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Transfer Pricing Rules Bhavesh Dedhia 21 February 2015
Transfer Pricing Rules
Bhavesh Dedhia
21 February 2015
Agenda
2
Transfer Pricing – Importance
Transfer Pricing Rules
- Overview
- Practical Experience
- Case Laws
Advance Pricing Agreement
Safe Harbour Rules
Emerging issues
Q & A
Transfer Pricing - Importance
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Transfer Pricing in News !!
India accounting for about 70% of all global
TP disputes by volume – Financial Express,
1 September 2012
High Pitched Adjustments
5
Total TP adjustments* made by Revenue upon audit
*The above figures are approximate and based on informal feedback
On an average, TP adjustments are made on 50%* of the cases picked up for
scrutiny •Estimates based on various sources
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
2001-02
2002-03
2003-04
2004-05
2005-06
2006-07
2007-08
2008-09
2009-10
Financial Year
Value in $ Millions
Transfer Pricing Rules
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Rule 10 of the Income-tax Rules, 1962
10AMeaning of expressions used in computation of ALP
10AB Other Method
10B Determination of ALP under Section 92C
10C
Advance Pricing Agreement
10D
Safe Harbour
10E Accountant’s Report
Most Appropriate Method
Information / Documentation to be maintained
10F to 10T
10TA to 10TG
8
Rule 10A – Meaning of expression used in computation of ALP
(a) ―associated enterprises‖ as defined in section 92A and in
relation to specified domestic transaction means - related parties
as defined in section 40A(2)(b) and units / undertakings /
persons as defined in section 80A / 80IA(8) / 80IA(10) / 10AA /
chapter VI-A
(aa) ―enterprises‖ as defined in section 92F and unit /
undertaking / business undertaking specified domestic
transactions
(ab) ―uncontrolled transaction‖ means a transaction between
enterprises other than associated enterprises, whether resident
or non-resident
(b) ―property‖ includes goods, articles or things, and intangible
property
(c) ―services‖ include financial services
(d) ―transaction‖ includes a number of closely linked transactions
Associated Enterprises
Third Party
Assessee
A
transaction
B
transaction
C
transaction
Judicial precedents
9
Cases Tribunal Ruling
Sony India
Delhi ITAT
The Tribunal held that an entity can be taken
as uncontrolled if its related party transaction
do not exceed 10 to 15 percent of total
revenue
Cases Tribunal Ruling
Star India
Mumbai ITAT
Aggregation of different business activities for
testing arm‘s length price is contrary to the
transfer pricing principles.
Control Transactions
Aggregation of Transactions
Cases Tribunal Ruling
Aithent
Technologies
Pvt Ltd
Transaction between Head-Office & Canada
Branch, not subject to S.92, not separate
entities
AE Relationship
10
Rule 10AB – Other Method
10AB. ……the other method for determination of the arm’s length
price in relation to an international transaction or a specified
domestic transaction shall be any method which takes into account
the price which has been charged or paid, or would have been
charged or paid, for the same or similar uncontrolled
transaction, with or between non-associated enterprises, under
similar circumstances, considering all the relevant facts."
• Allows flexibility to select a method other than five prescribed
methods for computing ALP
• Scenarios where the ―other method‖ could be used are:
Use of the revenue split / allocation in case of investment
banking, logistics and similar complex uncontrolled
transactions;
Use of tender documents, price quotations to demonstrate
arm‘s length intent in case of loan, guarantee transactions;
Reliance on the standard rate cards;
Managerial remuneration in case of SDT, etc.
Other Method – Flexibility !!
Rule 10B – Determination of arm’s length price under
section 92C
Prescribed Methods
Traditional Transaction
MethodTransactional Profit
Method
Comparable
Uncontrolled
Price Method
Price charged or paid/
Price would have been
charged or paid
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Resale Price
Method
Cost Plus
Method
Profit Split
Method
Transactional Net
Margin Method
Other
Method
No hierarchy or preference of methods prescribed under the Act
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Rule 10B - Summary of Methods
MethodProduct
Comparability
Functional
ComparabilityApproach Remarks
(a) CUP Very HighSubsumed in
product
Prices are
benchmarked
Very difficult to apply as
very high degree of
comparability required
(b) RPM High High
GPM
(on sales)
benchmarked
Difficult to apply as high
degree of comparability
required
(c) CPLM High High
GPM
(on costs)
benchmarked
Difficult to apply as high
degree of comparability
required
(d) PSM Medium HighProfit
Margins
Complex Method, sparingly
used
(e) TNMM Medium More tolerantNet Profit
Margins
Most commonly used
Method
(f) Other High High PriceGenerally used in absence
of comparable transaction
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Rule 10B(2) - Comparability Factors
Comparability factors
(a) Characteristics
Depends on type: tangible,
intangible or service
(b) Functional Analysis
Conduct is best evidence of risk bearing, should be
consistent with control
(d) Economic Circumstances
Geography, size of market, date and time
(c) Contractual terms
Where not written, deduce from
conduct
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Rule 10B(2) - Comparability Factors
Practical Experience
– Sources of information and reliability
– Timing issues in comparability
– Documenting a search of comparables
– Identifying comparables having uncontrolled
transactions
– Comparability adjustments
– Selecting or rejecting internal / external
comparables
– Other issues (Loss making
companies, companies with extreme
results, etc.)
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An Uncontrolled transaction shall be comparable to international
transactions or specified domestic transaction if:
(i) none of the differences between the transactions
being compared or between the enterprises entering
into such transactions are likely to materially affect
the price, or cost charged, or profit arising from, such
transactions in the open market; or
(ii) reasonable accurate adjustments can be made to
eliminate the material effects of such differences.
• Practical Experience – Kind of adjustments asked for:
– Working capital adjustment, Volume adjustment, Idle
capacity adjustment
– Adjustment for difference in risk profile
– Adjustment for differences in accounting policies
– Adjustment for difference in depreciation rates
Rule 10B(3) - Adjustments for Comparability
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• Practical Experience:
– Indian law permits adjustments only to comparables
and not tested party
– The TPOs generally reject adjustments inter-alia
stating that the assumptions, approximations and
estimations used in computation are not tenable
– Challenge lies in obtaining reliable and adequate
data of comparables for computation of adjustments
– Lack of guidance on computation methodology
– Courts favor adjustments for proper comparability
– Quantification of adjustment is a huge challenge
– Adjustments being accepted
Rule 10B(3) - Adjustments for Comparability
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Rule 10B(3) - Adjustments for Comparability
Assessee Principal held
Fiat India
Pvt. Ltd.
and Ariston
Thermo
India
Limited
• The ITAT upheld the assessee‘s contention and
allowed claim for adjustment on account of under
utilization of capacity.
E-Gain
Communica
tion
Pvt. Limited
• The ITAT upheld the assessee‘s contention and
allowed claim for adjustment on difference in the
depreciation policy.
Mentor
Graphics
(Noida) Pvt.
Ltd.
• The ITAT allowed adjustments for working capital,
risk profile and R&D expenses.
Sumi
Motherson
Innovative
Engineering
Ltd.
• The ITAT rejected the depreciation adjustment as
the rationale for charging higher depreciation in
comparison to its comparables could not be
demonstrated.
• Further the ITAT rejected the claim for
consideration of cash profits since as per Rule
10B(1)(e) only denominator can vary on a case to
case basis.
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Rule 10B(4) - Usage of Multiple Year Data
• The data to be used in analysing the comparability of an
uncontrolled transaction with an international transaction or a
specified domestic transaction shall be the data relating to
the financial year in which the international transaction or
the specified domestic transaction has been entered into :
Provided that data relating to a period not being more than
two years prior to such financial year may also be considered
if such data reveals facts which could have an influence on
the determination of transfer prices in relation to the
transactions being compared.
Finance Act 2014 – Proposal to use multiple year data but legislative
amendment is yet awaited
19
Rule 10B(4) - Usage of Multiple Year Data
• Practical Experience:
– TPOs follow first leg of rule 10B(4), reject multiple year data
– Adopt only data relating to the relevant financial year and undertake adjustments
– Courts allow usage of multiple year data if proper reasoning in terms of proviso to rule 10B(4)
available
Assessee Principal held
Aztec Software
Bangalore ITAT
(Five Member
Special Bench)
• Multiple-year data may be used if one can demonstrate that such data has an influence on
determination of ALP
Customer Services
India (P) Ltd.
Delhi ITAT
• Mandatory and absolute requirement of law for use of the current financial year data cannot be
dispensed with even if the relevant data was not available with the appellant in the electronic data
base at the time of preparation of the TP report.
• The TPO is empowered to determine the ALP by using the current financial year data available at the
time of transfer pricing proceedings and to conduct the comparability analysis by using such data.
• Multiple year data should be used only when it adds value to the transfer pricing analysis.
Caterpillar Logistics
Services India Pvt.
Ltd.
• The ITAT held that instead of relying solely on the working results of the financial year under
consideration, the TPO should have considered the working results of recent past years as well, so
that a balanced picture is available on the consistency of the working results attributable to the
assessee.
• A cumulative value may be sometimes more appropriate to guard against adhoc seasonal changes of
circumstances.
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Rule 10C - Most Appropriate Method
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Rule 10C - Most Appropriate Method
Following factors to be taken into account for
selection of the Most Appropriate Method :—
a) Nature and class of international
transaction or specified domestic
transaction;
b) Class and functions performed by
associated enterprises;
c) Availability, coverage and reliability of
data;
d) Degree of comparability;
e) Possible adjustments;
f) Nature, extent and reliability of
assumptions.
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Rule 10C - Most Appropriate Method
Assessee Principal held
Starlite
Mumbai
ITAT
• Taxpayer – none of the methods can applied to
determined ALP
• TPO – selected TNMM as the MAM
• ITAT – remanded back the matter to determine
fresh assessment in line with the submissions
made by the Assessee
Nimbus
Communic
ation Ltd
Mumbai
ITAT
• TPO made adjustment without specifying any
method;
• The ITAT deleted the adjustment stating that arms‘
length price needs to be determined using one of
the prescribed methods mandated in section
92C(1) of the Act.
MSS India
Pvt Ltd
• The most appropriate method adopted by the
taxpayer cannot be disturbed unless the revenue
authorities are able to demonstrate that a particular
method is more appropriate vis-à-vis the method
adopted by the taxpayer
J P Morgan
India Pvt.
Ltd
• The ITAT held that in case of availability of internal
CUP method, TNMM cannot be applied as the
most appropriate method.
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Rule 10D - Information / Documentation to be maintained
Rule 10D - Information / Documentation to be maintained
Profile of industry
Profile of group
Profile of Indian entity
Profile of associated
enterprises
Transaction terms
Functional analysis (functions,
assets and risks)
Economic analysis (method
selection, comparable
benchmarking)
Forecasts, budgets, estimates
Agreements
Invoices
Pricing related
correspondence (letters,
emails etc)
Entity related Price related Transaction related
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Contemporaneous documentation requirement
Documentation to be retained for 9 years
No specific documentation requirement if the value of international transactions
is less than one crore rupees
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Rule 10D - Information / Documentation to be maintained
Assessee Principal held
Philips
Software
Bangalore
ITAT
• The ITAT held that the documentation
maintained by the assessee to justify arm‘s
length price based on contemporaneous
data cannot be rejected by the TPO without
pointing out any deficiency or insufficiency
therein.
UCB India Pvt
Ltd.
Mumbai ITAT
• Substantive compliance should be the
criteria and the test should be as to whether
non-maintenance/deficiency in maintenance
of some records fundamentally effects or
distorts the computation of arm‘s length
price; if it does not make a material
difference then the effect is not fatal.
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Rule 10E - Accountant’s Report
Rule 10E - Accountant’s Report
10E. The report from an accountant required to
be furnished under section 92E by every person
who has entered into an international
transaction or specified domestic transaction
during a previous year shall be in Form No.
3CEB and be verified in the manner indicated
therein.
Obtained by every person entering into an
international transaction / specified domestic
transaction
To be filed by the due date for filing return of income
– 30 November
Mandatory e-filing w.e.f. 1 April 2013
Opinion whether prescribed documents have been
maintained the particulars in the report are ―true
and correct‖
Review is limited to international transactions /
specified domestic transactions entered by the
assessee
Relevant annexures and appendices be attached
Form No. 3CEB
[See rule 10E]
Report from an accountant to be furnished under section 92E relating
to international transaction(s)
1. We have examined the accounts and records of <<Entity
Name, Postal Address and PAN Number>> relating to the
international transactions and specified domestic transactions
entered into by the assessee during the previous year ending on
31 March 2013.
2. In our opinion proper information and documents as are
prescribed have been kept by the assessee in respect of the
international transactions and specified domestic transactions
entered into so far as appears from our examination of the
records of the assessee.
3. The particulars required to be furnished under section 92E are
given in the Annexure to this Form. In our opinion and to the best
of our information and according to the explanations given to
us, the particulars given in the Annexure are true and correct.
Place : For ________
Date : Chartered Accountants
Firm‘s Registration No.
Partner
Membership No.
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Accountant’s Report – Legal Requirement
Accountant’s Report contains following
disclosures:-
– Nature of international transactions /
specified domestic transactions
– Book value and Arm‘s length value of
international transactions / specified
domestic transactions
– Method adopted for the purpose of
benchmarking
– Documentation to justify arm‘s length
nature of international transactions /
specified domestic transactions
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Rule 10F to 10T – Advance Pricing Agreement
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Rule 10F to 10T - Advance Pricing Agreement
• Global phenomenon – now introduced in India – Advance
Pricing Agreements (‗APAs‘) exists in most jurisdictions
(U.S. has entered over 900 APAs)
• Commenced from 1 April 2013
• Pre-filing consultation (anonymous application
possible)
• Agree upon a fixed pricing for 5 years
• Flexibility to use methods apart from prescribed methods
• APA binding on Applicant and Department qua-
transaction
• Option to convert Unilateral APA to Bilateral or
Multilateral
• Rollback provision introduced
APA Program - Key Features & Challenges
› Key features:
» APA legislation effective from 1st July 2012 & APA Rules
notified on 30th August 2012
» Types : Unilateral, Bilateral, Multilateral
» Validity : Up to 5 years (renewal possible)
» Flexibility in determining ALP available to taxpayers
» Coverage : Existing / ongoing transactions & New
transactions
» Mandatory Pre-Filing Application & Consultation – option to
remain anonymous
» APA Directorate to include panel of experts - Economists,
Statisticians, etc
» No regular TP audits - only an annual compliance audit
» Taxpayer can withdraw the APA application at any stage
» Fees only at the APA stage
Benefits outweigh the challenges: APA can help build certainty
› Challenges
» Confidentiality of information/
firewall mechanism
» Guidance in case of failed APAs
» Flexibility in providing information
sought in pre-filing consultation /
APA application
» Mechanism for resolving disputes
in interpretation of APAs
» Indicative time frame especially for
Unilateral APAs
» Roll back of APAs – can help
reduce past/pending litigation
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Rule 10TA to 10TG – Safe Harbour Rules
Rule 10TA to 10TG Safe Harbour Rules - Background
› ―Safe harbour‖ - Circumstances in which the
revenue authorities shall accept the transfer price
declared by the assessee
› Introduced in India by Finance (No.2) Act, 2009
w.r.e.f. 1.4.2009 and new Section 92CB inserted in
the Act
› Rangachary Committee had submitted six reports
for various sectors
› Final Safe Harbour Rules were released on 18
September 2013
› The option of being governed by Safe Harbour
Rules shall be valid for a period of five years or
for a lesser period, starting with AY 2013-14.
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Safe Harbours generally aim to provide certainty, administrative simplicity and reduced
litigation
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Intercompany Transaction Value of Intercompany
Transaction
Safe Harbour
Software Development (IT) or Back-
office support Services (ITES)
• Upto INR 500 crores
• Exceeds INR 500 crores
• Cost plus 20% or higher
• Cost plus 22% or higher
Knowledge processes outsourcing
services (KPO services), with
insignificant risks
• No monetary limit • Cost plus 25% or higher
Intra-group loan to wholly owned
subsidiary
• Upto INR 50 crores
• Exceeds INR 50 crores
• SBI base rate plus 150 bps
• SBI base rate plus 300 bps
Corporate guarantee • Upto INR 100 crores
• Exceeds INR 100 crores and the
credit rating of the AE is of the
adequate to highest safety
• Commission @ 2% or higher
• Commission @ 1.75% or
higher
Contract R&D services for software
development
• No monetary limit • Cost plus 30% or higher
Contract R&D services for
pharmaceutical drugs
• No monetary limit • Cost plus 29% or higher
Manufacture and export of core auto
components
• No monetary limit • Cost plus 12% or higher
Manufacture and export of non-core
auto components
• No monetary limit • Cost plus 8.5% or higher
Safe Harbour Margins
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United Nation Transfer Pricing Manual
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United Nation Transfer Pricing Practical Manual
The UN Practical Manual on Transfer Pricing was launched
on 29 May 2013;
Total 10 chapters
Chapter 1 to 9 contains practical guidance for tax
administration
Chapter 10 contain country specific view points
Brazil, China, India and South Africa have outlined
their views
Manual lists following as special transfer pricing issus
Documentation requirement,
Intangibles
Intra-group services
Cost contribution Agreement
Use of secret comparable;
Manual follows ―Arms Length Principle‖ adopted in the Article
9 of UN Model
Guidance for developing countries
!!
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Comparison of Rules
ParticularsIndian TP
RegulationUN TP Manual OECD
Timing IssueRelevant Financial
Year
Multiple YearMultiple Year
Lack of reliable
comparablesNo Guidance
Use of Foreign Comparables
Local comparables from other
industry
No Guidance
Loss Making
CompaniesNo Guidance
Loss making companies should
not be rejected
Loss making
companies should not
be rejected
Statistical MeasureArithmetic Mean/
RangeInter-quartile range
Inter-quartile range
Preference of any
MethodsNo preference No preference
CUP is the preferred
method
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Emerging issues
Emerging issues
Capital financing
Valuation is the key element
Business restructuring
Involves wide gamut of transactions
Intangibles
New definition widens scope
Contract R & D services
Circular 3 – stringent tests
Compliance for non-resident entities
Stringent penal provisions for violations
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Questions & Answers
Questions
&
Answers
40
