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PRACTICAL PROBLEMS INTRANSFER PRICING

By

NEERU AHUJA

DELOITTE HASKINS & SELLS

November 2003

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Contents

Definition of Transfer Pricing Operational Difficulties

Determination of Arms Length Price (ALP)

Associated Enterprise

Databases Benchmarking

Legal Issues Accounting Issues Problems in Documentation Tax Assessments Issues relating to Allied Laws Way Forward

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Transfer pricing is not an exact science

Transfer pricing

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Definition of Transfer Pricing

Transfer pricing provisions primarilyrequire any income arising from an

international transaction between two

or more Associated Enterprises (AE) tobe at arms length price and

comparable to similar transactions

between unrelated enterprises.

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Operational Difficulties

Determination of ALP Some intra-group transactions are so unique that

they can-not be compared

TP reports of two AEs would have conflictingconclusions

No recommended Profit Level Indicator (PLI) widefluctuations may result depending upon each PLI.

Corporates hesitant to disclose information

Major countries do not require rejection of othermethods

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Operational Difficulties

Associated Enterprise

Whether Section 92A(1) overrides section

92A(2)(a)

Applicability of Section 92A(2)(h) & clause

(i) to trading companies

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Operational Difficulties

Databases

Time gap in search of Databases

Non availability of recognized databases Lack of comparables

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Operational Difficulties

Benchmarking No recommended method for benchmarking

Transaction by Transaction

Aggregate of similar Transactions

Based on Functions

For each AE separately

Arms Length Range Vs Arithmetic Mean

Pricing of Intangibles soft targets

Difficulty in justifying adjustments for factors havinga bearing on prices

Insufficient information available for calculating grossmargins

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Operational Difficulties

Benchmarking

In case of rapidly fluctuating prices, which prices

to compare with

Gift from one enterprise to another Transfers at cost

Capital transaction

Cost Allocation & Cost Sharing Arrangements

Acceptable Band of (+ - 5%)

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Legal Issues

Rule 10D(2) No documents required

for transactions below 1 Crore, but still

to justifyArms Length basis

Determination of AEs unusual/

irrelevant situations

Whether AO can open previous yearsassessments on the basis of TP report

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Legal Issues

Whether transactions which do not affect

profitability are covered e.g

reimbursements

Whether Liaison Offices are covered

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Accounting Issues

Segmental accounts were not

mandatory in India till 2001

How to factor Internal Set-offs Comparability in special circumstances

startup losses, market strategy,

government controls, winding-up.

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Problems in Documentation

Duplication of Documents in case a

Foreign Company (FC) earns Royalty,

technical fee, interest on ECB etc ie

FC also required to file a ROI, TP report

How to document discussions over

phone and in meetings

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Tax assessments

Not an exact science Concept of TP is still in its infancy.

Flexibility to apply a method other than

that prescribed or apply a combinationof methods

Use of secret comparables

Confidentiality of informationAuthenticity & reliability of databases

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Role of Tax Officer

Brief given to the TPO by the tax authorities

Objective in mind

Degree/depth of the review

Overall understanding (general feel) Transactional analysis

Actual documentation review

Assessment Procedure

What level of information/document would beconsidered acceptable.

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Issues relating to Allied Laws

Whether Customs authorities can take

recourse of valuation in TP report

FERA/FEMA issues on higher valuationin TP report

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Way Forward

Transfer pricing "band" rather than atransfer pricing "price"

Safe harbour" rules

Procedures for obtaining "AdvancePricing Agreements (APA)

Use of multiple year data

Objective and reasonable approach ofthe tax officer