Backdrop Transfer Price and Transfer Pricing Indian TPR Associated/Deemed Enterprises International Transactions Specified Domestic Transactions.

TRANSFER PRICING

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AGENDA Backdrop Transfer Price and Transfer Pricing Indian TPR Associated/Deemed Enterprises International Transactions Specified Domestic Transactions Arm’s Length Price Various Methods To Compute ALP FAR Analysis Transfer Pricing Process Penalties Amendments by various Finance Acts Safe Harbor Rules

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BACKDROP

• Liberalization of trade and foreign exchange policy started in India in the year 1991

• This created huge increase in interest of MNEs in India• The Standing Committee in March 1991 observed that provisions of

Income Tax Act, 1961(Act) were inadequate to curb transfer pricing among MNEs

• The Expert Group constituted by Central Board Of Direct Taxes (CBDT) recommended complete revision of existing section 92 of the Act

• The Finance Act, 2001 introduced TPR in India by substituting existing Section 92 of the Act and introducing new sections 92A to 92F w.e.f April, 2001

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What Is Transfer Price?• When evaluations are based on profit, etc. we need to establish price for

internal transfers• “Transfer price is the price one subunit (department or division) charges for

a product or service supplied to another subunit of the same organization.” • Transfer prices can have a dramatic effect on the reported profitability of a

division but not on overall profit

What Is Transfer Pricing?• Transfer Pricing is a mechanism for the pricing of goods and services

between related entities, Tangible Goods Intangible Goods – trademarks, trade-names, patents Services – management, engineering, after-sales services

• Transfer pricing mechanism provide the conceptual framework for pricing intercompany transactions and ensuring an appropriate allocation of income between the various tax jurisdictions in which a multinational company operates.

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Indian TPR

• OECD TP Guidelines lays the foundation of the Transfer Pricing Regulation in India

• Section 92 - Income arising to “Associated Enterprises” from “International Transactions” (or Specified Domestic Transactions w.e.f AY 2013-14) shall be computed having regard to the “Arm’s Length Price”

• Preconditions: Two or more associated enterprises Enter into an international transactions Specified Domestic Transaction (w.e.f. AY 2013-14)

• Consequence: Income to be computed having regard to the arm’s length price

ASSOCIATED ENTERPRISESECTION 92A

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Associated/ Deemed Enterprises

Section 92A

• AE means direct or indirect participation in management control or capital: by one enterprise into another enterprise; or by the same person in both the enterprises

• Equity holding, Control of Board of Directors/ Appointment of one or more Executive Director, mutual interest will also constitute Associated Enterprise

• Either or both of Associated Enterprises should be non-residents

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• Deemed Associated Enterprises” includes:

– Holding of 26% of voting power by one enterprise into another enterprise; or by the same person in both the enterprises

– Dependence on intangible assets

– Sale of goods influence on price and conditions of supply by buyer

– Control by individual or his relative

– Financial transaction Loan - 51% or more of book value of total assets of the borrowing

enterprise Guarantee - 10 % or more of the total borrowings of an enterprise

INTERNATIONAL TRANSACTIONS

SECTION 92B

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International TransactionsSection 92B• Means “transaction” between 2 or more Associated Enterprises:

Transaction between two or more associated enterprises (at least one of which will be non-resident) of purchase, sale or lease of tangible and intangible property, provision of services, capital financing, cost sharing/cost contribution arrangements , or

affecting profits, losses, income, assets or liability of the enterprise

• The expression “International Transaction” has been amended by Finance Act, 2012 w.e.f 1.04.2002 and specifically includes: Inter-company Guarantees, Advance payments, deferred payments, receivables, Business restructuring / reorganisation, Purchase / sale/ use of intangibles such as customer lists, customer

contracts, customer relationships, Transfer / secondment of trained employees, etc.

SPECIFIED DOMESTIC TRANSACTIONS

SECTION 92BA

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Specified Domestic Transactions -Introduced by Finance Act, 2012

• Specified Domestic Transactions to include : Expenditure in relation to which payment has been made to related

party Transfer of goods or services between two units, undertakings or

companies which are related and one of them is eligible to avail deduction under Chapter VI-A, 80IA

Any transaction in Chapter VI-A or Section 10AA to which the transfer pricing clause under section 80IA are specifically made applicable

Any other transaction as may be prescribed

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Applicability to Domestic Transactionsw.e.f. AY 2013-2014

• Assessees have to file Form 3CEB in respect of Specified Domestic Transactions entered into with their related parties

• Minimum Threshold: INR 5 crores (This Threshold Limit will be 20 crores w.e.f. AY 2016-17)• May amount to double taxation in certain cases• All existing TP compliance requirements, mandatory documentation, TP

audits (assessments) and penalty provisions will be applicable

ARM’S LENGTH PRICE

SECTION 92F(II)

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Arm’s Length PriceSection 92F(ii)• Arm’s Length Price means a “price which is applied or proposed to be

applied in a transaction between persons other than associated enterprises, in uncontrolled conditions”

• Arm’s length price can be determined by selection of most appropriate method from any of the following methods (Sec. 92C):– Comparable Uncontrolled Price Method– Resale Price Method– Cost Plus Method– Profit Split Method– Transactional Net Margin Method– Other Method as prescribed under Rule 10AB

• Where arms length price is within 3% range of the transaction price, no adjustment is warranted and the transaction price will be deemed to be the Arm’s Length Price. (5% range was applicable till A.Y.2012-13).

MOST APPROPRIATE METHOD

SECTION 92C(1)

COMPARABLE UNCONTROLLED PRICE METHOD

RULE 10B(1)(A)

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CUP Method• CUP method can be applied where reliable data of similar uncontrolled

transaction between two unrelated parties or between related party and third party is available. Here, Prices are to be compared.

• Internal CUP

• External CUP

• Adjustments permitted for volume discount, geographical differences, etc.

Manufacturer A

Sale to related party B

Sale to non-related party C

Non-related party P

Non-related party Q

RESALE PRICE METHOD

RULE 10B(1)(B)

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RPM

• Compares the resale gross margin earned by AE, with gross margin of comparable independent distributors

• Comparable need not be in very same product• Software distributor compared with FMCG distributor• Difficult to use when processing is carried out before resale

Group Manufacturer (Eligible Unit)

Related Distributor (India)

Unrelated Wholesalers

INR 75 INR 100

COST PLUS METHOD

RULE 10B(1)(C )

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CPM• Used predominantly when AE works for another AE as contract

manufactures

• Typically applied to a contract manufacturer who: Does not bear risk of marketing Does not “normally” undertake high skill work

• May apply to contract manufacture, BPO, call centre, software developers, etc

Direct & Indirect Cost of Production

/ serviceALP = Comparable

Margin+

PROFIT SPLIT METHOD

RULE 10B(1)(D)

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PSM• Generally applicable in case of transaction involving

Transfer of unique intangiblesOR

Multiple transactions which are interrelated not permitting separate evaluation

• Split global profit according to contribution of each AE.• There are two approaches to this method

Total Profits Split Residual Profit Split

US Co A – Technology intangibles

Mfg. Co BMkt Co C

Marketing intangibles

Outside India India

TRANSACTIONAL NET MARGIN METHOD

RULE 10B(1)(E)

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TNMM• Comparable Net profit adopted in relation to :

Costs incurred, or Sales effected, or Assets employed, or Any other relevant base.

• Ideally, operating margin should be compared to operating margin earned by same enterprise on uncontrolled transaction – Internal TNMM

Parent A Unrelated Cos.

Subsidiary B

Net margin 5%

Unrelated Cos.

Net margin 3%

Outside India

India

OTHER METHOD -Sixth method notified by CBDT

RULE 10AB

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Other Method• CBDT has notified the “other method” vide a Notification and Rule 10AB has

now been inserted in the Income-tax Rules, 1962 (the Rules). Applicable from FY 2011-12.

• Rule 10AB describes the other method as “any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.“

• “Other Method” refers to “price which has been charged or paid, or would have been charged or paid”. Effectively, this implies that under this “other method” “quotations” rather than prices “actually” charged or paid can also be used by the taxpayers.

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FAR Analysis : Functions, Assets, Risk

• Functions: Analysis of critical functions performed in controlled environment with function performed in uncontrolled transactions that add value to transactions hence fetch higher returns.

• Assets: Analyzing assets employed in transaction in controlled environment by identifying the assets.

Type of assets– Capital – Tangibles– Intangibles

• Risks: Analysis involve identification of various risk assumed by each party in controlled transaction. Nature of Risk— Market Risk— Manpower Risk— Credit Risk— Technology Risk

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TRANSFER PRICING PROCESSIdentificationof intragrouptransactions

FAR Analysis

Identificationof comparable

transactions

Establishingcomparability,adjustment for

material differences

Selection of mostappropriate

method

Determination of

ALP

TP Adjustments

Documentation

Tax return filing

TP Assessment

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PENALTIESDefault Penalty

In case of a post-inquiry adjustment, there is deemed to be a concealment of income

100-300% of tax on the adjusted amount

Failure to maintain documents 2% of the value of transaction

Failure to furnish documents 2% of the value of transaction

Failure to furnish accountant’s report INR 100,000 (US $ 2000)

Failure to report a transaction in accountant’s report

2% of the value of transaction

Maintaining or furnishing incorrect information or documents

2% of the value of transaction

AMENDMENTS- BY VARIOUS FINANCE ACTS

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FINANCE ACT, 2002

Before Amendment After Amendment

Section 92A(2) Mere fact of participation by one enterprise in the management or control or capital of the other Enterprise, or the participation of one or more persons in the management or control or capital of both the enterprises shall make them associated enterprises

For the purposes of sub-section (1) of Section 92A, two Enterprises shall be deemed to be associated enterprises if, at any time during the previous year any of the conditions mentioned in clauses (a) to (m) are satisfied.

Section 92C(2) Arithmetical mean of all prices computed shall be taken to be the arm’s length price

The price which differs from the arithmetical mean by an amount not exceeding five per cent of such mean may be taken to be the arm’s length price, at the option of the assessee.

Section 92F The definition of Enterprise does not included business of construction

Include the business of construction as one of the activities in the definition of ‘enterprise’ and to provide a separate definition of permanent establishment

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FINANCE ACT, 2007 Before Amendment After Amendment

Section 92CA No extra time available to the AO for competing the assessment or reassessment in cases where a reference is made by him to the TPO

Extra time limit of 12 months is made available to AO.

Section 92CA(4) Assessing Officer shall proceed to compute the total income of the Assessee having regard to the Arm’s length price determined under sub-section (3) by the Transfer Pricing Officer.

Assessing Officer shall proceed to compute the total income of the assessee in conformity with the Arm’s length price determine under sub-section (3) of section 92CA by the TransferPricing Officer.

FINANCE ACT, 2006 Before Amendment After Amendment

First Proviso to Section 92C(4)

Section 10AA not included along with Section 10A

Section 10AA included along with Section 10A

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FINANCE ACT, 2009 Before Amendment After Amendment

Proviso to Section 92C

The arm’s length price shall be taken to be the arithmetical mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding five per cent of such arithmetical mean.

The arm’s length price shall be taken to be the arithmetical mean of such price. However, if the arithmetical mean, sodetermined, is within five per cent of the transfer price, then the transfer price shall be treated as the arm's length price and no adjustment is required to be made

Safe Harbor Rules Proposed to empower the Board to formulate safe harbor rules

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FINANCE ACT, 2011 Before Amendment After Amendment

Second Proviso to Section 92C(2)

If the variation between the actual price of the transaction and the ALP does not exceed 5% of the actual price, then, no adjustment will be made and the actual price shall be treated as the ALP.

Proposed to amend section 92C of the Act to provide that instead of a variation of 5%, the allowable variation will be such percentage as may be notified by Central Government in this behalf.

Section 92CA TPO can determine the ALP in relation to an international transaction, which has been referred to the TPO by the Assessing Officer.

Jurisdiction of the TPO shall extend to the determination ofthe ALP in respect of other international transactions

Section 92CA(7) TPO can exercise powers available to an assessing officer under section 131(1) and section 133(6)

Enable the TPO to also exercise the power of survey conferred upon an income-tax authority under section 133A of the Act.

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FINANCE ACT, 2012 Before Amendment After Amendment

Section 92B The term “intangible property” was not included

The term “intangible property” is included

Section 92BA Transfer Pricing Regulations were not applicable to domestic transactions

Transfer Pricing Regulations became applicable to specified domestic transactions

Section 92C Instead of a variation of 5%, the allowable variation will be such percentage as may be notified by Central Government in this behalf.

To provide an upper ceiling of 3% in respect of power of Central Government to notify the tolerance range for determination of arms length price.

Section 92CC Introduction of these Sections to provide a framework for Advance Pricing AgreementsSection 92CD

Section 271AA no penalty for non-reporting of an international transactionin report filed under section 92E or maintenance or furnishing of incorrectinformation or documents.

to provide levy of a penalty at the rate of 2% of the value of the international transaction, in addition to penalties in section 271BA and 271G

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Section 92BA-Insertion By Finance Act, 2012

Transfer Pricing Regulations to apply to certain domestic transactions• Transfer pricing regulations have been extended vide Finance Act, 2012 to

include transactions entered into with domestic related parties or by an undertaking with other undertakings of the same entity for the purposes of section 40A, Chapter VI-A and section 10AA.

• Domestic transfer pricing provisions are applicable from Assessment Year 2013-14 onwards.

• All of the compliance requirements relating to transfer pricing documentation, accountant’s report, etc shall equally apply to specified domestic transactions as they do for international transactions amongst associated enterprises.

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Advance Pricing Agreement It is an agreement between a taxpayer and a taxing authority on an

appropriate transfer pricing methodology for a set of transactions over a fixed period of time in future.

Salient Features –• Seeks to provide assurance of certainty and unanimity in transfer pricing

approach followed by the tax authorities and taxpayers• Validity: Upto 5 years• Binding on tax authorities as well as taxpayers• Pre – Consultation process (with anonymous application option)

Section 92CC and 92CD-Insertion By Finance Act, 2012

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FINANCE ACT, 2014 Before Amendment After Amendment

Section 271G AO or the Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to two percent, of the value of the international transaction or specified domestic transaction for each such failure.

AO or TPO or the Commissioner (Appeals) may direct that such person shall pay, by way of penalty, a sum equal to two percent, of the value of the international transaction or specified domestic transaction for each such failure

FINANCE ACT, 2015 Before Amendment After AmendmentSection 92BA Threshold Limit for SDT is 5

croresThreshold Limit for SDT is 20 crores

SAFE HARBOR RULES

SECTION 92CB

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• Safe Harbour (“SH”) Rules shall be applicable for a period of five fiscal years (i.e., tax AY 2013-14 onwards) and SH do not apply to specified domestic transactions

• Safe Harbour Rules are the circumstances under which tax authorities automatically accept the transfer prices declared by the taxpayer

• Provides certainty and compliance relief• Could be in the form margin threshold or exclusion of certain classes of

transactions from TP regulations• Safe Harbour and Presumptive Taxation provisions (Similar in nature)• Taxpayer would still be required to maintain TP documentation and Form

3CEB

Introduction to Safe Harbor Rules

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S. No. International Transaction Condition

1 ITS and ITeS – Max INR 500 crores (Insignificant risk bearer) OP/ OC >= 20%

2 ITS and ITeS – Above INR 500 crores (Insignificant risk bearer) OP/ OC >= 22%

3 ITES – KPO services - Max INR 100 crores (Insignificant risk bearer) OP/ OC >= 25%

4 Intra Group Loan to WOS <= INR 50 crores Base rate on 30 June of PY (SBI) + 150 bsp

5 Intra Group Loan to WOS > INR 50 crores Base rate on 30 June ofPY (SBI) + 300 bsp

6 Explicit Corporate Guarantee to WOS <= INR 100 crores 2% or more P.A onamount guaranteed

7 Explicit Corporate Guarantee to WOS > INR 100 crores (WOSrated to be of adequate to highest safety)

1.75% or more P.A onamount guaranteed

8 Contract R&D for software development (Insignificant risk bearer) OP/ OC >= 30%

9 Contract R&D for generic pharmaceutical drugs (Insignificant risk bearer)

OP/ OC >= 29%

10 Manufacture and export of core auto components OP/ OC >= 12%

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