Transfer Pricing

Regulations

Presented By:
Jahnavi Mohan
By:
Saumya Bourai

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 Transfer Pricing Explained
 Indian TP Regulations
 Arm’s Length Principle
 Meaning of Associated Enterprises
 Meaning of International Transaction
 Transfer Pricing Methods
 Applicability to Specified Domestic Transactions

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 Introduction

 What is Transfer Price from tax perspective ?

Pricing of the intercompany transactions of goods &

services or intangibles, that take place between two
associated enterprises.

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 Suppose a company A purchases goods for 100 rupees and
sells it to its associated company B in another country for 200
rupees, who in turn sells in the open market for 400 rupees.

 Had A sold it directly, it would have made a profit of 300

rupees. But by routing it through B, restricted it to 100
rupees, permitting B to appropriate the balance. The
transaction between A and B is arranged and not governed by
market forces.

 The profit of 200 rupees is, thereby, shifted to the country of

B. The goods is transferred on a price (transfer price) which is
arbitrary or dictated (200 hundred rupees), but not on the
market price (400 rupees).

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 Commercial transactions between the different parts of
the multinational groups may not be subject to the
same market forces shaping relations between the two
independent firms.

 One party transfers to another goods or services, for a

price. That price is known as “transfer price”.

 This may be arbitrary and dictated, with no relation to

cost and may diverge from the market forces.

 Transfer price is, thus, a price which represents the

value of good; or services between independently
operating units of an organisation.

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 The expression “transfer pricing” generally refers to
prices of transactions between associated enterprises
which may take place under conditions differing from
those taking place between independent enterprises.

 It refers to the value attached to transfers of goods,

services and technology between related entities.

 It also refers to the value attached to transfers between

unrelated parties which are controlled by a common
entity.

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 The effect of transfer pricing is that the parent company or a
specific subsidiary tends to produce insufficient taxable
income or excessive loss on a transaction.

 For instance, profits accruing to the parent can be increased

by setting high transfer prices to siphon profits from
subsidiaries domiciled in high tax countries, and low transfer
prices to move profits to subsidiaries located in low tax
jurisdiction.

 As an example of this, a group which manufacture products

in a high tax countries may decide to sell them at a low profit
to its affiliate sales company based in a tax haven country.

 That company would in turn sell the product at an arm's

length price and the resulting (inflated) profit would be
subject to little or no tax in that country.

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 Transfer Pricing Regulations ("TPR") are applicable to the
all enterprises that enter into an 'International
Transaction' with an 'Associated Enterprise'.
 Therefore, generally it applies to all cross border
transactions entered into between associated
enterprises.
 It even applies to transactions involving a mere book
entry having no apparent financial impact.
 The aim is to arrive at the comparable price as available
to any unrelated party in open market conditions and is
known as the Arm's Length Price ('ALP').

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 Provision Reference
Computation of income from international Section 92 of the
transaction having regard to arm’s length price Income tax Act, 1961
(‘the Act’)
Meaning of associated enterprises Section 92A of the Act
Meaning of international transaction Section 92B of the Act
Computation of arm’s length price Section 92C of the Act
Reference to transfer pricing officer Section 92CA of the
Act
Maintenance and keeping of information and Section 92D of the Act
document by person entering into an
international transaction

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 Provision Reference
Report from an accountant to be furnished Section 92E of the Act
by person entering into international
transaction
Definitions of various terms Section 92F of the Act
Penalty consequent to re-determination of Explanation 7, Section
arm’s length price 271(1)(c) of the Act
Penalty for failure to keep and maintain Section 271AA of the Act
information and document in respect of
international transaction
Penalty for failure to furnish report under Section 271BA
section 92E
Penalty for failure to furnish information or Section 271G
document under section 92D

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 Provision Reference
Meaning of certain expressions Rule 10A of the Income
tax Rules, 1962 (‘the
Rules’)
Determination of arm’s length price under Rule 10B of the Rules
section 92C
Most appropriate method Rule 10C of the Rules
Information and documents to be kept and Rule 10D of the Rules
maintained under section 92D
Report from an accountant to be furnished Rule 10E of the Rules
under section 92E

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 Section 92A (1) (a)
“an enterprise which participates directly or indirectly or
through one or more intermediaries, in the management
or control or capital of the other enterprise shall be
regarded as an associated enterprise.”

A Ltd. B Ltd.

Inter Ltd. C Ltd.

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 Section 92A (1) (b)
“in respect of which one or more persons who participate,
directly or indirectly , or through one or more
intermediaries, in its management or control or capital, are
the same persons who participate, directly or indirectly, or
through one or more intermediaries , in the management
or control or capital of the other enterprise.”
A Ltd.

B Ltd. C Ltd.

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 Section 92A (2) (a)
“One enterprise holds, directly or indirectly, shares
carrying not less than twenty-six per cent of the voting
power in the other enterprise.”

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 Section 92A (2) (b)
“Any person or enterprise holds, directly or indirectly,
shares carrying not less than twenty-six per cent of the
voting power in each of the such enterprise.”
A Ltd.
75%
75%

B Ltd. C Ltd.

◦ only to those cases where the investee enterprise is a

company

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 Section 92A (2) (c)
“A loan advanced by one enterprise to the other enterprise
constitutes not less than fifty-one per cent of the book
value of the total assets of the other enterprise.”

A Ltd.
• B’s book value of asset Rs.10cr
• Loan from A Ltd. Rs.6cr

B Ltd.

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 Section 92A (2) (d)
“One enterprise guarantees not less than ten per cent of
the total borrowings of the other enterprise.”

 Section 92A (2) (e)

“More than half of the board of directors or members of
the governing board, or one or more executive directors or
executive members of the governing board of one
enterprise, are appointed by the other enterprise.”

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 Section 92A (2) (f)
“More than half of the directors or members of the
governing board, or one or more executive directors or
executive members of the governing board of each of the
two enterprises, are appointed by the same person or
persons.”

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 Section 92A (2) (g)
“The manufacture or processing of goods or articles or
business carried out by one enterprise is wholly dependent
on the use of know-how, patents, copyrights, trade-marks,
licences, franchises or any other business or commercial
rights of similar nature, or any data, documentation,
drawing or specification relating to any patent, invention,
model, design, secret formula or process, of which the
other enterprise is the owner or in respect of which the
other enterprise has exclusive rights.

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 Section 92A (2) (h)
“Ninety per cent or more of the raw materials and
consumables required for the manufacture or processing
of goods or articles carried out by one enterprise, are
supplied by the other enterprise or by persons specified by
the other enterprise, and the prices and other conditions
relating to the supply are influenced by such other
enterprise.”

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 Section 92A (2) (i)
“The goods or articles manufactured or processed by one
enterprise, are sold to the other enterprise or to persons
specified by the other enterprise, and the prices and other
conditions relating thereto are influenced by such other
enterprise.”

A Ltd B Ltd

A Ltd. Is a mfr.
Prices are influenced by B Ltd. C Ltd

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 Section 92A (2) (j)
“The Where one enterprise is controlled by an individual,
the other enterprise is also controlled by such individual or
his relative or jointly by such individual and relative of
such individual”

 Section 92A (2) (k)

“Where one enterprise is controlled by a Hindu undivided
family, the other enterprise is controlled by a member of
such Hindu undivided family, or by a relative of a member
of such Hindu undivided family, or jointly by such member
and his relative.”

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 Section 92A (2) (l)
“Where one enterprise is a firm, association of persons or
body of individuals, the other enterprise holds not less
than ten per cent interest in such firm, association or body
of individuals”

 Section 92A (2) (m)

“There exists between the two enterprises, any
relationship of mutual interest, as may be prescribed.”

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 Section 92B (1)
For the purpose of this section and section 92, 92C, 92D and
92E, “international transaction” means
◦ a transaction between two or more associated enterprises
◦ either or both of whom are non-residents
◦ in the nature of purchase, sale or lease of tangible property
or
◦ Provision of services or
◦ Lending or borrowing money
◦ Any other transaction having a bearing on the profits,
income, assets or losses of such enterprises.

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 Section 92B (2)
A transaction entered into by an enterprise with a person
other than an associated enterprises shall for the purpose
of sub section (1),
◦ be deemed to be a transaction entered between two
associated enterprises
◦ if there exists a prior agreement
◦ in relation to the relevant transaction between such other
person and the associated enterprises, or
◦ the terms of the relevant transaction are determined in
substance between such other person and the associated
enterprise.

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 The Finance Act 2012 extended the scope of Transfer Pricing provision to
‘Specified Domestic Transactions (‘SDT’)
 A Specified Domestic Transaction would include the following:
 Expenditure for which payment is made or to be made to domestic related
parties-as mentioned in Section 40A 2(b)
 Any transfer of goods & services referred to in Sec 80-IA (8)
 - Any goods or services held for purpose of eligible business are transferred
to any other business carried on by assessee or vice-versa, if the transfer is
not corresponding to market value
 (for purpose of deduction under this section profits and gains of eligible
business shall be computed at market value)
 Sec 80 IA (10) – Course of business is so arranged between closely connected
persons that it produces more than ordinary profits for the assessee from
transactions.
◦ Reasonable profits are computed and used for the purpose of deduction.
 Tax Holiday/ Deductions claimed by the taxpayer, where;
 Transfer of goods or services between various businesses of same
taxpayer
Transfer Pricing provisions to apply to the ‘Specified Domestic
Transactions’ if the aggregate value of the transaction exceeds
five crores 26
Assessee Relatives or Close Associates

Individual • Any relative (i.e. spouse, brother, sister, any lineal

ascendant or descendant of the said individual
Company, Firm, AOP, HUF • (a) any director of the company, partner of the firm, or
member of the association, or family
• (b) any relative of such director, partner or member
• Any person in whose business or profession, the assessee
or director, partner or member of the assessee, or any
relative of such a person has a substantial interest
• Any individual who has substantial interest in the business
or profession of assessee
• (a) a company, firm, AOP, or HUF having substantial
interest in the business or profession of the assessee
• (b) any director, partner or member or any relative of above
mentioned persons or any other company carrying on
business or profession in which first mentioned company
has substantial interest
• A company, firm, AOP, HUF of which a director, partner or
member, has substantial interest in the business or
profession of assessee
• Any director, partner or member of any relative of such
person.

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 A person shall be deemed to have substantial interest in
a business or operation if:
A) In case where the business carried out by company,
such person is at any time the beneficial owner of
shares carrying not less than 20% of voting power
B) In any other case such person is beneficially entitled to
not less than 20% of the profits of such business or
profession.

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 Prices set for transactions between group entities should, for tax
purposes, be derived from prices which would have been applied by
unrelated parties in similar transactions under similar conditions in
the open market.

 Section 92F (ii) of the Act

“arms length price means a price which is applied or proposed to be
applied in a transaction between persons other than associated
enterprises, in uncontrolled conditions”

 Section 92 of the Act

“Any income arising from an international transaction shall be

computed having regard to the arms length price.
Explanation - For the removal of doubts, it is hereby clarified that
the allowance for any expense or interest arising from an
international transaction shall also be determined having regard to
the arms length price.”
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 Identify the international transaction.
 Also identify an uncontrolled transaction.
 Compare the international transaction with the uncontrolled
transaction.
 Ascertain the most appropriate method by taking into
account the factors discussed in rule 10(c). The rule states
that the method to be selected shall be the one best suited to
the facts and circumstances of each international transaction
and that which provides most reliable measure of the arm’s
length price.
 Finally determine the transfer price using the most
appropriate method chosen.

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 Identify price charged or paid for property transferred
or services provided in comparable uncontrolled
transactions.
 Adjust to account for differences between international
and uncontrolled transaction or between enterprises
entering into such transactions which could affect the
price in the open market.
 Adjusted price is the arm’s length price which is
compared with that in the international market.
 If price charged is lower or price paid is higher, an
adjustment has to be made by the amount of this
variance.

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Sony Japan and ltd. an Indian co. are associated enterprises. Y ltd.
Manufactures mobile phones and sells them to Sony Japan and L.G
Korea. Y ltd. Supplied 1,20,000 phones to Sony at a price of 2,000
and 20,000 units to L.G at 3,200 per unit. Following are the
differences in the two transactions: 1) Sales to Sony on FOB basis
and sales to L.G on CIF basis. Freight and insurance paid by Sony
for each unit is 300 2) Sales to LG under free warranty of 1 year
while no warranty to Sony. Cost of such warranty is 350. 3) Sony
placed a large order and Y ltd. Offered quantity discount of 50 per
unit to Sony.
Compute arm’s length price and amount of increase in total
income of Y if any due to such arm’s length price.

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Solution
Sale price to LG 3,200
Less: Adjustments of
differences on account
of:
Freight and insurance 300
Estimated cost of 350
warranty
Bulk quantity discount 50 700
Arm’s length price 2500
charged to Sony
Arm’s length Price for 3,00,00,000
1,20,000 units
(1,20,000 x 2500)
Price charged from Sony 2,40,00,000
(1,20,000 x 2000)
Total income of Y ltd. 60,00,000
would increase by

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 Identify the international transaction of purchase of
property or obtaining services.
 Identify the price at which property or services are
resold to an unrelated party
 Deduct normal gross profit margin from resale. This is
the margin the enterprise would earn from purchase of
similar product from unrelated party and resale to
another unrelated party.
 Deduct expenses incurred with purchase of goods from
the price so arrived
 Adjust for differences and obtain arm’s length price

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Solution
Resale price of goods purchased 17,000
from LG
Less Normal Gross Profit Margin @ (-) 1,700
10%
Less Difference in the expenses (-) 1,700
connected with purchase (1900-
200)
Arm’s length price 13,600
Price paid to LG (200 * 15000) 30,00,000
Arm’s length price (200 * 13600) 2720000
Increase in total income due to 2,80,000
reduction in purchased cost

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 Determine direct and indirect cost of production in
respect of property transferred or services provided.
 Identify comparable uncontrolled transaction
 Determine gross profit mark up in comparable
uncontrolled transaction
 Adjust gross profit mark up for differences between two
transactions
 Direct and indirect cost in the international transaction
to be increased by adjusted gross profit mark up to get
the arm’s length price

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Solution (INR)

Price charged to R 800

Gross profit mark up in case of R 40%

Less (differences) i) Technical know how (10% 4%

of 40%)
ii) Quantity discount (5% of 40%) 2%

Cost of credit to hotmail (2.5% of 40%) 1%

Arm’s length gross profit mark up 35%

Direct and Indirect Cost 6,50,000

Arm’s length billed value (6,50,000 * 10,00,000

100/65)
Billed income (2000 * 400) 8,00,000

Income Increased by 2,00,000

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 Determine combined net profit of all associated
enterprises
 Evaluate relative contribution made by each to functions
performed, assets employed, risks assumed, reliable
external data indicating how such contribution would be
evaluated
 Split the combined net profit in proportion to relative
net contribution
 Profit so apportioned is taken to arrive at arm’s length
price

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Solution

Price charged by X to Y 1,00,000

S ltd share of revenue 27,000

Z ltd share of revenue 24,000

X ltd share of revenue 49,000

Combined total profits 16,000

Profit apportioned on basis of contribution

X ltd (40% of 16000) 6400

Z ltd (25% of 16000) 4000

S ltd (35% of 16000) 5600

Total cost of S India 24000

Revenue of S India on the business of arm’s 29,600

length price
Actual revenue of S India 27000

Total income of S ltd increased by 2600

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 Identify the net profit margin from an international
transaction
 Identify the net profit margin from comparable
uncontrolled transaction
 The net profit margin so identified is adjusted to take
into account differences between international and
uncontrolled transactions
 Adjusted net profit margin is taken to arrive at arm’s
length price in relation to international transaction

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 The provisions contained in the TPR are exhaustive as far as the maintenance of
documentation is concerned.

 This includes background information on the commercial environment in which the

transaction has been entered into, information regarding the international transaction
entered into, the analysis carried out to select the most appropriate method and to identify
comparable transactions, and the actual working out of the ALP of the transaction.

 This also includes report of an accountant certifying that the ALP has been determined in
accordance with the TPR and that prescribed documentation has been maintained.

 This documentation should be retained for a minimum period of 8 years.

 However, it may be noted that in case the value of the international transaction is below INR
10 million, it would be sufficient for the taxpayer to maintain documentation and information
which substantiates his claim for the ALP adopted by him. In effect, they need not maintain
the prescribed documentation.

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 Penalties have been provided as a disincentive for non-
compliance with procedural requirements are 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.

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