transfer pricing a bird's eye view

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Transfer pricing – A Bird’s eye view Prepared by Pooja Jajwani, Sandesh Mundra & Associates

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Page 1: Transfer pricing a bird's eye view

Transfer pricing – A Bird’s eye view

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 2: Transfer pricing a bird's eye view

Basics in Transfer pricing

Transfer

Pricing

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 3: Transfer pricing a bird's eye view

STEP 1 - WHAT IS TRANSFER PRICING?

Transaction price excess of ALP to be disallowed

Compare ALP with actual transaction price

Is it at Arm’s Length Price (ALP) ?(ALP is price charged in uncontrolled transaction)

Whether you have done any specified transaction?

Concept if beneficial to assesse not applicable –

Constitutionally valid?

Not yet challenged

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 4: Transfer pricing a bird's eye view

Specified Transaction

InternationalTransactions

Specified Domestic Transaction

Businesses eligible for income based deductions. Ex – 80IA (Deduction to power generation units)

Types of Specified Transaction

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 5: Transfer pricing a bird's eye view

International Transaction

Between two or more ASSOCIATED ENTERPRISES AND

Either or Both (Ex. Mcd Burger and Pizza) should be Non-Residents AND

Of specified nature (All transactions are covered viz. goods, services, assets, apportionment of expense, corporate guarantee, business restructuring, loan

arrangements etc)

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 6: Transfer pricing a bird's eye view

Transaction between tax free and taxable enterprises of same assessee. Example – in SEZ and DTA or in tax free unit or taxable unit

Transaction to which Section 40A(2)(b) (Excess payment to related parties disallowed) applies

Specified Domestic Transaction

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 7: Transfer pricing a bird's eye view

STEP 2 – WHY TRANSFER PRICING?

Specified Domestic TransactionSection 40A(2)(b) disallows excess payments to related party

Controversy was what is the excess payment

Reference by authorities were made to Transfer pricing provisions for ALP

Afterwards the act got amended

International transactionIn International transaction :-Transferring of profit from taxable territories to tax heaven countries/exempted entities

To curb this tendency TP comes into picture

Let us check an example

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 8: Transfer pricing a bird's eye view

LET US CHECK AN EXAMPLEParticular At Actuals At

Arm’s length price

Difference in Revenue to Government

Purchase from Dubai

100 80 20

Sale of above

120 120 0

Taxable Profit generated

20 40 20

Government was losing tax on profit of Rs.20.

Hence govt. introduced ALP concept for

international transactions and

transaction between tax free and taxable

enterprises

Particular Tax without giving effects of TP

Tax after giving effects of TP

Difference

Taxable profit 20 40 20Tax on above 6 12 6

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 9: Transfer pricing a bird's eye view

STEP 3 – HOW TRANSFER PRICING?Comparable uncontrolled

Price Cost plus

Resale price Profit split

Transactional Net MarginAny other method (Rule 10AB)

Most appropriate

method (MAM) should be found

out

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 10: Transfer pricing a bird's eye view

METHOD NO – 1 – COMPARABLE UNCONTROLLED PRICE METHOD

Compares prices of controlled and uncontrolled transaction

There should not be any material difference in between comparable and actual transaction

Immaterial differences can be adjusted

Time of comparable and actual transaction should be same

Need of high comparability under this method

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 11: Transfer pricing a bird's eye view

EXAMPLE FOR CUP METHOD

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 12: Transfer pricing a bird's eye view

EXAMPLE (CONT..)

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 13: Transfer pricing a bird's eye view

METHOD NO – 2 – COST PLUS METHOD Cost of production plus

REASONABLE PROFIT MARGIN

Profit margin to be compared

Profit from any unrelated transaction compared with related transaction

Price to be recomputed with ALP profit

Compare price and add difference in taxable profit

Used in case of purchase from sister concern

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 14: Transfer pricing a bird's eye view

EXAMPLE – COST PLUS METHOD

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 15: Transfer pricing a bird's eye view

METHOD NO – 3 – RESALE PRICE METHOD

RPM computes purchase price paid to related party on the basis of resale price to an unrelated party

This method is used in case of trader or in case where the assessee has not done any material value addition and identity of goods purchased is retained for sale

RPM can be done on aggregate basis (all transactions of similar products can be clubbed together) whereas CUP needs to be done on individual transaction

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 16: Transfer pricing a bird's eye view

EXAMPLE – RESALE PRICE METHODA Ltd

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 17: Transfer pricing a bird's eye view

Unrelated Party Sale to Unrelated Party

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 18: Transfer pricing a bird's eye view

METHOD NO – 4 – TRANSACTIONAL NET MARGIN METHOD

Compares net profit margin of controlled transaction with comparable uncontrolled transaction

Alternatively can be compared with the margin earned by independent comparable companies

As it uses margin to compute ALP, TNMM is less direct method then other cost based methods

This method has its own demerits like comparable company may be in start up phase in which case the margin will be suppressed

This method does not take into account abnormal factors which suppress the profit margin. For ex. – Fire broke down, any abnormal event in any year etc.

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 19: Transfer pricing a bird's eye view

EXAMPLE – TNMM METHOD

Controlled Transaction

A Ltd (USA)$ 20

A Ltd(India) to customerRs. 1500

Net Margin = 4%

of A Ltd (India)

Uncontrolled

Transaction

B Ltd (USA)

C Ltd (India) to Customer

Net Margin is 5% of C Ltd (India)

Profit Level Indicators(1) return on assets (ROA)

operating profit / operating assets

(2) return on capital employed (ROCE)

operating profit / capital employed

(3) operating margin (OM)

operating profit /sales

(4) gross margin (GM)

gross profit / sales

(5) Berry Ratio gross profit / operating expenses

(6) return on total cost (ROTC)

operating profit /total costs

(7) return on cost of goods sold

gross profit / cost of goods sold

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 20: Transfer pricing a bird's eye view

METHOD NO – 5 – PROFIT SPLIT METHOD

ICC came out with a solution similar to Profit split method for distributing profit between Resident and

source country

Issue of sharing profit either by Resident or by source concept was there

Post World War 1 (1920-23) – England exported technology in India and India exported goods to

England

Roots in Indian History

ICC = International Chamber of Commerce

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 21: Transfer pricing a bird's eye view

METHOD NO – 5 – PROFIT SPLIT METHOD

ALP• Computation of ALP based on combined

profits derived by related parties

Uses• PSM is relevant where related parties are

doing typical activity in value chain and external comparable with similar FAR is not available

Usage

• PSM requires extensive working to derive reliable results and hence it is used in limited cases

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 22: Transfer pricing a bird's eye view

EXAMPLE – PROFIT SPLIT METHOD

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 23: Transfer pricing a bird's eye view

METHOD NO – 6 – ANY OTHER METHODAny other method which takes into account a comparable uncontrolled transaction can be selected

Rule 10AB gives freedom to select any other method as specified above

Dicey situation, Dept. may or may not accept the method

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 24: Transfer pricing a bird's eye view

SUITABILITY

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 25: Transfer pricing a bird's eye view

WHICH METHOD TO CHOOSE?

• Most Appropriate method

MAM

• No hierarchy in Act

Act • Choice based on FAR (Functions performed, Asset and Risk analysis)

FAR

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 26: Transfer pricing a bird's eye view

Confused for method???

Still confused????.....Consult us @ [email protected]

After APA we need to follow the same if the terms of contract continues to be same

We can go for Advance Pricing Agreement (APA) to IT Authorities

If the method which should be chosen is not clear then,

If department gives order against us and we do

not want to follow the

same order then, we can change the

terms of contract and violate APA

Prepared by Pooja Jajwani, Sandesh Mundra & Associates

Page 27: Transfer pricing a bird's eye view

Prepared by Pooja Jajwani, Sandesh Mundra & Associates