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PROJECT REPORT
ON
TRANSFER PRICING
Submitted for partial fulfillment of award ofMASTER`S DEGREE IN
BUSINESS ADMINISTRATION
BY
DEBASHISH ROY
MBAl Year, 3rd
trimesters
2/5/2011 To 31/7/2011
DAYANANDA SAGAR BUSINESS SCHOOL
Shavige Malleshwara Hills, kumaraswamy layout Bangalore-560078
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ACKNOWLEDGEMENT
I take this as an opportunity to thank with bottom of my hear all those without whom the
journey of doing my project would not have been as pleasant as it has been to me. Working
on my project was a constant learning experience with all sweat and tear which was its due
but not without being richly stimulating experience of life time.
I am very thankful to Dr. PARUL TANDON for giving me their valuable advice and
guidance towards fulfillment of the project
Finally I would like to convey my heartiest thanks to all my well wishers for their blessing
and co-operation throughout my study. They boosted me up every day to work with a new
and high spirit.
Debashish Roy
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DECLARATION
I hereby declare that this Research Project entitled, A Study on TRANSFER PRICING
written and submitted by me, under the guidance of Mr. MANISH KUMAR KOTHARI is
my original work and that has not been submitted to any other University / Institute
previously.
DEBASHISH ROY
PGDM-3RD
TRIMESTER
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CERTIFICATE
This is to certify that the Research Project Report entitled, TRANSFER PRICINGfor the award of POST GRADUATES DIPLOMAIN MANAGEMENT from DAYANANDA SAGAR BUSINESS SCHOOL,
BANGALORE, has been carried out by DEBASHISH ROY. The Report
embodies result of original work and studies carried out by the student himself
and the contents of the Report do not form the basis for award of any other
Degree to the candidate or to anybody else.
Dr. PARUL TANDON
DEPT. PGDM (AICTE)
DAYANANDA SAGAR BUSINESS SCHOOL
DATE:-
PLACE:-
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CONTENT
CHAPTER-I
,,
i) Introduction
ii) Objectives of the study
iii) Scope of the study
iv) Importance of study
v) Research Methodology
CHAPTER-2
vi) Theoretical perspective
vii) Objectives of transfer pricing
viii) Methods to calculate transfer pricing
ix) Checking transfer pricing manipulation
x) Penalties
xi) Changes in transfer pricing
CHAPTER-3
xii) Data
xiii) Problem solved
xiv) Recommendation
xv) Conclusion
xvi) Limitation of the study
xvii) Bibliography
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CHAPTERI
i) INTRODUCTION
ii)OBJECTIVE OF THE STUDY
iii)SCOPE OF THE STUDY
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INTRODUCTION
Over the course of past few years. Transfer pricing
become an increasingly important- and often complex issue facing by chief
financial officer (CFO) of the companies in India which provide service to theirparent or affiliated organization overseas. This is not just because of the
increase in such transaction as a result of the hectic pace of globalization, but
also importantly, due of the lack of the clarity in the minds of both tax payer as
well as revenue official on what the effective and optimal pricing mechanism
should be, the area of transfer pricing is still a relatively new field and bothcorporation and tax authorities are on a learning curve. Further, what is the right
margin for a business at a point of time is somewhat is subjective issue open to
different interpretation and hence disputes.
The price of a service, and therefore the margin of thatbusiness, is that function of the type of activity that the service provider is
engaged in. Ideally the margin charged by the provider should be directlyproportionate to the value addition undertaken software design and architecture
(higher value adding activities), or just code-writing (lower value addition).
Similarly, in the of a transaction involving manufacture of a component,
margins would be lower if design and tools were provided by the buyer and the
provider undertook only conversion or assemblingEqually, the risk borne by the taxpayer is an important
determinant of the margin-again both are directly proportionate; the greater therisk, the higher the margin. Risks, often considered for the purpose of
determination of margin, include market risk; human capital risk; credit risk;
foreign exchange fluctuation risk; product/service price risk and product
development risk.Captive units generally bear lower risks than other types
of Associated Enterprises (AE), For example, parent organization can afford
higher bench strength than an independent service provider. They will also carry
lower product development risk because they have much greater access to the
company information. However, they do carry foreign exchange fluctuation riskas much as any export organization. Since they carry lower risk, they can,
theoretically, operate at lower margins. Whether this logic is accepted by
transfer pricing auditors however, is a separate issue.
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What is transfer pricing and its method?
Transfer pricing is simply the act of pricing of goods and services or intangibles
when the same is given for use or consumption to a related party (e.g.
Subsidiary). There can be either Market-based, i.e. equivalent to what is being
charged in the outside market for similar goods, or it can be non-market based.
Importantly, two-thirds of the managers say their transfer pricing is non-marketbased. There can be internal and external reasons for transfer pricing. Internal
include motivating managers and monitoring performance, e.g. by putting a cost
to imported inputs. External would be taxes and tariffs.
Different method to calculate transfer pricing
1. Best rule method of transfer pricing
2. Multiple method if transfer pricing
3. Comparable uncontrolled price method
4. Resale price method of transfer pricing
5. Cost plus method of transfer pricing6. Profit split method of transfer pricing
7. Transactional net margin method (TNNM) of transfer pricing
.
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OBJECTIVE OF THE STUDY
1. To study about transfer pricing
2. To evaluate the various application of transfer pricing
3. To analyze the various method of transfer pricing
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Scope of study
The scope of this study is to identify the methods of the Client ofM.K.kothari
& Associates. This study is based on secondary data only because of the rules
of Indian government that a CHARTERED ACCOUNTANT cannot publish
their clients accounting details. Due to time constraint only limited number of
Clients was contacted. This study only focuses on the clients ofM.K. Kothari
& Associates because the study conducted with the clients of M.K. Kothari The
study does not say anything about the other firms which are not the clients of
M.K.kothari & Associates. The scope of study is limited for clients of
M.K.kothari & Associates in Kolkata. It provides help to further study for
transfer pricing in corporate sector.
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Research Methodology
Research Methodology is a set of various methods to be followed to find out
various informations regarding transfer pricing of different company.
Research Methodology is required in every industry for acquiring knowledge of
their method of calculating transfer pricing.
Area of study:
The study is exclusively done in the area of finance. It is a process
requiring care, sophistication, experience, judgment, and knowledge for which
there can be no mechanical substitutes.
Information Collection: -
Information is collected from various clients through personal interaction.
Information is collected with mere interaction and formal discussion with
different clients. Some other relevant information collected through secondary
data
Tools of Analysis : -
The survey about the techniques of marketing and nature of expenditure
is carried out by personally interacting with the potential clients in Kolkata.
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Theoretical Perspective
Transfer price refers to the amount used in accounting for transfer of goods or
services from one responsibility centre to another or from one company toanother which belongs to the same group. Transfer pricing is a mechanism for
distributing revenue between different divisions which jointly develop,manufacture and market products and services.
Transfer pricing systems are designed to accomplish the following objectives: to
provide each division with relevant information required to make optimaldecisions for the organization as a whole; to promote goal congruencethat is,
actions by divisional managers to optimize divisional performance should
automatically optimize the firm's performance; and to facilitate measuringdivisional performances.
The fundamental principle is that the transfer price should be similar to the price
that would be charged if the product were sold to outside customers orpurchased from outside vendors.
Market-based transfer pricing system provides optimal results when the market
for the intermediate product is perfectly competitive and the selling division can
sell its output either to insiders or outsiders and as long as the buying divisioncan obtain all its requirements from either outsiders or insiders.
In such a situation the company as a whole has no additional cost of providing
autonomy to divisions. For example, if division A decides to sell its product atthe market price of Rs. 100 per unit and division B decides to buy the same
product from market at the market price, net cash flow to the firm will be zero
If the market for the intermediate product is imperfect, this system may lead to
sub-optimal utilization of production capacity by the buying division. The
transfer price will form an element of the total marginal cost and the buyingdivision will restrict its output at the level where marginal cost = marginal
revenue. Thus the firm as a whole will lose an opportunity to improve its profitbecause actual marginal cost is lower than the transfer price.
For instance, the intermediate product that the sub-unit A of the firm uses is
produced by the sub-unit B of the firm and another firm. The market price of theproduct is Rs 100 per unit, while the variable cost of production in division B is
Rs 40 per unit. If, the transfer price is fixed at Rs 100 per unit (the market price)
the sub-unit A will consider Rs 100 per unit as a part of its marginal cost. It will
restrict the output at the level where marginal cost = marginal revenue. If the
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sub-unit B has excess capacity, the decision of the sub-unit A is sub-optimal for
the firm as a whole. Even in a situation where the sub-unit B has no excess
capacity, that is, it can sell its total output to outsiders at Rs 100 per unit, the
decision of the sub-unit A to restrict its output at a level lower than its
achievable capacity might be sub-optimal for the firm as a whole.
Assume that the firm earns a contribution of Rs 100 per unit on the final
product, the output of the sub-unit A. The contribution is higher than the
contribution of Rs 60 per unit on the intermediate product. The firm loses the
opportunity to earn higher profit by using the intermediate product internally inthe sub-unit A instead of selling the same to outsiders.
If competitive prices are not available or it is too costly to obtain market prices,
transfer prices may be determined based on the cost plus a profit. Cost-based
transfer prices should be used only as a second option to market-based transferprices because it involves complex calculations and results are less than
satisfactory
Companies use variations of market-based and cost-based transfer pricing
mechanisms to achieve the objective of goal congruence. Transfer-pricing
system must have in-built mechanisms for smooth negotiation and conflictresolution.
Although there is sound economic theory behind the selection of transferpricing methods, companies use transfer price methods to achieve certain other
objectives even at the cost of goal congruence. Often in family run businesses,decisions are taken at the group level.
Therefore, decisions aim to optimize group performance. When group
companies produce products that are used within the group, transfer price is
established with an aim to optimize the group performance, although it may hurtthe selling or the buying company within the group.
An issue that is often ignored is that whether this practice undermines theinterest of minority shareholders. If there is no minority shareholder in thecompany that is hurt, the ethical/corporate governance issue does not arise.
Otherwise, this is an important issue and need to be addressed by the board ofdirectors of individual companies.
For multinational corporations, it may be advantageous to arbitrarily select
prices such that most of the profit is made in a country with low taxes, thus
shifting the profits to reduce overall taxes paid by a multinational group.
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However, most countries enforce tax laws based on the arm's length principle as
defined in the OECD (Organization for Economic Co-operation and
Development) Transfer Pricing Guidelines for Multinational Enterprises and
Tax Administrations, limiting how transfer prices can be set and ensuring that
that country gets to tax its "fair" share. In India, the OECD principle wasadopted in 2001.
Applying transfer pricing rules based on the arm's length principle is not easy,
even with the help of the OECD's guidelines. It is not always possibleand
certainly takes valuable timeto find comparable market transactions to set anacceptable transfer price.
The revenue authority and the MNCs should work together in good faith to
implement regulations effectively. The question of ethics cannot be ignored
even in tax planning.
Objective of transfer pricing
The main objective is to take advantage of different tax rates between countries.Transfer pricing also is used to evaluate performance of divisions within acompany.
Tax Savings
Imagine a company with two branches, where one makes semi-finished goodsin a low-tax country and exports them to a branch in a high-tax country, where
they are finished and sold. By increasing the transfer price and declaring moreof its profits in the low-tax country, the company can reduce its global tax bill.
Boost Profits
By undercharging for goods crossing national borders, a company can save
money on customs duties paid by the branch in the importing country.
Conversely, by overcharging, a company can extract more money from a
country with tighter currency outflow restrictions.
Measure Performance
Companies need to know how their individual divisions are performing. A way
of measuring that is through transfer pricing. By setting a price for goods in
each stage of the production process, a company can measure the profitability ofeach division and decide where to make organizational adjustments.
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Arm's Length Standard
The basic principle of this standard used by most developed countries is that for
transactions between branches a company should use market prices. However,
enforcement of this rule is complicated, especially when a company hasbranches in numerous countries.
Method to calculate transfer pricing
Best rule method of transfer pricing
The best method rule is intended to avoid the rigidity of the priority of methods
that formerly had been required. The rule guides taxpayers and the IRS (internalrevenue service) as to which method is most appropriate in a particular case.
The temporary regulations no longer provided for an ordering rule to select themethod that provides for an arms-length result. Rather, in choosing a method,
the arms-length result must be determined under the method which providesthe most accurate measure of an arms-length result.
The best method rule appears to be somewhat subjective and, because of itstechnical nature, may require special expertise. Certainly, the rule does not
appear to eliminate the potential for controversy between the IRS and taxpayers.The rule will likely require taxpayers to expend more energy developingintercompany transfer prices and reviewing data.
The best method rule had three limitations:
1. Tangible property rules normally do not adequately consider the effect of
no routine intangibles in determining which method is the best method. Inthese cases, adjustments may be required under the intangible property
rules.
2. Tangible property comparable methods may be superseded, especially asthey effect significant no routine intangibles that are not defined.
3. A taxpayer can request an advance pricing agreement to determine itsbest method.
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Multiple Methods of Transfer Pricing
The temporary regulations encouraged the taxpayer to use more than one
transfer pricing method. When two or more methods produce inconsistent
results, the best method rule should be applied to determine which methodproduces the most accurate measure. Presumably, if the results are consistent, itmay not be necessary to invoke the best method rule.
If the best method rule does not clearly indicate the most accurate method,
consistency between results should be considered as an additional factor. Using
this approach, the taxpayer should ascertain whether any of the methods, or
separate applications of a method, yields a result consistent with any othermethod.
Comparable Uncontrolled Price Method
The CUP method provides the best evidence of an arm's length price. A CUPmay arise where:
the taxpayer or another member of the group sells the particular product,in similar quantities and under similar terms to arm's length parties in
similar markets (an internal comparable);
an arm's length party sellsthe particular product, in similar quantities and
under similar terms to another arm's length party in similar markets (anexternal comparable); the taxpayer or another member of the group buys the particular product,
in similar quantities and under similar terms from arm's length parties in
similar markets (an internal comparable); or
an arm's length party buys the particular product, in similar quantities and
under similar terms from another arm's length party in similar markets (anexternal comparable).
Incidental sales of a product by a taxpayer to arm's length parties may not be
indicative of an arm's length price for the same product transferred betweennon-arm's length parties, unless the non-arm's length sales are also incidental.
Transactions may serve as comparables despite the existence of differencesbetween those transactions and non-arm's length transactions, if:
the differences can be measured on a reasonable basis; and
Appropriate adjustments can be made to eliminate the effects of thosedifferences.
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Where differences exist between controlled and uncontrolled transactions, it
may be difficult to determine the adjustments necessary to eliminate the effect
on transfer prices. However, the difficulties that arise in making adjustments
should not routinely preclude the potential application of the CUP method.
Therefore, taxpayers should make reasonable efforts to adjust for differences.
The use of the CUP method precludes an additional allocation of related product
development costs or overhead unless such charges are also made to arm's
length parties. This prevents the double deduction of those costs-once as an
element of the transfer price and once as an allocation.
Resale price method of Transfer Pricing
The resale price method begins with the resale price to arm's length parties (of a
product purchased from an non-arm's length enterprise), reduced by acomparable gross margin. This comparable gross margin is determined byreference to either:
the resale price margin earned by a member of the group in comparable
uncontrolled transactions (internal comparable); or The resale price margin earned by an arm's length enterprise in
comparable uncontrolled transactions (external comparable).
Under this method, the arm's length price of goods acquired by a taxpayer in anon-arm's length transaction is determined by reducing the price realized on the
resale of the goods by the taxpayer to an arm's length party, by an appropriate
gross margin. This gross margin, the resale margin, should allow the seller to:
recover its operating costs; and
Earn an arm's length profit based on the functions performed, assets used,and the risks assumed.
Where the transactions are not comparable in all ways and the differences have
a material effect on price, the taxpayer must make adjustments to eliminate theeffect of those differences. The more comparable the functions, risks and assets,
the more likely that the resale price method will produce an appropriate estimateof an arm's length result.
An exclusive right to resell goods will usually be reflected in the resale margin.
The resale price method is most appropriate in a situation where the seller adds
relatively little value to the goods. The greater the value-added to the goods by
the functions performed by the seller, the more difficult it will be to determinean appropriate resale margin. This is especially true in a situation where the
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seller contributes to the creation or maintenance of an intangible property, suchas a marketing intangible, in its activities
Cost plus method of Transfer Pricing
The cost plus method begins with the costs incurred by a supplier of a product
or service provided to an non-arm's length enterprise, and a comparable gross
mark-up is then added to those costs. This comparable gross mark-up isdetermined in two ways, by reference to:
the cost plus mark-up earned by a member of the group in comparable
uncontrolled transactions (internal comparable); or The cost plus mark-up earned by an arm's length enterprise in comparable
uncontrolled transactions (external comparable).
In either case, the returns used to determine an arm's length mark-up must be
those earned by persons performing similar functions and preferably sellingsimilar goods to arm's length parties.
Where the transactions are not comparable in all ways and the differences havea material effect on price, taxpayers must make adjustments to eliminate theeffect of those differences, such as differences in:
the relative efficiency of the supplier; and Any advantage that the activity creates for the group.
The more comparable the functions, risks and assets, the more likely it is thatthe cost plus method will produce an appropriate estimate of an arm's lengthresult.
In general, for purposes of applying a cost-based method, costs are divided intothree categories:
(1) Direct costs such as raw materials;
(2) Indirect costs such as repair and maintenance which may be allocatedamong several products; and
(3) Operating expenses such as selling, general, and administrative expenses.
The cost plus method uses margins calculated after direct and indirect costs of
production. In comparison, net margin methods-such as the transactional net
margin method (TNMM) discussed in Section B of this Part-use margins
calculated after direct, indirect, and operating expenses. For purposes of
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calculating the cost base for the net margin methods, operating expenses usuallyexclude interest expense and taxes.
Properly determining cost under the cost plus method is important. Cost is
usually calculated in accordance with accounting principles that are generallyaccepted for that particular industry in the country where the goods areproduced.
However, it is most important that the cost base of the transaction of the tested
party to which a mark-up is to be applied be calculated in the same manner as-
and reflects similar functions, risks, and assets as-the cost base of the
comparable transactions. Where cost is not accurately determined in the same
manner, both the mark-up (which is a percentage of cost) and the transfer price(which is the total of the cost and the mark-up) will be misstated.
Transactional Profit Methods of Transfer Pricing
Traditional transaction methods are the most reliable means of establishing
arm's length prices or allocations. However, the complexity of modern business
situations may make it difficult to apply these methods. Where the information
available on comparable transactions is not detailed enough to allow for
adjustments necessary to achieve comparability in the application of a
traditional transaction method, taxpayers may have to consider transactional
profit methods.
However, the transactional profit methods should not be applied simply because
of the difficulties in obtaining or adjusting information on comparable
transactions, for purposes of applying the traditional transaction methods. The
same factors that led to the conclusion that it is not possible to apply a
traditional transaction method must be considered when evaluating thereliability of a transactional profit method.
The OECD Guidelines endorse the use of two transactional profit methods:
the profit split method; and Transactional net margin method (TNMM).
The key difference between the profit split method and the TNMM is that the
profit split method is applied to all members involved in the controlledtransaction, whereas the TNMM is applied to only one member.
The more uncertainty associated with the comparability analysis, the more
likely it is that a one-sided analysis, such as the TNMM, will produce aninappropriate result. As with the cost plus and resale price methods, the TNMM
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is less likely to produce reliable results where the tested party contributes to
valuable or unique intangible assets. Where uncertainty exists with
comparability, it may be appropriate to use a profit split method to confirm theresults obtained.
Profit split method of Transfer Pricing
Under the profit split method:
The first step is to determine the total profit earned by the parties from
a controlled transaction. The profit split method allocates the total
integrated profits related to a controlled transaction, not the total profits
of the group as a whole. The profit to be split is generally the operating
profit, before the deduction of interest and taxes. In some cases, it may be
appropriate to split the gross profit. The second step is to split the profit between the parties based on the
relative value of their contributions to the non-arm's length transactions,
considering the functions performed, the assets used, and the risks
assumed by each non-arm's length party, in relation to what arm's lengthparties would have received.
The profit split method may be applied where:
the operations of two or more non-arm's length parties are highlyintegrated, making it difficult to evaluate their transactions on an
individual basis; and
the existence of valuable and unique intangibles makes it impossible to
establish the proper level of comparability with uncontrolled transactionsto apply a one-sided method.
Due to the complexity of multinational operations, one member of the
multinational group is seldom entitled to the total return attributable to thevaluable or unique assets, such as intangibles.
Also, arm's length parties would not usually incur additional costs and risks to
obtain the rights to use intangible properties unless they expected to share in the
potential profits. When intangibles are present and no quality comparable data
are available to apply the one-sided methods (i.e., cost plus method, resale pricemethod, the TNMM), taxpayers should consider the use of a profit split method.
The second step of the profit split method can be applied in numerous ways,including:
splitting profits based on a residual analysis; and
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relying entirely on a contribution analysis.
Following the determination of the total profit to be split in the first step of the
profit split, a residual profit split is performed in two stages. The stages can be
applied in numerous ways, for example:
Stage 1: The allocation of a return to each party for the readily
identifiable functions (e.g., manufacturing or distribution) is based on
routine returns established from comparable data. The returns to these
functions will, generally, not account for the return attributable to
valuable or unique intangible property used or developed by the parties.
The calculation of these routine returns is usually calculated by applying
the traditional transaction methods, although it may also involve the
application of the TNMM. Stage 2: The return attributable to the intangible property is established
by allocating the residual profit (or loss) between the parties based on the
relative contributions of the parties, giving consideration to any
information available that indicates how arm's length parties would dividethe profit or loss in similar circumstances.
Transactional net margin method (TNMM) of Transfer Pricing
The TNMM:
compares the net profit margin of a taxpayer arising from a non-arm's
length transaction with the net profit margins realized by arm's length
parties from similar transactions; and
Examines the net profit margin relative to an appropriate base such ascosts, sales or assets.
This differs from the cost plus and resale price methods that compare gross
profit margins. However, the TNMM requires a level of comparability similar
to that required for the application of the cost plus and resale price methods.
Where the relevant information exists at the gross margin level, taxpayersshould apply the cost plus or resale price method.
Because the TNMM is a one-sided method, it is usually applied to the least
complex party that does not contribute to valuable or unique intangible assets.
Since TNMM measures the relationship between net profit and an appropriate
base such as sales, costs, or assets employed, it is important to choose the
appropriate base taking into account the nature of the business activity. The
appropriate base that profits should be measured against will depend on the
facts and circumstances of each case
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CHECKING TRANSFER PRICING MANIPULATION
Having understood the implications and growing importance of Transfer
Pricing, more Precisely Transfer Pricing Manipulation, we look at what
regulations have been enacted to counter this by India.
The Finance Act 2001 introduced detailed Transfer Pricing regulations w.e.f.
1st April, 2001. The basic idea behind regulations is determining whetherInternational Transactions between associated parties are conducted at
arms length pricesArms Length Price (ALP) This is the price that would
be charged in uncontrollable transactions, i.e. when parties are unrelated. Two
most common methods of doing this are
1. Checking the price in a similar transaction between two totally different
parties and
A B vs. C D2. Checking the price in a similar transaction between one of the involved party
and one
Unrelated party .
A B vs. A C
The various methodsprescribed by Indian regulations to find out the arms
length price.
There is generally more than one Transfer Price which is defendable in any
transaction and hence most countries talk of a transfer pricing band rather than a
singular transfer price.There are clearly some roadblocks in implementation of ALP, like:
- Specialized nature of goods/ services and uniqueness of intangibles
- Independent entities might not undertake similar transactions, because of
Copyright issues. For e.g. Coke would only share its formula with a related
party where it has some stakes.- There is a huge administrative burden on part of tax authorities in determining
the true transfer price and this exercise might sometime take years, by when the
Situation changes dramatically
- Confidentiality issue may restrict availability of comparable information.Associated PartiesThose having 26% or more Equity holding, having loans or
Guarantees over a certain value, having power to appoint Board Members or
Managers or when there is dependence for license, copyrights or raw materials
for that matter.
International TransactionsInternational transaction has been defined as a
transaction between two or more associated enterprises, either or both of whom
are non-residents. The transactions intended to be covered are purchase, sale or
lease of tangible or intangible property, provision of services, lending and
borrowing of money cost sharing and any other transaction which have a
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bearing on the profits, income, losses or assets of an enterprise. As such,
virtually every conceivable transaction is proposed to be roped infor scrutiny. The regulations apart from filing of proper tax returns require
maintenance of a host of documentary and other evidence to substantiate
transfer prices adopted by MNEs and penalties have gotten stricter. Anorganization can be fined up to 2% of the transaction value for not just evasion
of tax but also for non-compliance with procedural requirements.
PENALTIES
Penalties have been provided as a disincentive for non-compliance with
procedural requirements is as follows.
(a) Penalty for Concealment of Income - 100 to 300 percent on tax evaded
(b) Failure to Maintain/Furnish Prescribed Documentation - 2 percent of the
value of the international transaction
(c) Penalty for non-furnishing of accountants report - INR 100,000 (fixed)
The above penalties can be avoided if the taxpayer proves that there was
reasonable cause for such failures.
Changes in transfer pricing
India has a relatively short history of transfer pricing (TP) legislation comparedto some countries where this law is well developed. The detailed TP regulation
in the country was introduced in the Finance Act, 2001, with a view to check
erosion of tax base in the country. The domestic TP regulation is designed for
an international transaction, which has been defined to mean a transactionbetween associated enterprises, either or both of whom are non-residents.
As per the domestic TP regulation, an international transaction between
associated enterprises is required to adhere to arm's-length standard. In order to
ensure that the international transaction between associated enterprises is at
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arm's length, there are reporting and detailed documentation requirements that ataxpayer must maintain to avoid stringent penalties.
A domestic transactiona transaction between two tax residents of India
may not be governed specifically by the domestic TP regulation. Generally
speaking, one may assume that the overall tax base of a country is unaffected by
manipulation in the prices of domestic transactions between related parties,since it will have nullifying effect as far as overall taxability of the transaction is
concerned. However, there may be situations where pricing of a domestictransaction could be manipulated for tax arbitrage opportunities.
For instance, price manipulation could result in shifting of profits between a
loss-making entity and a profit-making entity to achieve an overall reduced tax
rate. Similarly, profit shifting to an entity enjoying tax concessions under an
incentive scheme could also be achieved through pricing of transactions of suchentity with another related company.
The Income-Tax Act has provisions (sections 40 A (2) and 80IA10) thatempower the assessing officer to get into the aspect of pricing of the transaction
between a taxpayer and a related person, and adjust the expense or income as
per the market value of such transaction. However, a taxpayer is not required to
maintain specific and detailed documentation to support the pricing of suchtransactions.
Also, there is no guidance in the Act or rules governing such provisionspertaining to determination of fair market value of the transaction. This oftenresults in the tax officer exercising his best judgment in estimating the market
value of the transaction and disregarding the excessive expenditure and incomereported by the taxpayer.
In an interesting development, the Supreme Court in the recent case of
Commissioner of Income Tax IV, Delhi, vs. GlaxoSmithKline Asia (P) Ltd
(SLP (Civil) no 18121/2007) discussed the above-mentioned limitations in the
current provisions governing pricing of domestic transaction between relatedparties.
In this case, the court, on the facts of the case, declined to interfere and
dismissed the special leave petition filed by the tax department. However, sincethe issue involved concerned section 40A (2) of the Act, the court took up a
larger issue of the scope of domestic TP regulation being limited to cross-border
transactions. The apex court observed that in the case of a domestic transaction,
under invoicing of sales and over invoicing of expenses would ordinarily be tax
neutral.
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However, there could be situations where a tax arbitrage could be created. The
court expressed the view that certain provisions of the Act, such as sections
40(A)(2) and 80IA(10), need to be amended to empower the tax officer to make
adjustments to income having regard to the fair value of the transactions
between related parties.
Identifying the shortcomings of current provisions and with a view to reducelitigation, the court has suggested that the ministry of finance should consider
whether the law ought to be amended to provide for extensive documentation to
be maintained by the taxpayer even for domestic transactions with related
parties. This would align the provisions governing domestic transactionsbetween related parties with the provisions of the domestic TP regulation.
The amendment of law to introduce documentation requirements even for
domestic transactions between related parties would not be unique to India.There are many countries that mandate compliance requirements for domestic
transactions within their transfer-pricing regimes. The UK, for instance, is a
jurisdiction where TP provisions governing domestic transactions are fairlydeveloped.
The issue is whether the objective of reduced litigation would be achieved?
Considering that litigation surrounding TP issues has increased significantly, the
change might not result in the desired outcome. However, it would rule out
absolute discretion and bring out some objectivity in the application of theprovisions.
So, are we ready for domestic transfer-pricing legislation? Or, more
importantly, whether the increased burden on the taxpayer as well as the tax
officers is worth the effort? The answer may not be a simple 'aye' or 'nay'.
However, as the Supreme Court has suggested, this is a change that meritsconsideration by lawmakers.
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In the books of nilimara jute mills
Trading & Profit and loss account for the year ending 31st
of March 2009
PARTICULAR AMOUNT PARTICULAR AMOUNT
Opening stock
Purchase
Wages
Expenses
Impartment
Interest
Depreciation
Net profit (b/f)
231000
718800
744900
73900
37100
228100
37100
658200
2729100
Sales
Closing stock
2500000
266200
2729100
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Balance sheet as at 31st
march 2009
PARTICULAR AMOUNT PARTICULAR AMOUNT
SHARE CAPITAL
AUTHORISED CAPITAL@2
ISSUED AND SUBSCRIBED
2 2963478@2
RESERVES & SURPLUS
General reserves
Tea board subsidy as capital res
Housing subsides
Preference shares
Loans
Secured loans
W.B.govt sales tax loan
Others
Bonds
9% secured redeemable
convertible 12yrs bond
Scheduled banks
State banks of India
Bank of Baroda
Allahabad banks
United banks of India
7500
45926956
1073500
114000
406000
294500
1851300
15000
125700
500000
461000
256000
Fixed assets
Goodwill
Land & building
Tea Estate
Roads & culverts
Plant/ machinery
Drawing design &trading
Vehicles
Computers software
Investment
Equity
Tide wale oil
228390@10
New beblwon coal ltd
Others
Gloster jute mills
208@10
Exide industry
212714@1
1215000
1753900
1245800
5375000
5306000
749000
599000
332000
1410700
12703805
2080
212714
Contd...
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Particular Amount Particular Amount
Sundry creditor& liabilities
Advances and Deposits received
Customers and others
Micro Small and Medium
Enterprises
Unclaimed Redeemed
Preference Shares
Interest accrued but not due on
and deposits
544300
121660
640
260
80000
36096190
Unquoted
The statesman
9966@10
ABC tea worker service
750@10
Debentures
Bond (FULLY PAID)
305@10000
SUNDRY DEBTOR
Unsecured debt
Other debt
Cash
Closing stock
99660
7500
3050000
509614
229418
.
1291833
3166
36096190
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Problems Solved
Assumption completive and perfectly competitive and the manager are motivated to
maximize short-run profit. The production capacity of department A is 1000 denotes
the quantity transferred by X.
Maximize = ( -)(1000-x)+(--)X
= (200-120)-(1000-X) + (300+150+120)
= 8000 -50X
Two decentralized decision makers each maximizing her division profits:-
Profit A = (200-120) (1000-X) + (TP-120) x
= 8000 + (TP-200) x
Profit B = (300-150-TP) x
= (150-TP) x
(1)What is the minimum transfer pricing according to the course text?
ANSWERS
Variable cost + Opportunity
=120+80
=200
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(2)What are the transfer price according to the variable cost and full cost?
ANSWER
VARIABLE COST: 120
FULL COST: 120+31000/1000=151
From the above calculation we can understand that how to calculate the
transfer pricing of a firm. The above calculation is one of the methods of
calculating transfer pricing. It is merely the amount of price of the
product or service which should be charged by the firm on the parent
company. The problem was very simple and it has been drawn on certain
assumption. And through this we can understand the concept of transfer
pricing.
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RECOMMENDATION
The calculation of the transfer pricing is very complex for the normal
person and so he has to take help of the expert
There are many method for calculating transfer pricing so the normalpeople are not able to get which methods will project the best and fairvalue for their business line
The calculation for the multinational companies are very difficult becauseof the international transaction and the complexity of international taxesrates and rules and regulation
The day to day changes in the taxes rates by the government makes it toocomplex for the Officer to calculate the correct figure for the transferpricing.
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CONCLUSION
Transfer pricing is inherent in the way the global economy is structured with
sourcing and consuming destinations being different, with numerousorganizations operating in multiple countries and most importantly due to
varying tax and other laws in different nations.
Also nations have to achieve a fine balance between loss
of revenues in the form of outflow of tax and making their country an attractive
investment destination by giving flexibility in Transfer Pricing. One can choose
to go to extremes like Singapore would be doing especially when it is the low
tax country. Given that countries are not integrated into a global system, each of
them want increase in total inflow through tax or FDI and something like VATis not expected to remove this non-competitive method of attracting investment,
countries will need to enact legislations on their own. Thus, achieving the
mentioned balance, suiting their conditions and pattern of international
transactions, according to the stage of economic development they are in, are
some of the challenges companies are facing as they become a global economiccommunity.
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Limitation of the study
Certain limitations do creep in a research study due to constraints of the time,
money and human efforts, the present study is also not free from certain
limitation, which were unavoidable.
Although all effort were taken to make the result of the work as accurate aspossible as study but the study have following constraints
a. Some clients were calculating there transfer pricing from their ownmethods of calculation, which were not applicable according to Indiangovernment rules & regulation.
b. Due to large number of clients only few clients books were studiedc. Due to time constraint and other imperative work load during the period it
could not be made possible to explore more area of concern pertaining to
study.d. Also impossible for company to provide their confidential details for the
study
e. As per the rules of a chartered accountant they cannot disclose or publishtheir client details in any place.
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Bibliography
Prasan chandra 2009 TATA McGraw-Hill Taxation of international business transaction
http://en.wikipedia.org/wiki/Transfer_pricing
http://www.business-standard.com/india/news/transfer-pricing-explained/327373/
Books provided by the chartered account
http://en.wikipedia.org/wiki/Transfer_pricinghttp://www.business-standard.com/india/news/transfer-pricing-explained/327373/http://www.business-standard.com/india/news/transfer-pricing-explained/327373/http://en.wikipedia.org/wiki/Transfer_pricing