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Management Control System

Assignment on Transfer
Pricing Mechanism

ITM Business School, Kharghar

Submitted To: Submitted By:

Prof. Bharat Shah Dhara Badiani

Roll No. –

Batch – A
Transfer Pricing

Concept of Transfer Pricing:

In divisionalised companies, where profits or investment centers are created, there
is likely to be interdivisional transfer of goods, or services and these internal
transfers create the problem of transfer pricing. A transfer price is that notional
value at which goods and services are transferred between divisions in a
decentralized organisation. Transfer prices are normally set for intermediate
products which are goods and services that are supplied by the selling division to
the buying division. It can be said that the problem of suitable transfer prices arises
only when divisions do business with one another. Thus in managerial accounting,
when different divisions of a multi-entity company are in charge of their own profits,
they are also responsible for their own "Return on Invested Capital". Therefore,
when divisions are required to transact with each other, a transfer price is used to
determine costs.

Principles of Transfer Pricing:

• There should be common management
• There should be an existence of intermediate product

Objectives of Transfer Pricing:

If two or more profit centers are jointly responsible for product development,
manufacturing and marketing, each should share in the cost and the revenue that is
generated when the product is finally sold. A question arises as to how the transfer
of goods and services between divisions should be priced. The price charged to the
interdivisional transfer of goods is revenue to the selling division and cost to the
buying division. Therefore the price charged will effect the profit of both the
divisions; benefit (revenue) to one division can be created only at the expense of
other division. The transfer prices, thus can have impact on the evaluation of each
division’s performance and measures applied for such measurements of
performance. While determining transfer prices a number of criteria (objectives)
should be fulfilled.
• Transfer prices should help in the accurate measurement of divisional
performance (profitability) measurement.
• Transfer prices should help goal congruence to take place, which in effect
means that the objectives of divisional managers are compatible with the
objectives of overall company.
• Transfer prices should ensure that divisional autonomy and authority is
preserved. The main purpose of decentralization is to enable divisional
managers to exercise greater autonomy and to measure the overall results
achieved on a profit centre or investment centre. It is therefore not proper to
give divisional managers authority by one hand placing them in charge of
divisional operations and to remove that authority by dictating transfer prices
that affect the performance of the division.
• To provide each division with relevant information required to make optimal
decisions for the organisation as a whole.

• A transfer pricing system, if properly established, can check multinational

companies and international groups which may try to manipulate transfer
prices between countries in order to minimize the overall tax burden.

Three Decisions

A transfer pricing situation usually involves three questions or decisions.

1. Should the transfer take place? This is essentially a (Make or Buy)

question. Should the company make the item or outsource, i.e.,
purchase it on the outside market? This is a relevant cost problem
(also referred to a differential or incremental cost). The key is which
costs will be different under the two alternatives, i.e., make inside
and transfer, or buy from outside the company?

2. If the answer to question one is yes, then what transfer price should
be used?

3. Should the central office interfere in establishing the transfer price?

Requisites of a sound transfer pricing system:

• It should be simple to understand and easy to operate.
• It should enable fixation of fair transfer prices for the output transferred or
service rendered. A divisional manager who considers the transfer price to be
unfair to the division may be demotivated.
• Ideally the divisional managers / business unit should be given the autonomy
and freedom, to sell a small portion of its production to customers outside the
organisation or to buy small quantities from sources outside it. Frequently the
divisional managers may have restrictions in this regard.
• The business unit/ divisions should have free access to various sources of
market information.
• There should be a negotiation for transfer prices between the business unit /
divisional managers of the selling and the buying unit / division. Negotiated
transfer prices are far more better than the prices imposed by the top
• Sound transfer pricing ground rules should be framed to guide negotiations
between business unit / divisional managers. These rules will provide
consistency and also minimize interdepartmental conflicts.
• Top management should discourage prolonged arguments between business
units / divisional managers.

Methods of Transfer Pricing:

Broadly, there are three bases available for determining transfer prices, but many
options are also available within each base. These methods are:
1. Market Prices
2. Cost based Prices
a. Variable Cost
b. Actual full Cost
c. Full Cost Plus Profit Margin
d. Standard Full Cost
e. Opportunity Cost
3. Negotiated Prices
4. Dual Prices

Market Bases Prices:

Market price refers to a price in an intermediate market between independent
buyers and sellers. When there is a competitive external market for the transferred
product, market prices work well as transfer prices.

When transferred goods are recorded at market prices, divisional performance is

more likely to represent the real economic contribution of the division to total
company profits. If the goods cannot be bought from a division within the company,
the intermediate product would have to be purchased at the current market price
from the outside market. Therefore in this case managers of both the divisions are
indifferent between trading with each other or with outsiders.

Market- based prices are based on the opportunity cost concepts. The opportunity
cost approach signals that the correct transfer price is the market price. Since
selling divisions can sell all that it produces at the market price, transferring
internally at a lower price would make the division worse off. Similarly the buying
division can always acquire the intermediate goods at the market price, so it will be
unwilling to pay more for internally transferred goods.

Since the minimum selling price for the selling division is the market price and the
maximum buying price for a buying division is the market price , the only possible
price is the market price.

However there are some problems in using the market price approach:

• Most markets are not perfectly competitive. In other words, the demand
curve and price structure may shift if the firm buys outside.

• Market prices may not exist for some products.

• A market price may not be comparable because of differences in quality,

credit terms, or extra services provided.

• Price quotations may not be reliable because they are based on temporary
distress or dumping conditions.

• A market price may not be relevant because the selling division would not
have the same transportation cost, accounting cost for A/R, credit etc. as an
outside supplier.

• If selling division is not operating at full capacity and unused capacity exists
in that division, the use of market price may not lead to maximization of total
company profit. To illustrate this point, assume that selling division has
unused capacity of 30,000 units and it can continue to sell only 50,000 units
to outside buyers. In this situation the transfer price should be set to
motivate the manager of buying division to purchase from selling division if
the variable cost per unit of product of selling division is less than the market
price. If the variable costs are less than the market price and if transfer price
is set equal to market price than the manager of the buying division will be
indifferent. However, Division A’s purchase of 20,000 units of materials from
the outside suppliers at the market price may not benefit the company, since
this market price is greater than the unit variable cost of the selling division.
Hence the intracompany transfer could save the company the difference
between the market price and the variable expenses of the selling division.

Cost Based Prices:

When external markets do not exist or are not available to the company or when
information about external prices is not readily available, companies may decide
to use some forms of cost based transfer pricing system.

• Variable cost: This is useful when the selling division is operating below
capacity. The manager of the selling division may not like this transfer
price because it yields no profit to that division. In this pricing system only
the variable production costs are transferred. Variable cost has the major
advantage of encouraging maximum profits for the entire firm. The
obvious problem is that the selling division is left holding all its fixed costs
and operating expenses.

• Variable Cost Plus: This will be a better option than fixing transfer price
only at the variable cost as the selling division will be motivated to
transfer the goods at a transfer price fixed more than the buying division.

• Actual Full Cost: In actual full cost approach, transfer price is based on
the total product cost per unit which will include direct materials, direct
labor and factory overhead. When full cost is used on transfer pricing, the
selling division cannot realize a profit on the goods transferred. This may
be a disincentive to the selling division. As a result the selling decision
cannot be evaluate as a profit center or investment center as it will be
treated as a cost center.

• Full Cost Plus Profit Margin: This method overcomes the problem of
Actual Full Cost method. It includes the allowed cost of the item plus a
mark up or other profit allowance. With such a system, the selling division
obtains a profit contribution on units transferred and hence, benefits if
performance is measured on the basis of divisional operating profits.
However the manager of buying decision will naturally object that his
costs are adversely affected.

• Standard Costs: In actual cost approaches, there is a problem of

measuring costs. Actual cost does not provide any incentive to the selling
division to control costs. While transferring actual costs any variances or
inefficiencies in the selling division are passed along to the buying
decision. To promote responsibility in the selling division and to isolate
variances with in divisions, standard costs are usually used as a basis for
transfer pricing in cost-based systems. Use of standard cost reduces the
risk to the buyer.

• Opportunity Costs: The transfer pricing based on opportunity cost

identifies the minimum price that a selling division would be willing to
accept and the maximum price that the buying division will be willing to
pay. These minimum and maximum prices correspond to the opportunity
costs of transferring internally. It is used in the situations where the
market is imperfect. The opportunity cost based transfer prices for each
division are as follows:

o Selling Division: For the selling division, the opportunity cost of

transferring is the greater of:

 The outside sales value of the transferred product

 Differential production cost for the transferred product

o Buying Division: For the buying division the opportunity cost of

transfer is the lesser of:

 The price that would be required to be purchased from


 The profit that would be lost from producing the final product
if the transferred unit cannot be obtained at an economic

As long as the transfer price is greater than the opportunity cost of the selling
division and less than the opportunity cost of the buying division, a transfer will be

Negotiated Prices:

Negotiated prices may be best if:

a. An imperfect market exists for the product making it difficult, if not impossible, to
determine the appropriate market price.

b. The seller has excess capacity, thus the transfer becomes a differential cost
problem to the seller. Any transfer price above the seller's differential cost would
benefit the seller.

c. There is no external market for the product, thus no market price.

In these cases the buyer and seller may negotiate a price that allows both parties to
share in the benefits of the transfer. The managers involved act much the same as
the managers of independent companies. A negotiated price avoids mistrusts, bad
feelings and undesirable bargaining interests among divisional managers. Also it
helps in achieving the objectives of goal congruence, autonomy and accurate
performance evaluation. The use of negotiated prices is consistent with the concept
of decentralized decision making in the divisionalised firms.

However the disadvantages of this method are:

• A great deal of management effort, time and resources can be consumed in

the negotiating process.

• The final emerging negotiated price may depend more upon the divisional
managers ability to negotiate than on the other factors.

Dual Prices: Under dual prices of transfer pricing, selling division sells the
transferred goods at a profit or using full cost plus mark up. But the transfer price
for the buying division is the market price. The difference in transfer prices for the
two divisions could be accounted for by special centralized account. Dual prices
give motivation and incentive to selling divisions as goods are transferred at a profit
or mark up. Market price can be considered as the most appropriate for the buying
decision. Thus it plays the function of motivating both the selling divisions and the
buying divisions to make decisions that are consistent with the overall goals of the

Guidelines for an Optimum Transfer Pricing Mechanism:

• If market prices are used as a base for evolving transfer prices through
negotiations, long run competitive market prices should be used.

• When a competitive market exists for an intermediate product, the market

price should be used as the transfer price.

• When cost based transfer prices are used standard costs, and not actual
costs, per unit of output should be used.

• If divisional managers are allowed to buy / sell a small quantity (5-10 per
cent) outside the company, it gives them an awareness of the supply and
demand conditions of the market, which facilitates negotiation of transfer
prices by them.

Managers at different levels in a firm attempt to achieve different objectives

through their transfer pricing policies.

Corporate managers want transfer prices to:

• Encourage division managers to make decisions that maximize the long-run

profitability of the overall firm
• Provide information so that managers can make good short term decisions
(such as bids for orders) and long term decisions (such as adding or deleting
product lines)

Division Managers want Transfer Prices to:

• Represent fairly the financial performance of their division

• Reflect the impact of good decisions with in their division

Financial Staffs want Transfer Prices that:

• Are simple and credible, so that they will be used and useful by managers

• Are easy to use and easy to explain

Transfer Pricing Mechanism in Banks

Of late, there has been a marked shift in the measures used for evaluating the bank
branches. From deposit mobilization criterion the emphasis is now being turned on
to the profits made by the bank branches. When the concept of ‘profit centre’ is
being applied the significance of the methodology involved in ascertaining the
profits gains prominence for the management control system. Transfer price, in the
context of banking sector, is the interest charged by the surplus funds branch to the
deficit funds branch on the transferred funds. Though branches are identified to be
of deposit intensive, advances intensive and ancillary business intensive for
administrative convenience there are other material factors like the location, size,
and the nature of clientele that impinges on the performance of the branches.

Profit is the most commonly acceptable measure for evaluation of Branch

performance. To what extent profit is a good indicator of viability of the branches
depends upon how independent the branches are in the commercial sense. As the
branches of a Bank, in reality, are not truly and entirely independent commercial
units, it is difficult to determine the real profitability of such branches with the help
of existing systems that are less transparent, less accurate and having weak linkage
with the overall costing and pricing structure of business/products.
In the light of the above, the present study probes into various modalities of
Transfer Pricing Systems and suggests a suitable mechanism so as to reflect the
true profitability, productivity and efficiency of the Branches.
The bank branches are identified into two:
1. Deposit oriented
Majority of bank branches comes under this category. Though 80% of
branches are acting as deposit-pooling centers all branches are not uniform
in terms of deposit mix. It is a fact that the deposit mix is favorable (low cost
deposits) with respect to Metro/Urban branches where as depositors of Rural
and Semi-urban branches tend to keep their deposits in Term deposits. This
has effect on branch profitability.
2. Advance oriented
Though the branches are independent units in terms of accepting deposits
and lending funds, the CD ratio is below 25% in many of the bank branches. It
speaks that the lending activity is considered as centralized activity and the
lending of top 10% branches constitutes 80% of lending. However, all lending
branches are not uniform in terms of yield on advances since it depends on
sectoral deployment and quality of lending. Obviously, the yield on advances
at Metro/Urban branches is higher when compared to rural and Semi-Urban

Fund Transfer Pricing (FTP)

In the banking industry, the deposits are collected by one branch and used by
another to fund loans. This process is usually handled using an FTP system.

When a bank makes a loan to a customer, the funding for this loan has to come
from one source or another. Typically, the funding in a financial institution will come
from deposits collected by the bank. This type of funding is normally the cheapest
and most desirable; however, when deposits are not sufficient to fund all the needs
for cash that the bank has, the bank will have to get additional funding in the
wholesale market. Therefore, each deposit brought in to the bank has a value to the
financial institution for funding purposes, and, by the same token, a loan also has an
underlying cost of funds and is not just interest income for the bank, as it would
look in a typical income statement analysis. The purpose of FTP is to place a value
on each deposit and assign a cost to each loan that a bank has.

When implementing an FTP system, banks' must determine a "funding curve" that
most reflects their source or use of funds on the wholesale market. Many banks in
the past used United States Treasuries as their funding curve. But recently, the
government has dropped some buckets from its information. Therefore, many banks
have switched to the LIBOR/Swap curve. The funding curve for a financial
instrument shows the relationship between time to maturity and interest rate. Many
banks make adjustments to these curves to customize the curve to fit the banks
unique lending environment.

Next, each loan or deposit that the bank has is assigned a rate based upon this
adjusted funding curve. The rate that is assigned to these customer relationships
will vary based upon the characteristics of the relationship. One characteristic that
will cause a rate to change is time to maturity. For instance, a 5 year fixed rate note
will be assigned a different rate than a 5 year variable rate note. Also, for loans, the
longer the term is to maturity, the higher the rate to fund that loan. By the same
principle, a deposit that has a longer maturity would be assigned a higher funding
rate credit because the bank is guaranteed the use of these funds for a longer
period of time.

Other unique characteristics of a loan will cause the rate assigned to it to vary. One
such characteristic is a prepayment option on a loan. A prepayment option will
change the average expected life of the loan. This is an assumption that is based on
looking at historical trends in the bank.

Once all the data is input into the FTP system, management will have to decide how
often the rates will be assigned. This may be done monthly, weekly or sooner
depending on the capabilities of the system and the needs of management for
decision making. Large amounts of data must be stored and many calculations must
be made for an FTP system to provide useful information for management. In the
past, the technological hardware and software used within banks were not of
sufficient power or flexibility to handle the data volumes involved or provided the
analytical capabilities demanded. Today, however, such technology is available,
enabling the appropriate levels of contract-level detail handling and providing the
ability to analyze data across any number of dimensions in ad hoc fashion.

Using FTP to measure Branch Profitability

Financial Institution's income statement is designed to calculate net-interest income

for the entire organization. It is not designed to calculate the net-interest income of
one product. This is also true of calculating the net interest income of branches for
comparative purposes. Branches within a bank are almost never the same in terms
of loans and deposits. Some branches are heavy on the loan side, while others are
heavy on the deposit side and still others are fairly evenly balanced. Determining
the profitability of individual branches in a traditional accounting sense is extremely
difficult. Looking at an income statement for a branch using a typical accounting
analysis, interest collected from loan payments are shown as interest income and
interest paid out on deposits are shown as interest expense. But this does not take
into account that deposits have a positive value to the bank by providing cheap
funding for its loan purposes. Conversely, it also does not take into account that a
loan has an underlying funding cost associated with the process of making the loan.
Therefore, using a typical income statement format, a branch that is heavy on the
deposit side will look like it is losing money, while a branch that is heavy on the loan
side will look like it is highly profitable.

International Transfer Pricing:

International transfer pricing is concerned with the prices that an organisation uses
to transfer products between divisions in different countries. The rise of
multinational organisation introduces additional issues that must be considered
when setting transfer prices.

When the supplying and the receiving divisions are located in different countries
with different taxation rates, and the taxation rates in one country are much lower
than those in the other, it would be in the company’s interest if most of the profits
were allocated to the division operating in the low taxation country.

Problems with Multinational Transfer Pricing

1. Tax rates in different countries.

The firm's strategy is to shift income from the high tax country to the low tax
country. If the buying division is in a low tax country, then transfers would be made
at the lowest cost possible. If the seller is in a low tax country transfers would be
made at high prices.

2. Foreign Laws preventing income and dividend repatriations.

If there are restrictions on the buying division payments of dividends and transfers
of income to the central office, then transfers of products to the buyer would be
made at high prices. Transfers from the foreign division would be made at low

To avoid these problems a detail framework has been set up under Income Tax Act.

Transfer Pricing Law in India

Increasing participation of multi-national groups in economic activities in the

country has given rise to new and complex issues emerging from transactions
entered into between two or more enterprises belonging to the same multi-national
group. With a view to provide a detailed statutory framework which can lead to
computation of reasonable, fair and equitable profits and tax in India, in the case of
such multinational enterprises, the Finance Act, 2001 substituted section 92 with a
new section and introduced new sections 92A to 92F in the Income-tax Act, relating
to computation of income from an international transaction having regard to the
arm’s length price, meaning of associated enterprise, meaning of information and
documents by persons entering into international transactions and definitions of
certain expressions occurring in the said section.

Section 92: As substituted by the Finance Act, 2002 provides that any income
arising from an international transaction or where the international transaction
comprise of only an outgoing, the allowance for such expenses or interest arising
from the international transaction shall be determined having regard to the arm’s
length price. The provisions, however, would not be applicable in a case where the
application of arm’s length price results in decrease in the overall tax incidence in
India in respect of the parties involved in the international transaction.

Arm’s length price: In accordance with internationally accepted principles, it has

been provided that any income arising from an international transaction or an
outgoing like expenses or interest from the international transaction between
associated enterprises shall be computed having regard to the arm’s length price,
which is the price that would be charged in the transaction if it had been entered
into by unrelated parties in similar conditions. The arm’s length price shall be
determined by one of the methods specified in Section 92C in the manner
prescribed in Rules 10A to 10C that have been notified vide S.O. 808 E dated
The specified methods are as follows:

a) Comparable uncontrolled price method (CUP):

 The direct and indirect costs of production incurred by the
enterprise in respect of property transferred or services
provided to an associated enterprise, are determined;
 The amount of a normal gross profit mark-up to such costs
(computed according to the same accounting norms) arising
from the transfer or provision of the same or similar property or
services by the enterprise, or by an unrelated enterprise, in a
comparable uncontrolled transaction, or a number of such
transactions, is determined;
 The normal gross profit mark-up referred to in sub-clause (ii) is
adjusted to take into account the functional and other
differences, if any, between the international transaction and
the comparable uncontrolled transactions, or between the
enterprises entering into such transactions, which could
materially affect such profit mark-up in the open market;
 The costs referred to in sub-clause (i) are increased by the
adjusted profit mark-up arrived at under sub-clause (iii);
 The sum so arrived at is taken to be an arm's length price in
relation to the supply of the property or provision of services by
the enterprise.

b) Resale price method (RPM):

 The price at which property purchased or services obtained by
the enterprise from an associated enterprise is resold or are
provided to an unrelated enterprise is identified;
 Such resale price is reduced by the amount of a normal gross
profit margin accruing to the enterprise or to an unrelated
enterprise from the purchase and resale of the same or similar
property or from obtaining and providing the same or similar
services, in a comparable uncontrolled transaction, or a number
of such transactions;
 The price so arrived at is further reduced by the expenses
incurred by the enterprise in connection with the purchase of
property or obtaining of services;
 The price so arrived at is adjusted to take into account the
functional and other differences, including differences in
accounting practices, if any, between the international
transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which
could materially affect the amount of gross profit margin in the
open market;
 The adjusted price arrived at under sub-clause (iv) is taken to be
an arm's length price in respect of the purchase of the property
or obtaining of the services by the enterprise from the
associated enterprise.

c) Cost plus method (CPM):

d) Profit split method (PSM): The Indian Regulations define PSM, which may be
applicable mainly in international transactions involving transfer of unique
intangibles or in multiple international transactions which are so interrelated that
they cannot be evaluated separately for the purpose of determining the arm's
length price of any one transaction, as follows:
 The combined net profit of the associated enterprises arising
from the international transaction, in which they are engaged, is
 The relative contribution made by each of the associated
enterprises to the earning of such combined net profit, is then
evaluated on the basis of the functions performed, assets
employed or to be employed and risks assumed by each
enterprise and on the basis of reliable external market data
which indicates how such contribution would be evaluated by
unrelated enterprises performing comparable functions in
similar circumstances;
 The combined net profit is then split amongst the enterprises in
proportion to their relative contributions, as evaluated under
sub-clause (ii);
 The profit thus apportioned to the assessee is taken into account
to arrive at an arm's length price in relation to the international

Provided that the combined net profit referred to in sub-clause (i) may, in the first
instance, be partially allocated to each enterprise so as to provide it with a basic
return appropriate for the type of international transaction in which it is engaged,
with reference to market returns achieved for similar types of transactions by
independent enterprises, and thereafter, the residual net profit remaining after such
allocation may be split amongst the enterprises in proportion to their relative
contribution in the manner specified under sub-clauses (ii) and (iii), and in such a
case the aggregate of the net profit allocated to the enterprise in the first instance
together with the residual net profit apportioned to that enterprise on the basis of
its relative contribution shall be taken to be the net profit arising to that enterprise
from the international transaction.
This method evaluates whether the allocation of the combined profit or loss
attributable to one or more controlled transactions in arms length. This method is
applied where each party to the transaction has significant intangible assets or
operations are integrated and cannot be separately evaluated.
e) Transactional net margin method (TNM):
 The net profit margin realised by the enterprise from an
international transaction entered into with an associated
enterprise is computed in relation to costs incurred or sales
affected or assets employed or to be employed by the enterprise
or having regard to any other relevant base;
 The net profit margin realised by the enterprise or by an
unrelated enterprise from a comparable uncontrolled transaction
or a number of such transactions is computed having regard to
the same base;
 The net profit margin referred to in sub-clause (ii) arising in
comparable uncontrolled transactions is adjusted to take into
account the differences, if any, between the international
transaction and the comparable uncontrolled transactions, or
between the enterprises entering into such transactions, which
could materially affect the amount of net profit margin in the
open market;
 The net profit margin realised by the enterprise and referred to
in sub-clause (i) is established to be the same as the net profit
margin referred to in sub-clause (iii);
 The net profit margin thus established is then taken into account
to arrive at an arm's length price in relation to the international

The transactional net margin method (TNMM) assesses the arms length character of
transfer prices in a controlled transaction by testing the profit results of one
participant in the transaction.
f) Such other method as may be prescribed by the Board.

The taxpayer can select the most appropriate method to be applied to any given
transaction, but such selection has to be made taking into account the factors
prescribed in the Rules. With a view to allow a degree of flexibility in adopting an
arm’s length price the provison to sub-section (2) of section 92C provides that
where the most appropriate method results in more than one price, a price which
differs from the arithmetical mean by an amount not exceeding five percent of such
mean may be taken to be the arm’s length price, at the option of the assessee.

Associated Enterprises: Section 92A provides meaning of the expression

associated enterprises. The enterprises will be taken to be associated enterprises if
one enterprise is controlled by the other, or both enterprises are controlled by a
common third person. The concept of control adopted in the legislation extends not
only to control through holding shares or voting power or the power to appoint the
management of an enterprise, but also through debt, blood relationships, and
control over various components of the business activity performed by the taxpayer
such as control over raw materials, sales and intangibles.

International Transaction: Section 92B provides a broad definition of an

international transaction, which is to be read with the definition of transactions
given in section 92F. An international transaction is essentially a cross border
transaction between associated enterprises in any sort of property, whether
tangible or intangible, or in the provision of services, lending of money etc. At least
one of the parties to the transaction must be a non-resident. The definition also
covers a transaction between two non-residents where for example, one of them
has a permanent establishment whose income is taxable in India.

Sub-section (2), of section 92B extends the scope of the definition of international
transaction by providing that a transaction entered into with an unrelated person
shall be deemed to be a transaction with an associated enterprise, if there exists a
prior agreement in relation to the transaction between such other person and the
associated enterprise, or the terms of the relevant transaction are determined by
the associated enterprise.

Section 92CA provides that where an assessee has entered into an international
transaction in any previous year, the AO may, with the prior approval of the
Commissioner, refer the computation of arm’s length price in relation to the said
international transaction to a Transfer Pricing Officer. The Transfer Pricing Officer,
after giving the assessee an opportunity of being heard and after making enquiries,
shall determine the arm’s length price in relation to the international transaction in
accordance with sub-section (3) of section 92C. The AO shall then compute the total
income of the assessee under sub-section (4) of section 92C having regard to the
arm’s length price determined by the Transfer Pricing Officer.

The Transfer Pricing Officer means a Joint Commissioner/Deputy

Commissioner/Assistant Commissioner authorized by the Board to perform functions
of an AO specified in section 92C & 92D.

The first provison to section 92 C(4) recognizes the commercial reality that even
when a transfer pricing adjustment is made under that sub-section the amount
represented by the adjustment would not actually have been received in India or
would have actually gone out of the country. Therefore no deductions u/s 10A or
10B or under chapter VI-A shall be allowed in respect of the amount of adjustment.

The second provison to section 92C(4) provides that where the total income of an
enterprise is computed by the AO on the basis of the arm’s length price as
computed by him, the income of the other associated enterprise shall not be
recomputed by reason of such determination of arm’s length price in the case of the
first mentioned enterprise, where the tax has been deducted or such tax was
deductible, even if not actually deducted under the provision of chapter VIIB on the
amount paid by the first enterprise to the other associate enterprise.

Documentation: Section 92D provides that every person who has undertaken an
international taxation shall keep and maintain such information and documents as
specified by rules made by the Board. The Board has also been empowered to
specify by rules the period for which the information and documents are required to
be retained. The documentation has been prescribed under Rule 10D. The
documentation should be available with the assessee by the specified date defined
in section 92F and should be retained for a period of 8 years.

Further, Section 92E provides that every person who has entered into an
international transaction during a previous year shall obtain a report from an
accountant and furnish such report on or before the specified date in the prescribed
form and manner. Rule 10E and form No. 3CEB have been notified in this regard.
The accountants report only requires furnishing of factual information relating to the
international transaction entered into, the arm’ s length price determined by the
assessee and the method applied in such determination. It also requires an opinion
as to whether the prescribed documentation has been maintained.