Transfer Pricing

1. Transfer Pricing An Overview

2. TP Index TP Basics TP Objectives General considerations Income Tax provisions brief Detailed Tax regulations Associated Enterprises TP Methods for ALP Documentation Accounting for TP TP Disclosures General TP issues Way forward for TP

3. TP Basics TP: A tool to measure and account for the performance of various divisions of a large entity. A method employed by large organizations operating worldwide and having numerous inter divisional exchanges of goods and services. Transfer Price is that price at which product or services of one division of an organization is supplied to another division of the same organization. The Finance Act,2001 has introduced sections 92 to 92F in the Income Tax Act, 1961 from A.Y 2002-03 commonly referred to as Transfer Pricing Regulations(TPR). Hence, a behavioral concept having finance and taxation sides to it.

4. TP Objectives Improve the profit positioning of an Enterprise: - Conversion of an entity into various profit centers - Systematic recording of data pertaining to operations of such profit centers - Studying the Finance & Taxation aspects of operations - Determine the arm’s length price best suited to entity. Deciding upon the product mix, extent of economic exchanges and utilisation of group synergies Optimise the allocation of entity’s financial resources Tax planning and, Better utilization of plant capacity through transfer pricing policies.

5. TP Considerations TP governs the principles of determining the transfer price, its comparison with market price & deciding the more profitable option. The above decisions rallies around the factors of “cost cutting” and “tax saving” in every deal. TP lays emphasis on to the overall profitability of company, not just individual units. Contribution/cost unit of products is a common consideration to examine the most viable product mix. TP also examines the factors such as return on investment and obligation to minimum profits, along with the alternative options to save & invest in profitable deals.

6. Key Operative Provisions

7. TP Regulations……..Sec. 92-92F Following shall be based on Arm’s length price: - Any income including expense/interest arising from international transactions - Any Cost sharing agreement between AEs International Transaction is the deal between two AE (either or both of whom are non-residents) including: - Purchase, sale or lease of tangibles, intangibles. - Provision of services - Financing - Cost allocation / apportionment / contribution arrangements - Soft transaction (I.e without consideration) - Any other transaction bearing on profits, income, assets of the AE - Interposing an unrelated party between two related parties.

8. Associated Enterprises (AE) Basic Guiding Principle – Participation in Management / Capital / Control (M-C-C) One enterprise participating directly or indirectly or through intermediaries in M-C-C of other enterprise or Same people participating in M-C-C of both entities constitutes AE. Deeming Criteria for considering two entities as AE - Shareholding >= 26% - Loans>=51% of book value of total assets - Guarantee >= 10% total borrowing - Appointment>= 50% of board of directors - Supply>= 90% raw material+price influenced by supplier - Firm/AOP/BOI>= 10% interest - Dependence on IPR / Business know-how of other entity - Existence of mutual interest or common control

9. TP Methods………For ALP Comparable Uncontrolled Price : Price charged from an unknown party, adjusted to account for respective differences. Resale Price Method : Resale price of goods obtained from AE and sold to unknown parties reduced by normal gross profits margin. Cost Plus Method : Total cost of production of supplies to AE marked up by normal profits on such costs. Profit Split Method : Allocation of combined net profits of AEs to each enterprise based on functions performed, assets employed and risks assumed. Transactional Net Margin Method : Pure Profits realized from transaction computed in relation to costs incurred/sales effected/assets employed, adjusted on account of differences.

10. TP Best Method: No Best Method prescribed for determination of ALP. Selection of method as per generally accepted principles considering nature of transaction, nature of goods etc. When goods are transferred between related parties before sale to an independent party, Resale price method can be used. When semi-finished goods are supplied or there are long term buy and supply arrangements or in case of services, Cost plus method can be used. Use of Profit split method wherein multiple inter related transactions which cannot be separately evaluated. However, comparable uncontrolled price is the most widely used method and transactional net margin method (for Banks and finance) is the residual method.

11. TP Documentation I TP Return has to be furnished in Form 3CEB. Accountant’s Report (Form 3CEB) to be filed along with tax return. Rule 10D(1) requires maintenance of 13 types of information and documents classified as: - Enterprise- wise: Describe relations between AEs - Transaction specific: Details of international transactions - Computation related: Actual workings of ALP is described Prescribed information should be latest and contemporaneous to the extent possible. Information / documentation to be retained for 8 years from the end of relevant assessment year Such information need not be kept if the aggregate value of international transactions recorded in books does not exceed Rs. 1 crore in a year.

12. TP Documentation II Following documents to be maintained: Details of ownership structure I.e. shareholders and extent of shareholding Details of AEs specifying their Name, Address, Legal status, Country of tax incidence and ownership linkages Details of international transactions stating the nature & terms of transactions, details of property transferred, value and quantum of each such transaction Description of functions performed, assets employed and risks assumed in the international transaction A record of economic and market analysis, forecasts, budgets or estimated prepared by assessee Record of analysis performed to evaluate comparability of uncontrolled transactions with relevant transaction A description of methods, actual workings and assumptions made for determining the arm’s length price

13. TP Accounting No strict laws prescribed, thus, as per generally accepted principles. Transfers to a Branch: - Transaction gets nullified in consolidated balance sheet - No profit should be recognized from transaction Transfers to the Subsidiaries and other AE - Should be treated as trade with separate entities - Transfer of goods should be recorded as sales - Profit can be recognized on conservative basis Value of the Transaction - Should be taken as cost plus agreed mark up - Book value can vary with value for Tax purposes

14. TP Disclosures Disclosures in Annual Report: - Director’s Report to certify that the TP guidelines are complied with and arm’s length price is not prejudicial to company - Auditors to certify the implementation of TP policy in conformity with TP guidelines and Policy statement. - TP policy statement to be annexed to Director’s Report. Disclosures required under AS - 18 (Related Parties Disclosure) : - Name of the transacting related party - Description of relationship between the parties - Description of nature of transactions - Volume of transactions either as an amount or as an appropriate proposition. - Amounts written off or written back in the period in respect of debts due from or to related parties. - Any other element of the transaction necessary for an understanding of the financial statements.

15. TP Issues General

16. TP Issues Detailed Provisions of the IT Act or International Tax Treaty, whichever is more beneficial shall apply to Assessee. Exhaustive ‘international transaction’ definition. Gift - Whether a transaction - Whether arm’s length principle can apply Subvention (Grant) - Whether a transaction - Whether measurement possible TPR applicable on capital gains if capital gains are taxable in India as per treaty. Limited reliable data availability for comparables and other TP issues. Justifications for the method employed.

17. TP Way Forward From a traditional technique of tax planning TP is now seen as a commercial concept catering to a variety of needs. 61% of the MNC’s consider transfer pricing as a key concern today and in the years to come. Indian Pharma industry, Textiles industry and BPOs are the major performers in the global market to adhere to TP policies in a grand way. With increasing globalization and awareness worldwide, TP will grow with the businesses in the time to come.