. Similarly the
buying division can always acquire the intermediate goods at the market price, so it will be unwilling to pay more for internally transferred goods.
Since the minimum selling price for the selling division is the market price and the maximum buying price for a buying division is the market price , the only possible price is the market price.
However there are some problems in using the market price approach:
Most markets are not perfectly competitive. In other words, the demand curve and price structure may shift if the firm buys outside.
Market prices may not exist for some products.
A market price may not be comparable because of differences in quality, credit terms, or extra services provided.
Price quotations may not be reliable because they are based on temporary distress or dumping conditions.
A market price may not be relevant because the selling division would not have the same transportation cost, accounting cost for A/R, credit etc. as an outside supplier.
If selling division is not operating at full capacity and unused capacity exists in that division, the use of market price may not lead to maximization of total company profit. To illustrate this point, assume that selling division has unused capacity of 30,000 units and it can continue to sell only 50,000 units to outside buyers. In this situation the transfer price should be set to motivate the manager of buying division to purchase from selling division if the variable cost per unit of product of selling division is less than the market price. If the variable costs are less than the market price and if transfer price is set equal to market price than the manager of the buying division will be indifferent. However, Division A’s purchase of 20,000 units of materials from the outside suppliers at the market price may not benefit the company, since this market price is greater than the unit variable cost of the selling division. Hence the intracompany transfer could save the company the difference between the market price and the variable expenses of the selling division.
Cost Based Prices:
When external markets do not exist or are not available to the company or when information about external prices is not readily available, companies may decide to use some forms of cost based transfer pricing system.
Variable cost: This is useful when the selling division is operating below capacity. The manager of the selling division may not like this transfer price because it yields no profit to that division. In this pricing system only the variable production costs are transferred. Variable cost has the major advantage of encouraging maximum profits for the entire firm.
The obvious problem is that the selling division is left holding all its fixed costs and operating expenses.
Variable Cost Plus: This will be a better option than fixing transfer price only at the variable cost as the selling division will be motivated to transfer the goods at a transfer price fixed more than the buying division.
Actual Full Cost: In actual full cost approach, transfer price is based on the total product cost per unit which will include direct materials, direct labor and factory overhead. When full cost is used on transfer pricing, the selling division cannot realize a profit on the goods transferred. This may be a disincentive to the selling division. As a result the selling decision cannot be evaluate as a profit center or investment center as it will be treated as a cost center.
Full Cost Plus Profit Margin: This method overcomes the problem of Actual Full Cost method. It includes the allowed cost of the item plus a mark up or other profit allowance. With such a system, the selling division obtains a profit contribution on units transferred and hence, benefits if performance is measured on the basis of divisional operating profits. However the manager of buying decision will naturally object that his costs are adversely affected.
Standard Costs: In actual cost approaches, there is a problem of measuring costs. Actual cost does not provide any incentive to the selling division to control costs. While transferring actual costs any variances or inefficiencies in the selling division are passed along to the buying decision. To promote responsibility in the selling division and to isolate variances with in divisions, standard costs are usually used as a basis for transfer pricing in cost-based systems. Use of standard cost reduces the risk to the buyer.
Opportunity Costs: The transfer pricing based on opportunity cost identifies the minimum price that a selling division would be willing to accept and the maximum price that the buying division will be willing to pay. These minimum and maximum prices correspond to the opportunity costs of transferring internally. It is used in the situations where the market is imperfect. The opportunity cost based transfer prices for each division are as follows:
o Selling Division: For the selling division, the opportunity cost of transferring is the greater of:
The outside sales value of the transferred product
Differential production cost for the transferred product
o Buying Division: For the buying division the opportunity cost of transfer is the lesser of:
The price that would be required to be purchased from outside
The profit that would be lost from producing the final product if the transferred unit cannot be obtained at an economic price.
As long as the transfer price is greater than the opportunity cost of the selling division and less than the opportunity cost of the buying division, a transfer will be encouraged.
Negotiated Prices:
Negotiated prices may be best if:
a. An imperfect market exists for the product making it difficult, if not impossible, to determine the appropriate market price.
b. The seller has excess capacity, thus the transfer becomes a differential cost problem to the seller. Any transfer price above the seller's differential cost would benefit the seller.
c. There is no external market for the product, thus no market price.
In these cases the buyer and seller may negotiate a price that allows both parties to share in the benefits of the transfer. The managers involved act much the same as the managers of independent companies. A negotiated price avoids mistrusts, bad feelings and undesirable bargaining interests among divisional managers. Also it helps in achieving the objectives of goal congruence, autonomy and accurate performance evaluation. The use of negotiated prices is consistent with the concept of decentralized decision making in the divisionalised firms.
However the disadvantages of this method are:
A great deal of management effort, time and resources can be consumed in the negotiating process.
The final emerging negotiated price may depend more upon the divisional managers ability to negotiate than on the other factors.
Dual Prices: Under dual prices of transfer pricing, selling division sells the transferred goods at a profit or using full cost plus mark up. But the transfer price for the buying division is the market price. The difference in transfer prices for the two divisions could be accounted for by special centralized account. Dual prices give motivation and incentive to selling divisions as goods are transferred at a profit or mark up. Market price can be considered as the most appropriate for the buying decision. Thus it plays the function of motivating both the selling divisions and the buying divisions to make decisions that are consistent with the overall goals of the decentralization.
Guidelines for an Optimum Transfer Pricing Mechanism:
If market prices are used as a base for evolving transfer prices through negotiations, long run competitive market prices should be used.
When a competitive market exists for an intermediate product, the market price should be used as the transfer price.
When cost based transfer prices are used standard costs, and not actual costs, per unit of output should be used.
If divisional managers are allowed to buy / sell a small quantity (5-10 per cent) outside the company, it gives them an awareness of the supply and demand conditions of the market, which facilitates negotiation of transfer prices by them.
Managers at different levels in a firm attempt to achieve different objectives through their transfer pricing policies.
Corporate managers want transfer prices to:
Encourage division managers to make decisions that maximize the long-run profitability of the overall firm
Provide information so that managers can make good short term decisions (such as bids for orders) and long term decisions (such as adding or deleting product lines)
Division Managers want Transfer Prices to:
Represent fairly the financial performance of their division
Reflect the impact of good decisions with in their division
Financial Staffs want Transfer Prices that:
Are simple and credible, so that they will be used and useful by managers
Are easy to use and easy to explain
Transfer Pricing Mechanism in Banks
Of late, there has been a marked shift in the measures used for evaluating the bank branches. From
deposit mobilization criterion the emphasis is now being turned on to the profits made by the bank
branches. When the concept of ‘profit centre’ is being applied the significance of the methodology
involved in ascertaining the profits gains prominence for the management control system. Transfer
price, in the context of banking sector, is the interest charged by the surplus funds branch to the deficit
funds branch on the transferred funds. Though branches are identified to be of deposit intensive,
advances intensive and ancillary business intensive for administrative convenience there are other
material factors like the location, size, and the nature of clientele that impinges on the performance of
the branches.
Profit is the most commonly acceptable measure for evaluation of Branch performance. To what extent
profit is a good indicator of viability of the branches depends upon how independent the branches are in
the commercial sense. As the branches of a Bank, in reality, are not truly and entirely independent
commercial units, it is difficult to determine the real profitability of such branches with the help of
existing systems that are less transparent, less accurate and having weak linkage with the overall costing
and pricing structure of business/products.
In the light of the above, the present study probes into various modalities of Transfer Pricing Systems
and suggests a suitable mechanism so as to reflect the true profitability, productivity and efficiency of
the Branches.
The bank branches are identified into two:
1. Deposit oriented
Majority of bank branches comes under this category. Though 80% of branches are acting as
deposit-pooling centers all branches are not uniform in terms of deposit mix. It is a fact that the
deposit mix is favorable (low cost deposits) with respect to Metro/Urban branches where as
depositors of Rural and Semi-urban branches tend to keep their deposits in Term deposits. This
has effect on branch profitability.
2. Advance oriented
Though the branches are independent units in terms of accepting deposits and lending funds,
the CD ratio is below 25% in many of the bank branches. It speaks that the lending activity is
considered as centralized activity and the lending of top 10% branches constitutes 80% of
lending. However, all lending branches are not uniform in terms of yield on advances since it
depends on sectoral deployment and quality of lending. Obviously, the yield on advances at
Metro/Urban branches is higher when compared to rural and Semi-Urban branches.
Fund Transfer Pricing (FTP)
In the banking industry, the deposits are collected by one branch and used by another to fund loans.
This process is usually handled using an FTP system.
When a bank makes a loan to a customer, the funding for this loan has to come from one source or
another. Typically, the funding in a financial institution will come from deposits collected by the bank.
This type of funding is normally the cheapest and most desirable; however, when deposits are not
sufficient to fund all the needs for cash that the bank has, the bank will have to get additional funding in
the wholesale market. Therefore, each deposit brought in to the bank has a value to the financial
institution for funding purposes, and, by the same token, a loan also has an underlying cost of funds and
is not just interest income for the bank, as it would look in a typical income statement analysis. The
purpose of FTP is to place a value on each deposit and assign a cost to each loan that a bank has.
When implementing an FTP system, banks' must determine a "funding curve" that most reflects their
source or use of funds on the wholesale market. Many banks in the past used United States Treasuries
as their funding curve. But recently, the government has dropped some buckets from its information.
Therefore, many banks have switched to the LIBOR/Swap curve. The funding curve for a financial
instrument shows the relationship between time to maturity and interest rate. Many banks make
adjustments to these curves to customize the curve to fit the banks unique lending environment.
Next, each loan or deposit that the bank has is assigned a rate based upon this adjusted funding curve.
The rate that is assigned to these customer relationships will vary based upon the characteristics of the
relationship. One characteristic that will cause a rate to change is time to maturity. For instance, a 5 year
fixed rate note will be assigned a different rate than a 5 year variable rate note. Also, for loans, the
longer the term is to maturity, the higher the rate to fund that loan. By the same principle, a deposit
that has a longer maturity would be assigned a higher funding rate credit because the bank is
guaranteed the use of these funds for a longer period of time.
Other unique characteristics of a loan will cause the rate assigned to it to vary. One such characteristic is
a prepayment option on a loan. A prepayment option will change the average expected life of the loan.
This is an assumption that is based on looking at historical trends in the bank.
Once all the data is input into the FTP system, management will have to decide how often the rates will
be assigned. This may be done monthly, weekly or sooner depending on the capabilities of the system
and the needs of management for decision making. Large amounts of data must be stored and many
calculations must be made for an FTP system to provide useful information for management. In the past,
the technological hardware and software used within banks were not of sufficient power or flexibility to
handle the data volumes involved or provided the analytical capabilities demanded. Today, however,
such technology is available, enabling the appropriate levels of contract-level detail handling and
providing the ability to analyze data across any number of dimensions in ad hoc fashion.
Using FTP to measure Branch Profitability
Financial Institution's income statement is designed to calculate net-interest income for the entire
organization. It is not designed to calculate the net-interest income of one product. This is also true of
calculating the net interest income of branches for comparative purposes. Branches within a bank are
almost never the same in terms of loans and deposits. Some branches are heavy on the loan side, while
others are heavy on the deposit side and still others are fairly evenly balanced. Determining the
profitability of individual branches in a traditional accounting sense is extremely difficult. Looking at an
income statement for a branch using a typical accounting analysis, interest collected from loan
payments are shown as interest income and interest paid out on deposits are shown as interest
expense. But this does not take into account that deposits have a positive value to the bank by providing
cheap funding for its loan purposes. Conversely, it also does not take into account that a loan has an
underlying funding cost associated with the process of making the loan. Therefore, using a typical
income statement format, a branch that is heavy on the deposit side will look like it is losing money,
while a branch that is heavy on the loan side will look like it is highly profitable.
International Transfer Pricing:
International transfer pricing is concerned with the prices that an organisation uses to transfer products between divisions in different countries. The rise of multinational organisation introduces additional issues that must be considered when setting transfer prices.
When the supplying and the receiving divisions are located in different countries with different taxation rates, and the taxation rates in one country are much lower than those in the other, it would be in the company’s interest if most of the profits were allocated to the division operating in the low taxation country.
Problems with Multinational Transfer Pricing
1. Tax rates in different countries.
The firm's strategy is to shift income from the high tax country to the low tax country. If the buying division is in a low tax country, then transfers would be made at the lowest cost possible. If the seller is in a low tax country transfers would be made at high prices.
2. Foreign Laws preventing income and dividend repatriations.
If there are restrictions on the buying division payments of dividends and transfers of income to the central office, then transfers of products to the buyer would be made at high prices. Transfers from the foreign division would be made at low prices.
To avoid these problems a detail framework has been set up under Income Tax Act.
Transfer Pricing Law in India
Increasing participation of multi-national groups in economic activities in the country has given rise to new and complex issues emerging from transactions entered into between two or more enterprises belonging to the same multi-national group. With a view to provide a detailed statutory framework which can lead to computation of reasonable, fair and equitable profits and tax in India, in the case of such multinational enterprises, the Finance Act, 2001 substituted section 92 with a new section and introduced new sections 92A to 92F in the Income-tax Act, relating to computation of income from an international transaction having regard to the arm’s length price, meaning of associated enterprise, meaning of information and documents by persons entering into international transactions and definitions of certain expressions occurring in the said section.
Section 92: As substituted by the Finance Act, 2002 provides that any income arising from an international transaction or where the international transaction comprise of only an outgoing, the allowance for such expenses or interest arising from the international transaction shall be determined having regard to the arm’s length price. The provisions, however, would not be applicable in a case where the application of arm’s length price results in decrease in the overall tax incidence in India in respect of the parties involved in the international transaction.
Arm’s length price: In accordance with internationally accepted principles, it has been provided that any income arising from an international transaction or an outgoing like expenses or interest from the international transaction between associated enterprises shall be computed having regard to the arm’s length price, which is the price that would be charged in the transaction if it had been entered into by unrelated parties in similar conditions. The arm’s length price shall be determined by one of the methods specified in Section 92C in the manner prescribed in Rules 10A to 10C that have been notified vide S.O. 808 E dated 21.8.2001.
The specified methods are as follows:
a) Comparable uncontrolled price method (CUP):
The direct and indirect costs of production incurred by the enterprise in respect
of property transferred or services provided to an associated enterprise, are
determined;
The amount of a normal gross profit mark-up to such costs (computed according
to the same accounting norms) arising from the transfer or provision of the
same or similar property or services by the enterprise, or by an unrelated
enterprise, in a comparable uncontrolled transaction, or a number of such
transactions, is determined;
The normal gross profit mark-up referred to in sub-clause (ii) is adjusted to take
into account the functional and other differences, if any, between the
international transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which could materially
affect such profit mark-up in the open market;
The costs referred to in sub-clause (i) are increased by the adjusted profit mark-
up arrived at under sub-clause (iii);
The sum so arrived at is taken to be an arm's length price in relation to the
supply of the property or provision of services by the enterprise.
b) Resale price method (RPM):
The price at which property purchased or services obtained by the enterprise
from an associated enterprise is resold or are provided to an unrelated
enterprise is identified;
Such resale price is reduced by the amount of a normal gross profit margin
accruing to the enterprise or to an unrelated enterprise from the purchase and
resale of the same or similar property or from obtaining and providing the same
or similar services, in a comparable uncontrolled transaction, or a number of
such transactions;
The price so arrived at is further reduced by the expenses incurred by the
enterprise in connection with the purchase of property or obtaining of services;
The price so arrived at is adjusted to take into account the functional and other
differences, including differences in accounting practices, if any, between the
international transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which could materially
affect the amount of gross profit margin in the open market;
The adjusted price arrived at under sub-clause (iv) is taken to be an arm's length
price in respect of the purchase of the property or obtaining of the services by
the enterprise from the associated enterprise.
c) Cost plus method (CPM):
d) Profit split method (PSM): The Indian Regulations define PSM, which may be applicable mainly in
international transactions involving transfer of unique intangibles or in multiple international
transactions which are so interrelated that they cannot be evaluated separately for the purpose of
determining the arm's length price of any one transaction, as follows:
The combined net profit of the associated enterprises arising from the
international transaction, in which they are engaged, is determined;
The relative contribution made by each of the associated enterprises to the
earning of such combined net profit, is then evaluated on the basis of the
functions performed, assets employed or to be employed and risks assumed by
each enterprise and on the basis of reliable external market data which
indicates how such contribution would be evaluated by unrelated enterprises
performing comparable functions in similar circumstances;
The combined net profit is then split amongst the enterprises in proportion to
their relative contributions, as evaluated under sub-clause (ii);
The profit thus apportioned to the assessee is taken into account to arrive at an
arm's length price in relation to the international transaction:
Provided that the combined net profit referred to in sub-clause (i) may, in the first instance, be partially
allocated to each enterprise so as to provide it with a basic return appropriate for the type of
international transaction in which it is engaged, with reference to market returns achieved for similar
types of transactions by independent enterprises, and thereafter, the residual net profit remaining after
such allocation may be split amongst the enterprises in proportion to their relative contribution in the
manner specified under sub-clauses (ii) and (iii), and in such a case the aggregate of the net profit
allocated to the enterprise in the first instance together with the residual net profit apportioned to that
enterprise on the basis of its relative contribution shall be taken to be the net profit arising to that
enterprise from the international transaction.
This method evaluates whether the allocation of the combined profit or loss attributable to one or more
controlled transactions in arms length. This method is applied where each party to the transaction has
significant intangible assets or operations are integrated and cannot be separately evaluated.
e) Transactional net margin method (TNM):
The net profit margin realised by the enterprise from an international
transaction entered into with an associated enterprise is computed in relation
to costs incurred or sales affected or assets employed or to be employed by the
enterprise or having regard to any other relevant base;
The net profit margin realised by the enterprise or by an unrelated enterprise
from a comparable uncontrolled transaction or a number of such transactions is
computed having regard to the same base;
The net profit margin referred to in sub-clause (ii) arising in comparable
uncontrolled transactions is adjusted to take into account the differences, if any,
between the international transaction and the comparable uncontrolled
transactions, or between the enterprises entering into such transactions, which
could materially affect the amount of net profit margin in the open market;
The net profit margin realised by the enterprise and referred to in sub-clause (i)
is established to be the same as the net profit margin referred to in sub-clause
(iii);
The net profit margin thus established is then taken into account to arrive at an
arm's length price in relation to the international transaction.
The transactional net margin method (TNMM) assesses the arms length character of transfer prices in a
controlled transaction by testing the profit results of one participant in the transaction.
f) Such other method as may be prescribed by the Board.
The taxpayer can select the most appropriate method to be applied to any given transaction, but such selection has to be made taking into account the factors prescribed in the Rules. With a view to allow a degree of flexibility in adopting an arm’s length price the provison to sub-section (2) of section 92C provides that where the most appropriate method results in more than one price, a price which differs
from the arithmetical mean by an amount not exceeding five percent of such mean may be taken to be the arm’s length price, at the option of the assessee.
Associated Enterprises: Section 92A provides meaning of the expression associated enterprises. The enterprises will be taken to be associated enterprises if one enterprise is controlled by the other, or both enterprises are controlled by a common third person. The concept of control adopted in the legislation extends not only to control through holding shares or voting power or the power to appoint the management of an enterprise, but also through debt, blood relationships, and control over various components of the business activity performed by the taxpayer such as control over raw materials, sales and intangibles.
International Transaction: Section 92B provides a broad definition of an international transaction, which is to be read with the definition of transactions given in section 92F. An international transaction is essentially a cross border transaction between associated enterprises in any sort of property, whether tangible or intangible, or in the provision of services, lending of money etc. At least one of the parties to the transaction must be a non-resident. The definition also covers a transaction between two non-residents where for example, one of them has a permanent establishment whose income is taxable in India.
Sub-section (2), of section 92B extends the scope of the definition of international transaction by providing that a transaction entered into with an unrelated person shall be deemed to be a transaction with an associated enterprise, if there exists a prior agreement in relation to the transaction between such other person and the associated enterprise, or the terms of the relevant transaction are determined by the associated enterprise.
Section 92CA provides that where an assessee has entered into an international transaction in any previous year, the AO may, with the prior approval of the Commissioner, refer the computation of arm’s length price in relation to the said international transaction to a Transfer Pricing Officer. The Transfer Pricing Officer, after giving the assessee an opportunity of being heard and after making enquiries, shall determine the arm’s length price in relation to the international transaction in accordance with sub-section (3) of section 92C. The AO shall then compute the total income of the assessee under sub-section (4) of section 92C having regard to the arm’s length price determined by the Transfer Pricing Officer.
The Transfer Pricing Officer means a Joint Commissioner/Deputy Commissioner/Assistant Commissioner authorized by the Board to perform functions of an AO specified in section 92C & 92D.
The first provison to section 92 C(4) recognizes the commercial reality that even when a transfer pricing adjustment is made under that sub-section the amount represented by the adjustment would not actually have been received in India or would have actually gone out of the country. Therefore no deductions u/s 10A or 10B or under chapter VI-A shall be allowed in respect of the amount of adjustment.
The second provison to section 92C(4) provides that where the total income of an enterprise is computed by the AO on the basis of the arm’s length price as computed by him, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the first mentioned enterprise, where the tax has been deducted or such tax was deductible, even if not actually deducted under the provision of chapter VIIB on the amount paid by the first enterprise to the other associate enterprise.
Documentation: Section 92D provides that every person who has undertaken an international taxation shall keep and maintain such information and documents as specified by rules made by the Board. The Board has also been empowered to specify by rules the period for which the information and documents are required to be retained. The documentation has been prescribed under Rule 10D. The documentation should be available with the assessee by the specified date defined in section 92F and should be retained for a period of 8 years.
Further, Section 92E provides that every person who has entered into an international transaction during a previous year shall obtain a report from an accountant and furnish such report on or before the specified date in the prescribed form and manner. Rule 10E and form No. 3CEB have been notified in this regard. The accountants report only requires furnishing of factual information relating to the international transaction entered into, the arm’ s length price determined by the assessee and the method applied in such determination. It also requires an opinion as to whether the prescribed documentation has been maintained.