transfer pricing a bird's eye view
TRANSCRIPT
Transfer pricing – A Bird’s eye view
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Basics in Transfer pricing
Transfer
Pricing
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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
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Specified Transaction
InternationalTransactions
Specified Domestic Transaction
Businesses eligible for income based deductions. Ex – 80IA (Deduction to power generation units)
Types of Specified Transaction
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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)
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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
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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
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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
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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
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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
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EXAMPLE FOR CUP METHOD
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EXAMPLE (CONT..)
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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
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EXAMPLE – COST PLUS METHOD
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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
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EXAMPLE – RESALE PRICE METHODA Ltd
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Unrelated Party Sale to Unrelated Party
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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.
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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
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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
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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
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EXAMPLE – PROFIT SPLIT METHOD
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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
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SUITABILITY
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WHICH METHOD TO CHOOSE?
• Most Appropriate method
MAM
• No hierarchy in Act
Act • Choice based on FAR (Functions performed, Asset and Risk analysis)
FAR
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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
Prepared by Pooja Jajwani, Sandesh Mundra & Associates