Transfer Pricing

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Seminar on Income Tax Northern India Regional
Council Institute of Chartered Accountants of
India
Transfer Pricing A Perspective
By Aseem Chawla Partner, Amarchand
Mangaldas aseem.chawla_at_amarchand.com
May 21, 2011
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Contents
Key Concept
Legislative Overview
Documentation
Form 3CEB Accountants Report
Dispute Resolution Mechanism
Indian Judicial Update
OECD Update, 2010
Direct Taxes Code, 2010
Points for Consideration
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Key Concept

Transfer Pricing Keeping it at Arms Length
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Key Concept (Contd)
Circular No. 14/2001 dated 27-11-2001 55. New
legislation to curb tax avoidance by abuse of
transfer pricing- 55.1 The increasing
participation of multi-national groups in
economic activities in the country has given rise
to new and complex issues emerging from
transactions entered into between two or more
enterprises belonging to the same multi-national
group. The profits derived by such enterprises
carrying on business in India can be controlled
by the multi-national group, by manipulating the
prices charged and paid in such intra-group
transactions, thereby, leading to erosion of tax
revenues.
Objectives of Transfer Pricing

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Scope of Transfer Pricing Regulations
Key Concept (Contd)


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Legislative Overview

• Legislation introduced effective from April 1,
  2001
• Provisions applicable only if
• There is an international transaction(s) Section
  92B between
• Two or more associated enterprises Section 92A
• Deeming provisions Section 92B(2)
• Transaction between an enterprise and a person
  (other than an associated enterprise) shall be
  deemed to be a transaction between two associated
  enterprises, if there exists a prior agreement or
  the terms of such a international transaction are
  in substance determined between one of these
  entities and the associated enterprise of the
  other contracting entity

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Legislative Overview (Contd)

• Computation of Arms Length Price by applying the
  most appropriate method out of
• Comparable Uncontrolled Price (CUP)
• Resale Price Method (RPM)
• Cost Plus Method (CPM)
• Transaction Net Margin Method (TNMM)
• Profit Split Method (PSM) Section
  92C
• Mandatory contemporaneous documentation
  requirements Section 92D
• Stringent Penal Consequences on Non-compliance /
  TP adjustments

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Legislative Overview (Contd)

• Recent Amendments Finance Act, 2011
• Change in computation of arms length range
  Notification of an allowable variation for
  different business activities and types of
  transactions
• Expanded powers of transfer pricing officer
  (TPO) - TPO would now have powers to conduct a
  survey for enquiry and verification as provided
  under 133A of the Income-tax Act, 1961 (Act)
• Further, where any other international
  transaction other than that referred comes to the
  notice of the TPO during the course of the
  proceedings before him, he may include those in
  his transfer pricing audit
• Transactions with notified tax havens - An entity
  located in a notified tax haven will be now
  deemed to be an associated enterprise

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Documentation Rule 10D

• Documentation requirements Rule 10D of Income
  Tax Rules, 1962
• The statute requires information/ documents in
  relation to an international transaction to be
• kept and maintained in by every person
• List of documents prescribed in Rule 10D
• kept and maintained for a prescribed time 9
  years
• furnished within 30 / 60 days of Revenues
  requisitioning

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Documentation Rule 10D (Contd)
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Form 3CEB - Accountants Report

• Section 92E requires every person who has entered
  into an international transaction to obtain a
  report from an accountant
• Rule 10E prescribes the requisite repot to be in
  Form 3CEB
• Accountant shall give in his report declaration
  about
• Examination of accounts records
• Maintenance of prescribed information documents
• Factual accuracy of contents mentioned in
  annexure to form 3CEB
• Scope of examination Guidance Note of Institute
  of Chartered Accountants of India
• Restricted examination of books related to
  international transaction only
• Not an audit for expression of opinion
• Reconciliation between figure mentioned in 3CEB
  general purpose financial statements

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Form 3CEB - Accountants Report (Contd)

• While certifying in the Report, Accountant should
  consider the following
• Rely upon judicial pronouncement about inclusion
  exclusion of any information
• If conflict of judicial opinion- mentioned the
  view followed
• Follow Accounting standard, Guidance notes
  standard on Auditing issued by ICAI
• Obtain details of Associated Enterprise (AE) of
  taxpayer and all the transaction between them
• Obtain written representation from taxpayer in
  relation to Business of AE and from taxpayer to
  the effect that all international transactions
  have been properly disclosed
• Verify computation of Arm length price

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Dispute Resolution Mechanism

• In the recent past, the use of alternative
  dispute resolution practices has been growing in
  importance and popularity world wide, having
  resolved both international conflicts and
  domestic arrangements
• In the international tax scenario, an impetus was
  provided with the introduction of the Mutual
  Agreement Procedures in the bilateral tax
  treaties
• With this expansion of new methods of dispute
  resolution worldwide, a need arose for such a
  mechanism in India to facilitate speedy
  resolution of numerous pending tax disputes
• Section 144C of the Income Tax Act, 1961 (Act)
  was introduced vide Finance Act, 2009 to set up
  the mechanism of reference to DRP with effect
  from October 1, 2009

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Dispute Resolution Mechanism (Contd)

• On receipt of the draft order, eligible assessee
  has an option to
• File acceptance to the proposed variations
• Take no action
• File objections to the proposed variations
• Collegium of 3 Commissioners to constitute DRP
  subordinate to CBDT
• Manner of filing objections
• Objection to the proposed variation to be
  furnished in Form 35A in quadruplicate, within 30
  days of receipt of draft order, alongwith a copy
  to the AO

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Dispute Resolution Mechanism (Contd)

• Manner of filing objections (Contd.)
• Objections to state factual / legal arguments
  against the proposed variation
• Objections to be filed against entire order
  both corporate tax issues and transfer pricing
  issues
• Additional evidence to be filed through a
  separate application
• DRP has the power to confirm, reduce or enhance
  the variations or issue directions to the AO to
  cause further enquiry
• Power of further enquiry by AO restricted -
  Requirement to be reported to DRP and directions
  of DRP are binding
• Directions shall be issued within nine months
  from the end of month in which draft order is
  forwarded

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Indian Judicial Update

• Serdia Pharmaceuticals v. ACIT (2011) 44 SOT 391
• The arms length price for importing active
  pharmaceutical ingredients from related
  enterprises should be determined on the basis of
  price at which locally manufactured generic API
  are sold in the domestic market
• Provides guidance on several important aspects of
  transfer pricing jurisprudence preference of CUP
  over TNMM, irrelevance of customs valuation,
  persuasive value of foreign rulings, economic
  importance of an intangible like patent and the
  requirement to select the most appropriate method
  under the relevant rules
• Cheil India (P) Ltd. vs ACIT
• ITA No. 767/Del/2010
• Pass-through costs that are incurred for non
  value-added purposes should not form a apart of
  the cost base while determining mark up
• Tax administration should not depart from its
  previous position on the same set of facts

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Indian Judicial Update (Contd)

• DHL Express India (P) Ltd. vs ACIT
• I.T.A. No. 7360/Mum./2010
• Where enough comparables are available, companies
  with segmented results should not be accepted
• Only those items that have something to do with
  the business shall be included in the operational
  income for the purpose of transfer pricing
  analysis, thereby clarifying and specifying the
  parameters required for a valid and acceptable
  transfer pricing study

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Organisation for Economic Co-operation and
Development (OECD) Update, 2010

• Significantly expanded guidance on application of
  the TNMM and the Transactional Profit Split
  Method.
• Completely new chapter on Comparability including
  a typical process that can be followed when
  performing a comparability analysis.
• A nine-step process is outlined in the
  Guidelines.
• Recognition that the TNMM may be applied if
  non-unique intangibles exist for which
  comparables can be found.
• Detailed guidance on the use of commercial
  databases, foreign comparables, limitations in
  available comparables, selecting or rejecting
  potential comparables, etc.
• Detailed Guidelines of Business Restructuring
  Attribution of Profits

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Direct Taxes Code, 2010

• Concept of Advance Pricing Arrangements (APA)
  introduced in order to eliminate uncertainty over
  determination of arms length price
• APA provides for determination of arms length
  price of an international transaction entered
  into by a person through an advance pricing
  agreement by the Central Board of Direct Taxes
• APA shall be valid for specified period as
  mentioned in the agreement (not exceeding 5
  consecutive financial years)
• APA shall be binding only on the taxpayer, the
  Commissioner the IT authorities subordinate to
  him only in respect of the transaction in
  relation to which APA has been entered into

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Direct Taxes Code, 2010 (Contd)

• Code proposes safe harbor rules in determination
  of arm length price
• It intends to specify tolerable mark up to the
  cost of the goods or service for the taxation
  authority to accept the transfer price computed
  by the assessee as such
• Adoption of Safe Harbour rules, absolves the
  taxpayers from the burden of a detailed
  benchmarking analysis  for transfer pricing while
  retaining the onus to maintain documentation for
  intra-group transactions
• The TPO may determine the ALP in relation to the
  best of his judgment, if the assessee does not
  co-operate or comply with his directions
• The Assessing Officer shall make the assessment
  of the tax base of the assessee after taking into
  account the order of the TPO

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Points for Consideration

• Application of deeming provisions under Section
  92B(2)
• Cherry picking of comparables exclusion of
  loss making low turnover comparables
• Disregarded transaction wise analysis in case of
  low profit/loss at net margin on a company wide
  level
• Dispute on allocation of common costs in case
  of segmental date in TP analysis
• Application of CUP method using comparative
  prices of localised vis-à-vis Import price

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Points for Consideration

• Inherent conflict between customs and income tax
  laws
• Objectives different

Higher Price for higher customs duty
Customs Department
Assessee
Lower Price for higher taxable income
Income Tax Department
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Precept
There is no art which one government sooner
learns from another than that of draining money
from the pockets of the people Adam
Smith (Father of Modern Economics)
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• NOTE This presentation is for discussion and
  general guidance purposes, prepared on the basis
  of information available. It may not be used for
  any other purpose, or distributed to any other
  party, without seeking our prior written consent.
  No party should rely on this presentation without
  taking necessary prior professional advice

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Comparable Uncontrolled Price Method

• CUP method compares the price transferred in a
  controlled transaction to the price charged in a
  comparable un-controlled transaction
• CUP method is the most direct and reliable way to
  apply the arms length principle

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Resale Price Method

• The resale price method begins with the price at
  which a product is resold to an independent
  enterprise (IE)by an associate enterprise
• X sold to AE at Rs. 1000 (profit 300)
• AE sold to an IE at Rs. 2000
• (profit of Rs. 500 for relevant IE)
• Arms length price 2000 - 500 1500

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Profit Split Method

• PSM is used when transactions are inter-related
  and is not possible to evaluate separately
• PSM first identifies the profit to be split for
  the AE. The profit so determined is split between
  the AE on the basis of the functions
  performed/assets/CE

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Cost Plus Method

• In CP method, first the cost incurred is
  determined. An appropriate cost plus mark-up is
  then added to the cost to arrive at an
  appropriate profit. The resultant figure is the
  arms length price

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Associate Enterprise Section 92A

• Direct Control/Control through intermediary
• Holding 26 of voting power
• Advance of not less than 51 of the total assets
  of borrowing company
• Guarantees not less than 10 on behalf of
  borrower
• Appointment of more than 50 of the BoD
• Dependence for 90 or more of the total raw
  material or other consumables

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International Transactions Section 92B

• Transaction between two or more AE of which
  either both or anyone is a non-resident
• Transactions
• Purchase/Sale/Lease
• Provision of service
• Lending or borrowing

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Arms Length Price

• Price which two independent firms would agree on
• Price which is generally charged in a transaction
  between persons other than associated enterprises

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Transactional Net Margin Method (TNMM)

• TNMM is adopted in cases of transfer of
  semi-finished goods, distribution of finished
  products (where resale price method (RPM) cannot
  be adequately applied) and transactions involving
  the provision of services
• TNMM compares the net profit margin relative to
  an appropriate base (sales, assets or costs
  incurred) of the tested party with net profit
  margin of the independent enterprises in similar
  transactions after making adjustments regarding
  functional differences and risk involved

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Deemed International Transactions
Arrangement (non-related parties)
XYZ Bank US
ABC Finance Corporation
Debt
Interest
XYZ Branch India
Benchmarked at Arms Length as Deemed
International Transaction