Transfer PricingRegulations

S-I S-2 S-3 S-4 S-5C Transfers to X 200 280 300 400 500Cost to C 100 100 100 100 100SP of X 300 300 300 300 300Tax Rate for CTax Rate for X

Impact of TP

20%60%

C X Total C X Total C X TotalSP 200 300 500 280 300 580 300 300 600Cost 100 200 300 100 280 380 100 300 400PBT 100 100 200 180 20 200 200 0 200Tax 20 60 80 36 12 48 40 0 40PAT 80 40 120 144 8 152 160 0 160

S-3S-1 S-2

C X Total C X TotalSP 400 300 700 500 300 800Cost 100 400 500 100 500 600PBT 300 -100 200 400 -200 200Tax 60 60 80 80PAT 240 240 320 320

S-4 S-5

R even u e P ro fitC ap ita l G a in

R oya lty

In te r C om p an y

C on tro l S ys temcos t c en tres

reven u e cen tresp ro fit /In ves tm en t c en tre

In tra C om p an y

In te rn a l(W ithin the country )

N on -R e la ted :P ro fit /D ivid en d /R oya lty

F o rex F lu c tu a tion sA cc ou n tin g

R e la tedP ro fit /D ivid en d /R oya lty

T ra ns fer Pr ic ingF orex/A c cou n tin g

In te r C om ap n y

C on tro l S ys tem sF orex F lu c tu a tion s

A cc ou n tin gTran s fe r P ric in g

In tra C om p an y

E xte rn a l(outs ide the country )

Tran sac tion s

Transfer Price: What and Why?

• TP means the value or price at which transactions take place amongst related parties.

• TP are the prices at which an enterprise transfers physical goods and intangible property and provides services to associated enterprises

• TP gain significance because these can be used by the controlling party to their advantage to minimise tax incidence.

Transfer Price: What and Why?

• Approximately 60% of the total transactions across the world are between related parties.

• If the transactions are across different tax jurisdictions, where tax rates are different, shifting is beneficial.

Factors Affecting Transfer Pricing

• Internal factors: Performance Measurement and Evaluation

• External Factors:– Accounting Standard– Income Tax – Custom Duty– Currency Fluctuations – Risk of Expropriation

Transfer Price Regulations

International• OECD formulated

“Guidelines on transfer pricing”. They serve as generally accepted practices by the tax authorities

India• The Finance Act 2001

introduced the detailed TPR w.e.f. 1st April 2001

• The Income Tax Act• AS-18• Other Relevant Acts

Accounting Standard 18

Requires disclosure of ‘any elements of the related party transactions necessary for an understanding of the financial statements’.

Related Parties

• Control by ownership– 50% of the voting right

• Control over composition of board of directors– Power to appoint or remove the directors

• Control of substantial interest– 20% or more interest in the voting power

AS-18 and Transactions

• Purchase and sale of goods;• Rendering or receiving services;• Agency arrangements;• Leasing arrangements;• Transfer of research and development;• Licence aggrements;• Finance• Guarantees and collaterals;• Management contracts.

Income Tax Act and TP

• Finance Act 2001 substituted the old section of 92 of the ITA by sections 92,92A to 92 F.

• These sections are the backbone of Indian TPR.

• These sections define the meaning of related parties, international transactions, pricing methodologies etc.

TPR: Some Important Concepts

• Income/Expenses/Cost arising from an international transaction shall be computed having regard to arm’s length price (ALP).

• ALP provisions can be applied if it leads to decrease in taxable income or increase in losses.

Associate Enterprise: 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

International Transactions: 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

Arm’s Length Price

• Price which two independent firms would agree on.

• Price which is generally charged in a transaction between persons other than associated enterprises.

Arm’s Length Price: 92C

• Comparable uncontrolled price method• Resale price method• Cost plus method• Profit split method

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 arm’s length principle.

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

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

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 arm’s length price.

Some Transactions subject to ALP

• Purchase at little or no cost.

• Payment for services never rendered.

• Sales below MP/ Purchase above MP

• Interest free borrowings

• Exchanging property• Selling of real estate at

a price different from MP

• Use of trade names or patents at exorbitant rates even after their expiry.

Some Cases

• Kinetic Honda Motors– Collaborator: Honda Motor Co. Ltd Japan and

their Subsidiary Honda Trading Corpn. Japan• Hero Honda Motors Ltd.

– Parent: Honda Motor Co. Ltd Japan and their Subsidiary Honda Trading Corpn. Japan

Some Cases

• Peico Electronics & Electricals Ltd.– Parent: Phillips Netherlands and its subsidiaries

• Asea Brown Boveri– Parent: ABB Switzerland and its subsidiaries

• Videocon Group– Collaborators: Toshiba Co., Mitsubishi Co

Computers 4% 2% 4 4 16% 8%Software 10% 10% 2 2 15% 20%Books 4% 5% 3 2 10% 10%Overall 6.1% 5.1% 2.4 2.6 14.40% 13.51%

ROS Sales/Asset ROI