TRANSFER PRICING

TRANSFER PRICING
• The increasing participation of multinational 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 multinational group
• Business carried on between resident and non resident, and owing to
the connection between them, the business may be so arranged that
the resident makes either no profits or less than ordinary profits in that
business.
• Such arrangement deprive Indian revenue of taxes and which other
would have been earned by the resident
• To provide a statutory framework for a reasonable, fair and equitable
profits to be taxed in India, the Transfer pricing provisions have been
introduced under Chapter X
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TRANSFER PRICE
• The Transfer price is a that price which is arrived at when two
associated or related enterprises have business arrangement with
each other. Since the enterprises involved are related entities,
they can manipulate prices in a manner whereby the profits are
transferred to the entity of that country, where the tax rates are
lower
• To prevent this erosion of tax which was otherwise leviable in
India, these provisions have been introduced
• In 2012, the scope was expanded by including certain specified
domestic transaction under the transfer pricing regulations

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TRANSFER PRICING – RELATING TO AVOIDANCE OF
TAX IN CASE OF INTERNATIONAL TRANSACTION
• There must be an international transaction
• Should be between two or more associated enterprises
• Should be in the nature of:
• Purchase, sale or lease of tangible or intangible property; or
• Provision of services
• Lending or borrowing money
• Any other transactions having a bearing on the profits, income, losses or
assets of such enterprise; or
• A transaction of business restructuring or reorganization, entered into by
such enterprise, irrespective of the fact that it has bearing on the profit,
income, losses or assets of such enterprises
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ASSOCIATED ENTERPRISES
• Two enterprises shall be deemed to be associated enterprises if
any time during the previous year any of the conditions are
satisfied.
• Holding at least 26% voting power in another enterprise
• Holding at least 26% voting power in more than one company
• Advancing of loan which constitutes at least 51% of the book value of the
assets of the borrower enterprise
• Providing guarantee for at least 10% of total borrowings of other
enterprise
• Appointment of more than half of the board of directors, members of the
Governing Board or appointment of at least one executive
director/member
• Manufacturing wholly dependent on use of intangibles of other enterprise
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METHODS & COMPUTATION OF ARM’S LENGTH PRICE
• “Arm’s length prices” means a price which is applied or proposed
to be applied in a transaction between persons other than
associated enterprises, in a uncontrolled conditions
• Methods adopted to determine whether the international
transactions are at arm’s length:
• Comparable uncontrolled price method
• Resale price method
• Cost plus method
• Profit split method
• Transactional net margin method
• Such other methods as prescribed by the Board
• The comparison of prices of similar uncontrolled transaction, under
similar circumstances, should be adopted
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PROCEDURE FOR DETERMINING THE METHOD
• Identify the international transaction
• Identify uncontrolled transaction
• Compare the international transactions with uncontrolled
transactions
• Ascertain the most appropriate method, best suited to the facts
and circumstances of the international transaction and that which
provides the most reliable measure of the arm’s length price
• Finally determine the arm’s length price by applying the most
appropriate method chosen

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METHODS & COMPUTATION OF ARM’S LENGTH PRICE
• Where the variation between arm’s length price and the price at
which the international transaction has been undertaken – if
• It does not exceed 1% of the international transaction price – for
wholesale trading and
• It does not exceed 3% of the international transaction price – for all other
cases
• Shall be deemed to be at arm’s length price

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COMPARABLE UNCONTROLLED PRICE - CUP
Problem: Sony Japan and Y Ltd., an Indian company, are associated
enterprise. Y Ltd manufactures mobile phones and sells them to Sony
Japan and LG Korea. Y Ltd supplied 1,20,000 units at a price of
Rs.2,000 to Sony Japan and 20,000 units to LG Korea at Rs.3,200.
The transactions are comparable subject to the following difference
i) Sales to Sony is on FOB basis, sales to LG is on CIF. The freight
and insurance paid by Sony for each unit at Rs.300
ii) Sales to LG was with 1yr free warranty and for Sony it was without
warranty. The cost for such an activity may be at Rs.350
iii) Sony placed a huge order hence got a discount of Rs.50 per unit
Compute arm’s length price
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COMPARABLE UNCONTROLLED PRICE - CUP
Solution:
Sale price to LG Rs.3,200
Less: Adjustments for differences
a) Freight and insurance 300
b) Estimated warranty cost 350
c) Bulk quantity discount 50 Rs. 700
Arm’s length price for sale to Sony Japan Rs.2,500

Arm’s length price (2500 * 1,20,000 units) 30,00,00,000

Price charged to Sony Japan (2000 *1,20,000 units) 24,00,00,000
6,00,00,000

Income of Y Ltd will be increased by 6,00,00,0000

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