Taxation Transfer Pricing in India

What is Transfer Pricing in India

What is transfer pricing in Indian Economy

Ans. The increasing participation of multinational groups in the Indian economy has arisen various issues of a transaction entered by those groups.

Business may be carried on between resident and a person who is non-resident or not ordinarily resident in India and owing to close connection between them, the course of business may arrange that the resident may make either no profit or less than the ordinary profit in that business, such an arrangement would deprive that Indian revenue of the tax which would otherwise be payable by the resident.

Transfer pricing means the value of Goods or Services Tax which is transferred between two or more related parties.

Hence the Transfer Pricing can be defined as the price payable on goods or services transfer between one economy unit to another economy unit (assuming both units are in different countries but belongs to same multinational company & firm).

Rule of Arm’s Length Price.

Ans. The Arm’s Length rule is applied in both case either it is transfer pricing or distribution of profit. The arm length price can be defined as a price which is payable on GST Eligibility which has been transferred from one entity to another entity within a group and having a place of business in two different economies if these entities were not related.

Method of Arms Length Price?

Ans. There are 6 Method of calculation of Arm’s Length Price in relation to an international transaction:-

1. Comparable uncontrolled price method (CUP Method).
2. Resale Price Method (RPM).
3. Cost Plus Method (CPM).
4. Profit Split Method (PSM).
5. Transactional net margin method (TNMM).
6. Such Method as prescribed by the Board (N/N 18/2012,dated23-05-2012)
7. Any other method prescribed under rule 10AB.

Before choosing any method the following procedure must be followed:-

1. Identify international transaction.
2. Identify the uncontrolled transaction. Rule 10A (a) define the uncontrolled transaction means the transaction between the two enterprises which is directly or indirectly unassociated with each other.
3. Compare the international transaction with the uncontrolled
4. Ascertain the most appropriate method. The most appropriate method means the method which is suited to the facts & circumstance and provides the most reliable measure of the arm’s length price.
5. Determine the ALP by applying the most appropriate method.

The central Govt. has notified that the variation between the ALP determined & price at which international transaction or specified domestic transaction has actually been undertaken does not exceed 1% of the latter in respect of wholesale trading and 3% later in other cases

What is Comparable uncontrolled price method (CUP Method)?

Ans. As per the Guidance Note issued by the ICAI the comparable uncontrolled price (CUP) may be determined with the following steps.

• Identify the price charged or paid for the property (here property means goods, articles, things and intangible property) in comparable uncontrolled transaction or series of such transaction.

• Adjust such price eg. Transport charges, freight, warranty cost, Discount, etc.

• The adjusted price shall be called Arm’s length price

• The Arm’s length price is compared with the price charged in the international transaction.
• If there is variance in the price charged for the international transaction and the Arm’s length price then price charges to an international transaction shall be adjusted the extent of the variation.

Suitability:-Transfer of goods, provision of services, transfer of intangible assets, a transaction relating to loan or provision of finance.

Eg.EntersliceUSA USA and XYZ Ltd. an Indian company are associated enterprises. XYZ Ltd. manufactures Mobile phones to EntersliceUSA and BITTU LTD., Korea. During the year, XYZ Ltd. manufactures Mobile phones and sells them to EntersliceUSA at price of Rs. 2000 per unit. The transaction of XYZ Ltd. with Enterslice and BITTU LTD. are comparable subject to the followings differences:-

1. While sales to Enterslice USA are on FOB basis, Sales to BITTU LTD. are the CIF The Freight and insurance paid by Enterslice USA for each unit Rs.300/-.
2. The sales BITTU LTD. are under a free warranty for 1 year whereas sales to Enterslice USA are without such a warranty. The estimated cost of executing such warranty may be taken at Rs. 350/-.

• Enterslice USA placed a large order and such XYZ Ltd. offered a quantity discount of Rs.50 per unit on Enterslice USA.

Compute the Arm’s Length price and the amount of increase in the total income of XYZ ltd., if any due to such Arm’s length price.

Calculation of Arm’s length price

The sale price of mobiles phones sold to BITTU	3,200/-
Less: –   ·         Freight & insurance cost ·         Estimated cost of warranty ·         Bulk quantity Discount	Adjustments   300/- 350/- 50/-  700/-
Arm’s Length price for mobile sold to Enterslice	2,500
Arm’s Length price for 1, 20,000 phones	30, 00, 00,000(1, 20,000*2,500)
Price charged from Enterslice	24, 00, 00,000(1, 20,000*2000)
Therefore the income of XYZ Ltd. will be increased by	6, 00, 00,000

What is the resale price method (RPM)?

Ans. As per the Guidance Note issued by the ICAI the Resale Price Method (RPM) may be determined with the following steps:-

1. Identify the international transaction of purchase of property or obtaining the services.
2. Identify the price at which such property resold or service provided if it was an unrelated
3. Deduct the normal gross profit margin from the resale price of such property or service. Normal gross profit margin means the margin charged to the sale of property or services rendered if the same transaction has been entered with an unrelated
4. Deduct the expense incurred in connection with the purchase of goods
5. Adjust the price so computed for the difference between the uncontrolled transaction and the international transaction.

• The difference maybe
  • Functional
  • Due to accounting practice

However, if it is material then it should be adjusted.

1. The adjusted price will be called Arm’s length price.
2. Substitute the Arm’s length price with the price charged and make an adjustment to the income accordingly.

Suitability:-This method is more suitable for the transaction which involves the distribution of goods with no or little value addition. It is not suitable for the goods which further processed.

Eg.EntersliceUSA and XYZ India Ltd. are associated with the enterprise. XYZ India Ltd. Import 200 Mobile phones from Enterslice USA at a price of Rs. 15,000/- per unit and these are sold to ITC Hotel Ltd. at a price 17,000 per unit. XYZ India Ltd. has bought similar products from Xiomi India Ltd. and sold Oberon Hotel at a gross profit of 10% on sales. XYZ Ltd. incurred freight of Rs.400 and customs duty of Rs. 1500/- per unit in case of a purchase made from Enterslice Japan and Rs. 200 in case of purchase from Xiomi India Ltd.

Compute the Arm’s length price and the amount of increase in the total income of XYZ Ltd., if any, due to such arm’s length price.

Calculation of Arm’s length price

Resale price of Y Ltd. to ITC Hotels	17000/-
Less: Gross profit Margin	1700/-
Less: – Difference of Expenses	1700/-
Arm’s Length Price	13,600/–
Price paid to LG (200 units *15,000 each)	30,00,000/-
Arm’s Length Price	27,20,000/-
Increase in income of XYZ Ltd.	2,80,000/-

What is the Cost Plus Method (CPM)?

Ans. As per the Guidance Note issued by the ICAI the Cost Plus Method (CPM) may be determined with the following steps:-

1. Determine the Direct and indirect cost incurred in respect of the production of the property transferred or services provided to an associated enterprise.
2. Identity the comparable uncontrolled transaction or number of transaction with an unrelated party for the same
3. Adjust the mark up to the comparable uncontrolled transaction.
4. Adjust the mark up to account for functional and accounting practice difference.
5. The direct and indirect cost of production in relation to such an international transaction is to be increased by such adjusted markup.
6. The resulted figure shall be called Arm’s length price.
7. The Arm’s length price shall be compared with the price charged for the international transaction then adjustment of income shall be made accordingly.

Suitability:- Long-term buying and selling arrangement, transfer of semi-finished goods, joint facility arrangement.

Egg. Enterslice USA Inc., a U.S.A company holds 30% shares in Enterslice Business Solution Private Ltd. (India). Enterslice Business Solution Private Ltd. develops software for various customers including Enterslice, USA. Enterslice Business Solution Private Ltd. during the year billed Enterslice U.S.A for 2000 man-hours at the rate of Rs 400/- per man-hour. The total cost (direct and indirect) for executing this work amounted to Rs. 6, 50,000/-.

Enterslice Business Solution Private Ltd. billed XYZ Ltd. India at the rate of Rs. 800/-per man-hour although the person who was working for the development of the software of XYZ Ltd. were of the same caliber and level that of person who developed the software for Enterslice U.S.A.  Enterslice Business Solution Private Ltd. earned a gross profit of 40% of its sales to XYZ Ltd.

The transaction of Enterslice Business Solution Private Ltd^[3]. with Enterslice U.S.A and XYZ. Ltd. are comparable subject to the following difference:

• While Enterslice U.S.A has given technical know-how to Enterslice Business Solution Private Limited, there is no such know-how provided by XYZ Ltd. The value of technical know-how received from the USA can be taken at 10% of normal gross profit.
• A quantity discount was given by Enterslice Business Solution Private Ltd. to Enterslice, USA. Which can be valued at 5% of normal gross profit?
• Enterslice Business Solution Private Ltd. offered 60 days credit to Enterslice, Start Company Registration in the USA. The cost of providing such credit may be valued at 2.5% of gross profit. No such trade discount was given to XYZ Ltd.

Compute the arm’s length price and the amount of increase in the total income of staffing solution Ltd., if any, due to such arm’s length price.

Calculation of Arm’s length price

The price charged to XYZ Ltd.	800/-
Gross Profit Mark up in case of XYZ Ltd.	40%
Less: – Value of Technical know- How from Enterslice, USA	4%
Less: – Quantity Discount	2%
Add: – Cost of credit of Enterslice, USA	1%
Arm’s Length gross profit mark up	35%
Direct & indirect cost	Rs.6,50,000/-
Arm’s Length Billed value (6, 50,000*100/65)*	Rs.10,00,000/-
Billed Income (2000 hours*Rs.400)	Rs.8,00,000/-
Income of EBS shall be increased by	Rs.2,00,000/-

What is Profit Split method?

Ans. As per the Guidance Note issued by the ICAI the Profit Split Method (PSM) may be determined by the following steps:-

1. Determine the combined net profit of all the associated enterprise which is engaged in the international
2. Evaluate their contribution in relation to:-

-Risk assumed

-Assets employed

-Functions Performed

-Market data indicating how such contribution will be evaluated.

1. Apportionment of combined net profit in proportion to their relative contribution.
2. The profit so apportioned is taken to arrive at the arm’s length price in relation to the international transaction.

Eg. Ent. Ltd. UK received an order from XYZ Ltd. Germany for developing a software product for a sum of US $1, 00,000/-. In order to execute the same, Ent. Ltd. QPR Ltd. (A company in which Ent. Ltd. holds 50% shares) and S Ltd. India (where Z Ltd. holds 50% shares) and Sarthak Ltd. India( where QPR Ltd. holds 40% shares) together develop the above software.

Ent. Ltd.  UK pays to QPR Ltd and Sarthak Ltd., India a sum of US $ 24,000/- and $ 27,000/- respectively and keeps the balance for itself.

In the entire transaction, a profit of $16,000/- is earned. Sarthak Ltd. India incurred a total cost of $24,000/- in the execution of its work relating to the above project.

Assume the relative contribution of Ent. Ltd, QPR Ltd, and Sarthak Ltd. is 40%, 25%, 35/% respectively.

Compute the arm’s length price and the amount of increase in the total income of Sarthak Ltd., if any due to such arm’s length price.

The Arm’s Length Price under the profit split method shall be determined as under:-

Price charged by Ent. Ltd. to XYZ Ltd.	$1,00,000/-
Sarthak Ltd. India Shares of revenue	$27,000/-
PQR Ltd. share of revenue	$24,000/-
Ent. Ltd. Share of Revenue	$49,000/-
Combined total profit	$16,000/-
Profit Apportionment equivalent to their relative contribution
Ent. Ltd. 40% of $16,000	$6,400/-
PQR Ltd. 25% of $16,000	$ 4,000/-
Sarthak Ltd. 35% of $16,000	$5,600/-
The total cost of Sarthak. Ltd. India	$24,000/-
Revenue of Sarthak Ltd. on the basis of ALP (24000+5,600)	$29,600/-
Actual revenue of Sarthak Ltd. India	$27,000/-
Therefore the total income of Sarthak Ltd. owned incurred by	$2,600/-

What is Transactional net margin method (TNMM)?

Ans. As per the Guidance Note issued by the ICAI the Transactional net margin method TNMM (Transactional net margin method)^[1] may be determined by the following steps:-

1. Identify the net profit margin realized by the enterprise from international transactions. The net profit margin may be computed in relation to

• costs incurred
• sales effected
• assets employed
• Any other relevant case.

1. Identify the net profit margin of the comparable uncontrolled transaction.
2. The material difference, if any of the net profit margin is to be adjusted with the price charged for the international transaction.
3. The adjusted net profit margin is taken into account to arrive at arm’s length price in relation to the international transaction.

Suitability: – Provision of services, distribution of finished goods (if resale price method is not applicable)

Eg.Revenue                                                    Rs.25,00,000/-

     Direct Cost                                                Rs.18,00,000/-

Gross profit                                                   Rs. 7,00,000/-

Indirect cost                                                   Rs. 2,00,000/-

Net Profit                                                       Rs. 5,00,000/-                           Net profit Ratio                                                     20%

Comparable Transaction

Revenue                                                                    Rs.20,00,000/-

     Direct Cost                                                Rs.8,00,000/-

Gross profit                                                   Rs.12,00,000/-

Indirect cost                                                   Rs.5,00,000/-

Net Profit                                                       Rs. 7,00,000/-                           Net profit Ratio                                                     35%

Material difference (35%-20%)                                       15%

Revised Profit at ALP                                              Rs.8,75,000/-

(5,00,000/20*35)

Earlier profit                                                            Rs. 5,00,000/-

Profit to be increased by                                         Rs.3,75,000/-

Define another method of determination of Arm’s length price?

Ans. As per CBDT (Central Board of Direct Taxes, Government of India)^[2] vide notification No. 18/2012, Dt.23.5.2012 has notified the following rule 10AB which has come into force A.Y. 2012-13 and onwards:

The other method in relation to the determination of Arm’s length price of international transactions or specified domestic transaction shall be the price which has been charged or paid or would have been paid to similar kind of comparable uncontrolled transaction between two non-associated enterprises under