Transfer pricing refers to the prices that related parties charge one another for goods and services passing between them.
The most common application of the transfer pricing rules is the determination of the correct price for sales between subsidiaries of a multinational corporation. These prices can be used to shift profits to tax-favored countries, if in a transaction between a subsidiary in high-tax countries and another in a low-tax country, the high-tax subsidiary charges a price below the “true” price, some of the group’s economic profit is shifted to the low-tax subsidiary. Obviously, taxpayers would want to engage in this sort of behavior because it can significantly reduce their taxes. If there were no limitations on this behavior, the entire income of multinational corporations would be taxed at the lowest tax rate in the world to zero rates of taxation. Consequently, most countries have some set of tax rules that regulate the prices that related persons can charge one another.
From past experience, it has been noticed that foreign multinational enterprises adopting the following practices to avoid tax payments: -
So to stop, these types of wrong practicing transfer pricing provisions are made by tax authorities.
Comparable and adjustments/Comparable – Illustrations : Where companies having revenues from software sales or software products development or being engaged in research or providing KPO services or product designing/engineering services, could not be compared to assessee providing software development services; a further company in which extraordinary events took place could not be comparable.
Comparable and adjustments/Comparable – Illustrations : Where the turnover of the assessee company was less than Rs. 20 crores, companies having turnover more than Rs. 200 crores could not be taken as comparable.
Comparable and adjustments/Comparable - Illustrations/Adjustments – Illustrations: While determining ALP foreign exchange gains/loss arising from transactions of revenue nature was to be considered as part of operating profit/cost of the assessee as well as that of comparables.
Comparable and adjustments/Comparable - Illustrations/Adjustments – Illustrations: In the case of the assessee, rendering ITES services to its AE, company rendering software development services such as verification and validation of software, can not be accepted as comparable.
Comparables and adjustments/Comparables – Illustrations: A leading company that was engaged in software products, owned significant IPRs and intangibles, had significant R&D activities, brand attributable profits, etc., could not be regarded as comparable to a captive software development service provider.
Foreign exchange loss/gain arising as a consequence of the realization of consideration for rendering software development services cannot be excluded from operating revenues for purpose of calculating the operating margin of the assessee.
Section 92 of the income tax act deals with the rules of transfer pricing. The rules of section 92 are as follows:
Following conditions have been satisfied for applicability of section 92:
If the conditions (i) & (iii) were satisfied, then the Assessing Officer under the Act has power:
Following are the compulsory documentation required by law: -
Benchmarking Methodology
Choice of benchmarking methodology
The fair market value of goods can be determined by the following methods: -
Having regard to different factors, the below can be used to calculate ALP in India:
Factual and Functional Analysis : In transactions between related parties, compensation will reflect the functions that the parties perform taking into account risks assumed and assets used.
Description of the company and the group : Description of Outline of the business, Structure of the organization, Legal ownership within the MNE Group, Overview of financial key figures.
Industry analysis: it includes details about competitors, market and trends, added values, USPs.
Overview of intercompany transactions: Giving details of all transactions which are related to the companies.
Economic Analysis:
Selection of most appropriate method among all the following methods: -
Comparable Uncontrolled Price (CUP) METHOD:
The CUP method evaluates the arm’s-length character of a controlled transaction by comparing the price and conditions to the price and conditions of similar transactions between the taxpayer and an unrelated party or between two unrelated parties. this method is the most direct and reliable way to apply the arm’s-length principle and to determine the prices for the related party transactions.
Computations of Arm’s length price are as follows: -
COST PLUS METHOD: this method is used to test the activities of manufacturing entities by comparing gross profits to the cost of sales. This method is less likely to be reliable if material differences exist between the controlled and uncontrolled transactions with respect to intangibles, cost structure, business experience, management efficiency, functions performed, and products.
Computations of Arm’s length price are as follows: -
RESALE PRICE METHOD: The resale price method is normally used to test gross profits earned by sales and distribution entities. This method compares gross profit relative to the turnover of the tested party to gross margins earned by comparable third parties.
Computations of Arm’s length price are as follows: -
PROFIT SPLIT METHOD:
This method will eliminate the effect on profits of special conditions made or imposed in a controlled transaction by determining the division of profits that independent enterprises would have expected to realize from engaging in the transaction or transactions.
Computations of Arm’s length price are as follows: -
TRANSACTIONAL NET MARGIN METHOD:
This method compares the tested party’s net profitability on a controlled transaction to the net profit obtained by broadly similar uncontrolled companies on similar transactions.
Computations of Arm’s length price are as follows: -
After the selection of the appropriate method apply the selected method inefficient manner.
Penalty: -
For Failing to submit CA Report
Entities entering into an international transaction are required to obtain a report from a chartered accountant. Failure to furnish a report from a chartered accountant can attract a penalty of Rs. 1,00,000
For Not Maintaining Required Documents
As mentioned above, entities entering into international transactions are required to maintain certain documents as listed above. Failure to maintain such document or failure to report or furnishing incorrect information can attract a penalty of up to 2% of the value of each transaction, where noncompliance exists.
for Not giving Documents to tax authorities within the time
Tax authorities may demand any related information or documents in the course of any proceeding, from any person who has entered into international transactions. The taxpayer must furnish such information or document within a period of 30 days from the date of receipt of a notice. Failure to furnish information can attract a penalty equal to 2% of the value of the specified transaction for each such failure.
Case law and judicial pronouncements: -
Analysis of tested party’s accounts – whether accounts are to be split vis-à-vis international transactions or profits of the entity as a whole to be analyzed
Documentation to be maintained for justifying arm’s length price
Functional Analysis
Selection of Method
The Transfer Pricing Compliance deadline is fast approaching and you may be struggling with the completion of TP Documentation, Master Files, or other compliances for clients that require specialized knowledge and access to tools such as benchmarking databases.
Name of Form | Particulars of reporting | Applicability Of TP | Timelines of compliance |
Local File | |||
3CEB | Report from an accountant to be furnished under section 92E relating to the international transaction(s) along with Transfer Pricing Study. | Companies engaged in international transactions with any associated enterprise. | By October 31 of the Assessment year |
Master File | |||
3CEAA (Part A) | Basic details of the group- consists of name, address, the tax identification number | To be filed by every person, being a constituent entity of an international group. | By November 30 of the Assessment year . |
3CEAA (Part B) | Provides an overview of the international group's business operations and transfers pricing policies by a constituent entity | To be filed if the following two conditions are satisfied: |
1. consolidated revenue of the international group exceeds RS 500 Cr &
2. Either of the following:
For further queries and professional assistance, feel free to contact ASC Group.
The task is further complicated when a foreign database benchmarking is needed, requiring substantial capital investment.
At Rajput Jain and Associates have over 12+ years of experience advising multinational corporations on their transfer pricing matters, including TP Documentation, Master Files and related forms, and TP benchmarking. We have Indian and foreign database subscriptions to provide high-quality comparable company benchmarks along with royalty and financial transaction benchmarks.
We can assist you with transfer pricing matters, including:
· Providing benchmarking studies (including foreign databases) that you can include in your clients’ TP Reports
· Preparation of full TP Reports
· Providing Industry Overviews
· Preparing Form 3CEAA format for uploading Master Files
· Preparing Master Files for Indian MNCs
· Providing royalty and interest benchmarks