Transfer Pricing

An overview

- Samir Kanabar
Agenda

► Concept and Rationale of Transfer Pricing

► Arriving at Arm’s Length

► Transfer Pricing Methods

► Comparable Searches

► Advance Pricing Arrangements (APAs)

► Safe Harbour Rules

► Master File (MF) and Country by Country reporting (CbCR)

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Concept & Rationale of Transfer Pricing

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Concept of Transfer Pricing (TP)

Associated Independent
enterprise entity

International transactions
- goods
- services
- intangibles
- loans
- guarantees

Taxpayer Taxpayer

Transfer Arm’s length

price price

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Rationale of Regulating Transfer Prices
► Differences in tax rates across tax jurisdictions

► Pricing flexibility (between associated enterprises)

► Presumption: prices between associated enterprises are not at arm’s length

► Every government wants to prevent erosion of their tax base and plug potential tax
leakages

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Definition of International Transactions
(Sec 92B)
► Transactions between two or more AEs, either or both of whom are non-residents
► Transaction relates to:​
► Purchase, sale or lease of tangible or intangible property; or​
► Provision of services; or​
► Lending or borrowing money; or​
► Any other transaction having a bearing on the profits, income, losses or assets of
the enterprises; or​
► Mutual agreements or arrangements for allocation or apportionment of, or any contribution
to, any cost or expense incurred; or​
► Business restructuring or reorganization irrespective of fact that it has bearing on the
profit, income, losses or assets​
As per Section 92F(V):
► “transaction” includes an arrangement, understanding or action in concert –
► (A) whether or not such arrangement, understanding or action is formal or in writing: or
► (B) whether or not such arrangement, understanding or action is intended to be enforceable by
legal proceeding.

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Meaning of Associated enterprises
(Sec 92A)
A Direct or indirect participation (through
one or more intermediaries) in
B Both A and B are management, control or capital
associated
enterprises of C
C

A D
D and E are also
Direct or indirect participation by same
associated
B E enterprises of C
person (through one or more
since they have a intermediaries) in management, control
common ultimate or capital
C parent (A)

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Deemed Associated enterprises
[Sec 92A(2)]
Associated Enterprises

Equity
Management Activities Control
Holding
► >= 26% direct/ ► Appointment > 50% ► 100% ► One enterprise
indirect holding by of Directors/ one or dependence on controlled by an
enterprise more Executive use of intangibles individual and the
OR Director by an for manufacture/ other by himself
► By same person in enterprise processing/ or his relative or
each enterprise OR business jointly
► Loan >= 51% of ► Appointment by ► Direct/ indirect ► One enterprise
Total Assets same person in supply of >= 90% controlled by HUF
► Guarantees > = each enterprise raw materials and the other by
10% of debt under influenced itself, a member
prices and or his relative or
► > 10% interest in conditions jointly
Firm / AOP / BOI
► Sale under
influenced prices
and conditions

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Arm’s length price

Price applied or proposed to be applied in a transaction between

persons other than AEs, in uncontrolled conditions

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Arriving at Arm’s length price

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Process Flow
Industry Analysis
Identifying the relevant
industry in which the
company operates
Conclusion
Ascertaining if ‘controlled’
transactions satisfy the
arm’s length principle or
not
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Company Transactional
Analysis Analysis
Appropriately positioning Identifying the various
the company in the ‘controlled’ transactions
industry undertaken by the
company
Economic Functional
Analysis Analysis
Undertaking a detailed Ascertaining FAR profile in
comparability analysis to respect of the identified
identify comparable ‘controlled’ transactions
‘uncontrolled’ transactions
Industry Analysis

► Seeks to understand the structure and dynamics of an industry

► Assists in identifying factors that influence the following:

► Characteristics of product/service offering

► Competitive advantage/ disadvantage

► Growth history and profit potential

► Critical success factors and key constraints

► Industry specific regulations

► Need for industry analysis for business enterprises:

► Guiding factor for entry/exit from the market – Industry attractiveness

► Serves as starting point for strategy formulation

► Helps understanding competitive landscape – Pricing considerations

► Helps in identifying key success factors to gain competitive advantage

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Why FAR?
Relevance of FAR analysis:

► To evaluate the relative contribution to profit of various related enterprises and to ascertain
value driver for inter-company transactions
► Assists in characterisation of entities into manufacturer, trader, service provider etc
► To determine the tested party
► To determine the most appropriate method (MAM) for determining ALP.

► To select comparable transactions/entities

► To make appropriate adjustments for functional differences to establish comparability.

► The FAR profile will affect the determination of an arm’s length remuneration for a controlled
transaction since compensation in transactions between two independent enterprises, will
usually reflect the functions that each enterprise performs, taking into account assets employed
and risks assumed.

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Components of FAR
1 Functions (examples)
► Research & Development ► Packaging and labeling
► Product strategy and design ► Marketing, Distribution and Logistics
► Procurement ► Quality Control
► Inventory management ► Warranty and after sale services
► Manufacturing/Assembly ► Billing and Collection

2 Assets (examples)
► Tangible Assets- Property, plant, equipment, other movable assets
► Intangible Assets- Brand, Trademark, Patent, Technical know-how, Distributor network, Distribution rights,
customer contract, workforce, etc

3 Risks (examples)
► Business risk/ Market risk ► R&D & Technology risk

► Inventory risk ► Credit and collection risk

► Capacity Utilization risk ► Foreign exchange risk

► Product liability, Warranty & Performance risk

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Transfer Pricing Methods

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 Prescribed Transfer Pricing Methods

Traditional Transaction Methods Transactional Profit Methods Other Methods

Comparable Resale Price Cost Plus Any other method

Profit Split Transactional
Uncontrolled as provided in
Price Method Method Method Net Margin
Method
Rule 10AB

► Tax payer may apply any of the above methods that is considered most appropriate for a
transaction

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Comparable Uncontrolled Price (CUP)
[Rule 10B(1)(a)]
► Considered the most preferred method, for all transactions, if
information is available

► Compares the price charged in a controlled transaction with the

price in an uncontrolled transaction

► Comparable can be ‘Internal’ or ‘External’

► Requires strict comparability in products, contractual terms,

economic terms, etc

► Most direct and accurate method

Applicability

► Transfer of tangibles i.e. standard products/ goods

► Use in case of – same products

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Comparable Uncontrolled Price (CUP)
[Rule 10B(1)(a)]
► Internal CUP

Rs 10 Sale to Related party B

Manufacturer A

Rs 20 Sale to non-related party C

► External CUP

Rs 20
Non-related party D Non-related party E

Whether transaction between A and B is at arm’s length under CUP?

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Comparable Uncontrolled Price (CUP)
[Rule 10B(1)(a)]

Identification of price charged or paid in comparable transaction(s)

Such price adjusted to account for differences if any between international transaction
and uncontrolled transaction(s)

Adjusted price arrived above taken to be arm’s length price

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Comparable Uncontrolled Price (CUP)
Example
Rate of Brokerage: 20 Rate of Brokerage: 35
bps X Ltd (Indian bps
A Ltd (AE in UK) B Ltd (Non-AE)
Broker dealer)
Volume of Trade: 90% Volume of Trade:
of total trades 10% of total trades

Other Facts
► X Ltd is engaged in rendering broking services
► Differences in levels of service
► Differences in Volumes
► Relevance of local transactions??
Particulars Amount
Rate of Brokerage charged to AE 20 bps
Rate of Brokerage charged to Non-AE B Ltd. [A] 35 bps
Less: Adjustment on account of Volume differences [B] (workings assumed) 5 bps
Less: Adjustment on account of difference in services [C] (workings assumed) 8 bps
Arm’s Length rate of brokerage [A – B – C] 22 bps

Rate of brokerage charged to AE is lower than the arm’s length rate of brokerage – TP Adjustment

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Resale Price Method (RPM)
[Rule 10B(1)(b)]
► To be used when purchase from AE for resale purposes

► Compares the resale gross margin earned by an associated enterprise with the resale
gross margin earned by comparable independent distributors

► An arms’ length gross margin should be sufficient for a reseller to cover its operating
expenses and make an appropriate operating profit (in light of its functions and risks)
► Preferred method for a distributor buying purely finished goods from a group company
without any value addition (if no CUP available)

$75 $100
Group Manufacturer Related Distributor Unrelated
(France) (India) Wholesalers

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Application of RPM

Identification of resale price by tested party

Resale price reduced by normal gross profit with reference to uncontrolled

transaction(s)

Such price reduced by expenses incurred (customs duty etc.) in purchase of the
product/ services.

This price may be adjusted to account for functional and other differences, if any.
Adjusted price arrived above taken to be arm’s length price

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Resale Price Method (RPM)
Example
Transaction: Import of goods from associated enterprises for resale to unrelated
parties
Particulars Amount
Actual resale price earned by XYZ India from sale of group company 100
products to unrelated enterprises
Less: Comparable gross profit margin (10)
Cost of Sales 90
ALP for products procured from group companies during the year 90

Hence, XYZ can pay a maximum of Rs 90 to its AE

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Resale Price Method (RPM)
Example
COGS-INR 150 Independent third Resale Price- INR 200
party in India
Product Gross Profit Margin = 50/200
A = 25%

Foreign Customer
Manufacturer
Resale Price- INR 150
Product
B
Transfer Price =??
Related Party in India
Transfer Price = 150 – (150*25%)
=112. 50

Particulars Amount

Gross Profit 50 i.e. (200-150)

Gross Margin 25% i.e. (50/200)

Arm’s Length Purchase Cost 112.50 i.e. [150 – (25% 0f 150)]

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Cost Plus Method (CPM)
[Rule 10B(1)(c)]
► Applicable when an enterprise is engaged in manufacturing activity or provision of services, sells
such goods or renders such services to AE’s to earn a margin above its cost

► Direct and indirect cost of production of property transferred or service provided is determined

► Compares the gross profit on costs the associated enterprise earns with the gross profit on costs
earned by comparable independent companies

► Preferred method for:

− Manufacturer supplying semi-finished goods

− company providing services

Cost + 40% Related

Manufacturer A
Manufacturer US Market
(Indian)
B (US)

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Application of CPM

Identification of direct and indirect costs of production incurred in tested party

transactions

Identification of normal gross profit with reference to uncontrolled transaction(s)

Normal gross profit adjusted to account for functional and other differences if any

Adjusted gross profit added to total costs identified in step 1. Sum arrived above
is taken to be arm’s length price

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Cost Plus Method (CPM)
Example
A Ltd. (AE)
Gross Profit earned from
manufacturing activity- 20%
Gross Profit Margin earned by Comparable company
C Ltd need to be adjusted for following differences:
(Third Party)
• Inventory Risk Adjustment (5% assumed)
Gross Profit earned from • Adjustment on account of difference in accounting
manufacturing activity-
treatment of selling and administrative expenses (5%
30%
assumed)

Calculation of ALP
GP margins of
Comparable Co.- 30%
Less: Inv Risk Adj (5%)
Less: S&A expenses adj (5%)
B Ltd Comparable Co. Arm’s length GP margin 20%

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Profit Split Method (PSM)
[Rule 10B(1)(d)]
► Appropriate for transactions which are not capable of being evaluated separately

► Calculates the combined operating profit resulting from a whole

inter-company transaction based on the relative value of each associated enterprise's
contribution to the operating profit

► The contribution made by each party is determined on the basis of a division of

functions performed, valued, if possible using external comparable data

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Application of PSM

Determination of combined net profit of the associated enterprises arising out of international
transaction

Evaluation of relative contributions by each enterprise on the basis of functions performed,

risks assumed and assets employed

Splitting of combined net profit amongst enterprises in proportion to their relative

contributions

Profit thus apportioned to the tested party is used to arrive at the arm’s length price

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Profit Split Method (PSM)
Example

Y GmbH Z Inc

Delivery of the software

product
Development of C (Customer)
software product

Outside India

India
30% 30% holding
holding

X Ltd

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Profit Split Method (PSM)
Example
► X Ltd, an Indian company is mainly engaged in software development and does both onsite and offsite
consultancy

► Y GmbH and Z Inc hold 30% shares each in X Ltd

► Z Inc received an order from C Inc, customer for developing a software product for which X Ltd, Y GmbH and Z
Inc contributed integrally

► Z Inc finally delivered the software product to C Inc and received a consideration of USD 50,000 out of which
Z Inc paid USD 12,000 to X Ltd, USD 10,000 to Y GmbH and retained the balance for itself

► In the entire transaction a profit of USD 10,000 was earned

► X Ltd, Y GmbH and Z Inc incurred total cost of USD 9,500, USD 8,500 and USD 22,000 respectively in executing
their functions

Key Assumptions:

► On the basis of functions performed, risks assumed and assets employed, relative contribution is taken at
50%, 20% and 30% for X Ltd, Y GmbH and Z Inc, respectively

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Profit Split Method (PSM)
Example
Determination of arm’s length price using Relative Contribution method:
Particulars X Ltd Y GmbH Z Inc Total
Revenue (Transfer price) (A) 12,000 10,000 28,000 50,000
Cost incurred (B) 9,500 8,500 22,000 40,000
Profits earned 2,500 1,500 6,000 10,000
Return based on relative contribution (C) 5,000 2,000 (20%) 3,000 10,000
(allocation of $10,000 on contribution basis) (50%) (30%)
Income based on relative contribution (arm’s length 14,500 10,500 25,000
price) (D=B+C)
Increased/ (decreased) income (D-A) 2,500 500 (3,000)

► Associated enterprises of X Ltd - Y GmbH and Z Inc

► Ultimate delivery of the product done by Z Inc to C Inc
► International transaction – Payment by Z Inc to X Ltd

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Transactional Net Margin Method (TNMM)
[Rule 10B(1)(e)]
► Examines net operating profit from transactions as a percentage of a certain base (can
use different bases i.e. costs, turnover, etc) in respect of similar parties

► Ideally, operating margin should be compared to operating margin earned by same

enterprise on uncontrolled transaction

► Can compare to “comparable transactions” between independent parties

► Applicable for any type of transaction and often used to supplement analysis under
other methods

► Most frequently used method in India, due to lack of availability of comparable

uncontrolled prices and gross margin data required for application of the comparable
uncontrolled price method/ cost plus method/ resale price method

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Transactional Net Margin Method (TNMM)
[Rule 10B(1)(e)]
► TNMM can be internal or external. Internal TNMM refers to transaction between AEs
and unrelated parties whereas External TNMM refers to transactions between third
parties. Internal TNMM is preferred over External TNMM as it provides more reliable
and accurate data for comparison

This is the most widely used method for ALP benchmarking

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Application of TNMM

Computation of net profit as a percentage of a certain base realised from the

international transaction.

Computation of net profit realized by the tested party or an unrelated enterprise in a

comparable uncontrolled transaction

Net profit from uncontrolled transaction adjusted to account for differences if any

The net profit thus established is taken into account to arrive at an arm’s length
price for the international transaction

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Transactional Net Margin Method (TNMM)
Example
► X Co renders software development & maintenance services to its AEs and earns an
Operating Margin (on cost) of 20%
► TNMM used and following are considered as comparable companies:

Company OPM on Cost (Scenario I) OPM on Cost (Scenario II)

A -5% 30%
B 30% 40%
C 5% 20%
D 15% 10%
E 35% 25%
Arithmetic 16% 25%
mean

Are the transactions between XCo and its AE at arm’s length under TNMM?

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Introduction of ‘range’ concept

► “Range” concept followed internationally; also propounded by OECD

► Use of inter-quartile range is amongst the globally accepted best practice and also closer to economic
realities wherein prices, and or margins, are compared to those within a range and not at to a
particular point.
► In order to align the transfer pricing regulations in India with international best practices, "range"
concept introduced by Finance Act 2015 for determination of arm's length price.

► Applicable for international transactions and SDTs undertaken w.e.f. 1 April 2014

► To be used only (a) if the dataset has six or more comparables; and (b) most appropriate method
selected is CUP, RPM, CPM or TNMM

► Dataset to be constructed by considering weighted average margin of comparables

► Where the transfer price falls within 35th and 65th percentile of the dataset so constructed,
the transaction will be accepted to be at arm’s length
► Where the transfer price does not fall within the above range, then median shall be taken as
the ALP

► Where the above conditions are not satisfied, the concept of arithmetic mean shall continue to
apply and benefit of 1% (wholesale traders) / 3% (others) is available

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The Sixth Method
(Rule 10AB)
“Rule 10AB - For the purposes of clause (f) of sub-section (1) of section 92C, the other
method for Determination of the arms' length price in relation to an international
transaction shall be 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."

► Operative from 1 April 2012 and applicable for Assessment Year (‘AY’) 2012-13

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The Sixth Method
(Rule 10AB)
Applicability
► Where the application of the five specific methods is not possible due to difficulties in
obtaining comparable data or due to uniqueness of transactions

► Intangibles or business transfers, transfer of unlisted shares, sale of fixed assets,

revenue allocation/splitting, guarantees provided and received, etc.

Possible methods
► Third party quotations

► Valuation reports

► Commercial & economic models

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Comparables

► All methods require comparables

► Transfer price is set/ defended using data from comparable companies

► Comparable company should be independent and similar to an associated enterprise.

► Following factors are generally used in judging comparability [Rule 10C(2)]:

− nature of transactions undertaken (i.e type of good, service etc.)

− company functions

− risks assumed
− contractual terms (i.e similar credit terms)

− economic and market conditions

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General Guidelines
Tested Party
► Every international transaction has at least two parties to it. The point of reference for an economic
analysis is the ‘tested party’;
► Choice of tested party;
► Least complex of all entities involved in the controlled transaction
► Entity whose profit attributable to controlled transaction can be verified using the most reliable
data
► Entity for which the benchmarking analysis will require the fewest and most reliable adjustments
► Entity for which the most reliable data regarding uncontrolled comparable transactions can be
located

Use of overseas entity as a tested party is not prohibited, but often

challenging due to non-availability of reliable financial data of tested
party and comparables

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Transfer Pricing Documentation

► A detailed list of mandatory documents are given in Rule 10D(1) of the Rules.

► Ownership Structure
► Profile of multinational group Entity Related
► Business description/ Profile of industry

► Nature and terms (including price) of international transactions

► Description of functions performed, risk assumed and assets
employed (functional analysis)
► Records of economic and market analysis (economic analysis)
► Record of budgets, forecasts, financial estimates
► Any other record of analysis (if, any) to evaluate comparability of
international transaction with uncontrolled transaction(s) Price Related
► Description of method considered with reasons of rejection of
other methods
► Details of transfer pricing adjustment(s) made (if, any)

► Any other information e.g. data, documents like invoices, Transaction Related
agreements, price related correspondence etc.

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Advanced Pricing Agreement (APA)
(Sec 92CC/CD)
► CBDT empowered, with effect from 1 July 2012 to enter into APA with any person in
relation to an international transaction for determination of ALP
► As per method referred in S. 92C or

► Any other method with such adjustments or variations as may be necessary/expedient

► The agreement shall be valid for period not exceeding five consecutive previous
years

► APA is binding on the concerned person and on the tax authorities provided there is
no change in law or no change in facts having a bearing on the agreement

► Roll back provision introduced for upto four years preceding the first year of the APA

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 Advanced Pricing Agreement (APA)
Process Flow
APA procedure in India

Indian CA will The APA team in

review the charge shall visit
Pr CCIT will
application and On The APA team will Applicant’s business Post site visit,
Preparation and assign APA
serve a acceptance of review the application premises for an APA team may
filing of APA application to
deficiency notice application, in detail and issue onsite evaluation of issue further
application* with one of the APA
within one month Indian CA will questionnaire(s) the functions questionnaire(s)
Indian CA** teams for
from the date of send the seeking further details performed by the to seek any
further
filing of application to in relation to covered Applicant and further
*Form 3CED processing of
application (in Pr CCIT *** transactions analysis of facts clarifications
the application
case of any documented in the
defect) application

Based on the
information/
details furnished,
the APA team will
draft a position
paper

The two CAs shall The Indian CA The final Pr CCIT

On acceptance of MAP meet and negotiate may conduct position shall send
APA will be document by Applicant the terms of the The draft
The draft further enquiry paper is sent the draft
entered into (within 30 days of it’s APA. On completion position paper is
APA is on the covered to Indian CA position
between communication), of negotiations, the shared with Pr
shared with transactions and for carrying paper to
CBDT and Indian CA and Indian CA shall CCIT for his
CBDT for may seek out member
Applicant Applicant shall finalize formalize a MAP approval
approval additional details/ negotiations CBDT for
a mutually agreed document with clarifications from with the approval
draft APA**** Finnish CA Applicant Finnish CA

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Safe Harbour Rules – Rules 10TA to 10TG

• Safe Harbour Rules refers to determination of price margin which are

acceptable to tax authorities to provide protection to taxpayers from TP
Meaning scrutiny proceedings
• Prices established under such rules would be automatically accepted by the
tax administrations that have expressly adopted such rules

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Safe Harbour Rules – Rules 10TA to 10TG
Eligible international
transactions
Provision of Software
development services other than
contract R&D services with
insignificant risks
Provision of ITES
Provision of KPO
Advancing of Intra Group Loans to
a non resident wholly owned
subsidiary where amount of loan
is denominated in INR
Provision of corporate guarantee
Contract R &D
Manufacture and export
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Circumstances
If Transaction ≤ 100 crore, then Min. 17%
If Transaction > 100 crore but < 200 crore, then Min. 18%
If Transaction ≤ 100 crore, then Min. 17%
If Transaction > 100 crore but < 200 crore, then Min. 18%
If Transaction < 200 crore, then Min. 24% for employee cost: 60% of operating
cost; Min 21% for employee cost: > 40% but < 60%; Min. 18% for employee cost:
< 40%
Min. One year marginal cost of funds lending rate of SBI as on 1 April of the
relevant PY plus basis points based on CRISIL credit ratings of AEs
Min. 1% per annum on amount guaranteed
If Transaction < 200 crore, then Min. 24% on total operating costs
Of core auto components, then Min. 12%
Of non-core components, then Min. 8.5%
Interplay of TP with other laws

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Requirements and key focus areas - section 188 of
Companies Act, 2013
Compliance to be evidenced through relevant
► Scope of relative documentation ► Covered transactions
curtailed defined
► Different from the ► Different from the
definition as per definition as per
SEBI 1. Identification revised clause 49 of
of related parties *ELA as issued by SEBI
(‘Revised Clause 49’)

5. 2.
6. Identifying
Evidencing
Documentation & Continuing covered
Disclosures Monitoring and transactions
Assurance,
including
independent
reviews
► Approval required
from: 4. 3.
► Approval process
► Audit committee
dependent on ALP and
Approval Assessing ALP and OCB assessment of :
Mechanism and Ordinary Course of
► Board
disclosures Business ► Arms length pricing
► Shareholders*
► Ordinary course of
*In case of specified business
transactions * ELA: Equity Listing Agreement

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Master File (‘MF’) and Country-by-country reporting
(‘CbCR’)

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MF and CbCR applicability flow chart

Consolidated revenue of the international Furnish only Part A of Form 3CEAA by the due
date for filing return of income under section
group for the relevant accounting year 139(1) i.e. 30 November
exceeds INR 500 crores No

Yes

Aggregate value of international transactions for a given FY :

For the entity, as per the Purchase/sale/transfer/

‘books of accounts’ lease or use of intangibles as
OR per the books of accounts No
exceeds INR 50 crores
exceeds INR 10 crores

Yes

Prepare & Furnish master file Part A and Part B of Form 3CEAA by the due date for
filing return of income under section 139(1) i.e. 30 November

In case of more than one CE of the Group in India, any one CE may be designated by the Group to furnish
Form 3CEAA by notifying DGIT in Form 3CEAB (Part A or Part B as the case may be) at least 30 days before
the due date of filing the report

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Thank you