Evolution, Concepts, Audit and Tax Aspects in

INDIA
V Y Srinath Sharma
Anatomy of Taxes
Mr A uses the resources
available in his country
like, men, material and
infrastructure to
ONE PERSON’S
manufacture the product.
EXPENSE IS
Since the country’s
resources are used by ANOTHER’S
him, Mr A will have to
compensate the INCOME
government.

This compensation is
called TAX

Governm
Mr A Mr B
ent
Evolution
Evolution
Why is Transfer Pricing so
Important? Transfer Price

Purchase US
Indian s Goods Subsidia
Parent ry
Compan Compan
y y
 Assume that the cost of manufacturing the goods by Indian
company is Rs. 500

 The price charged by the Indian company to its US Subsidiary is

Rs.1000 inclusive of Rs.500 profit.

 The same goods are sold by US Subsidiary @ Rs.1100 [incl. of

Rs.100 other exp.]

 This shows that the US Subsidiary is making no profit/no loss.

 The Indian Tax Administrators will not grumble as they have

got the tax at their end.
Transfer Pricing in
INDIA
 With the increasing participation of MNE’s in economic
activities in the country

 Given rise to new and complex issues emerging from

transactions entered into between two or more entities belonging
to the same group of MNE’s.

 The Profits Derived by such enterprises carrying business

in INDIA can be controlled by the multinational Group.

 By manipulating the prices charged and paid in such intra

group transactions, thereby, leading to erosion of tax revenues.

 Prior Finance Act 2001 SEC. 92 was the only section

dealing specifically with cross border transactions where an
adjustment could be made to the profits of a resident arising
from a business carried on between the resident and a non
resident, if it appeared to the A O that owing to the close
TP under Income Tax Act
1961
Relevant extracts of the Statement of Objects and Reasons in the
speech of the Finance Minister while introducing the Finance Bill,
2001:
 
“The presence of multinational enterprises in India and their
ability to allocate profits in different jurisdictions by controlling
prices in intra-group transactions has made the issue of transfer
pricing a matter of serious concern. Necessary legislative
changes are being made in the Finance Bill based on these
issues.”

The sections of 92 to 92F under the Income Tax Act, 1961 relating
to the international transactions between associated enterprises
have been substituted by the finance act 2002 with the effect
from 1-4-2002.

Section 92 of the Income Tax Act 1961 provides for computation

of income from international transaction between associated
enterprises should be with regards to the Arm’s Length Price.

Some of the important definitions :

International Transaction - Sec. 92B
International Transaction –
SEC.92B
 Transaction between two or more associated enterprises ,
either or both of them are non residents.

 Transactions in nature of :

 Purchase, sale or lease of tangible or intangible property

or provision of services lending or borrowing money or any
other transaction having a bearing on the profits income ,
losses or assets of such enterprises.

 Transaction in the nature of a mutual agreement or

arrangement between two or more AE’s for apportionment of
any cost or benefit.

 Any other transaction with other than an Associated

Enterprise:

•Transaction with any party with a prior agreement.

•Transaction which is deemed to be so in relation.
Associated Enterprise – 92A
As per the Income Tax Act 1961, An Associated
Enterprises are those which satisfy any of the conditions
specified Under Section 92A(2)(a) to 92A(2)(m). These
conditions have been segregated with regards to
Management, Capital and Control are as follows:-
Arm’s Length Price –
SEC.92F
 As per IT Act, 1961 ALP, means a price which is applied or
proposed to be applied in a transaction between persons other
than associated enterprises, in uncontrolled conditions.

 Although there are discrepancies in the specifics of each

country's laws concerning the application of the arm's length
principle, most countries have based their transfer pricing laws
and regulations on the OECD Guidelines.

 The OECD Guidelines refer to the following methods:

Comparable Uncontrolled Price method (CUP)

Resale Price Method (RPM);
Cost Plus Method (CPM)
Profit split method(PSM); and
Transactional Net Margin Method (TNMM)

The Same methods are also adopted by the Indian Income

Tax Act.
Steps involved in computing
ALP
Comparable Uncontrolled Price Method
[CUP]
 CUP Method is adopted for transactions such as Transfer
of Goods, Intangibles, Interest on loans,
services, etc..

 This Method compares prices between controlled and

uncontrolled transactions.
 Identify an identical
international transaction with
another unrelated entity No price
Related
difference
US Entity
Indian s,
 Sort out the price differences Entity compare
occurring due to unrelated Unrelated
US Entity the prices
scenarios
as it is
Adjust
 The adjusted price to be
price
compared with the related Related difference
party transaction US Entity
Indian s,
Entity Unrelated compare
Europe the
Entity adjusted
price
Resale Price Method [RPM]
 This method is adopted for transactions where the
distribution of goods involves a little or no value additions.

 Identify the products purchased

from a related party.

 Arrive at the price at which the Particulars Amount

said product is sold to an
unrelated party. Final Sale price XXXX

 Deduct the industry GP Margin Less: Industry Average GP XXXX

for similar products from the margin
sale price and work back to find Adjusted Cost price XXXX
out the cost price of the product
Actual cost of product from
 Compare the worked out price Related Party XXXX
with that of the related party
purchase price.
Cost Plus Method [CPM]
This method is adopted for transactions such as:
Provision for services,
Joint facility agreements,
Transfer of Semi finished goods, and
Long term Buying and selling arrangements.

 Accumulate the Direct and

Indirect Costs of the product.

Particulars Amount
 Arrive at the industry GP Margin
Direct Expenses XXXX
for similar products
Indirect Expenses XXXX

 Adjust the GP margin for the Total cost of Sales XXXX

related party specific transaction Add: Adjusted Gross Profit Margin XXXX
Total price from unrelated XXXX
 Compare the worked out price transaction
with that of the related party Actual price of the product from
purchase price. Related Party XXXX
Profit Split Method [PSM]
 This method is adopted for transactions involving
integrated services provided by more than one enterprise and
transfer of unique intangibles.

 It is also adopted for those multiple international

transactions which are so closely interrelated that they cannot
evaluated separately for determining ALP.
 Combined net profit of the
Whole group is ascertained.

 Profits are split in

proportionate to the Assets
Employed, Functions
undertaken and Risks
assumed by every entity in
the group

 Compare this with the

Actual profits
Transactional Net Margin
Method[TNMM]
 This method is adopted for transactions involving
Provisions for services, distribution of finished products where
RPM cant be applied, Transfer of Semi Finished Goods where
CPM cant be applied and Transfer of intangibles where PSM cant
be applied.

 The Transaction Net Margin Method evaluates industry

average of nearly independent companies
Entity and compares those
Industry Average

with Particulars AmtParticulars Assessee. Amt

 Net profits of the respective Sales XXXXIndependent Co
entity to be computed Sales XXXX
Less: Direct Less: Ind Co.
 Net profits of the other Expenses XXXXDirect Expenses XXXX
comparable entities in the
same nature of business Gross profit XXXXGross profit XXXX
and of same stature has to
be computed. Less: Cost of Less: Ind co.,
Sales & Admin XXXXCost of Sales & XXXX
Admin
 Adjust for the economic
differences Net Profit XXXXNet Profit XXXX
Net Profit % %Less:
Adjustments for
 Compare the Net profits of the specific XXXX
the entity and comparable circumstances
entities Adjusted Net XXXX
profit
What are the Documentation
Requirements?

Documentation requirement – Rule 10D

Documentation to be retained for 9 years
N o Specific Documentation requirement if value of
International Transactions is less than one crore Rupees
Why do you need a Transfer Pricing
Documentation in INDIA?
Assessment Procedure

 AO with previous approval of Commissioner can refer

computation of ALP to TPO.

 TPO will serve notice on the assessee to provide necessary

evidence to conclude the ALP and pass the Transfer Pricing
Order.

 On receipt of Transfer Pricing Order AO will further proceed to

Recent Amendments as per
Finance Act 2009
SECTION 92C
With Effect From 1 -4 -2009

Where more than one price is determined for adopting

the MAM the ALP shall be arithmetical mean of such
prices.

However if the price so determined doesn’t exceed 5% of

the price at which the international takes place shall be
deemed to be ALP.
SECTION 92CB
Introduced with effect from 1 -4 -2009

Provides that the determination of ALP u/s. 92 C or 92CA

shall be subject to SAFE HARBOUR rules prescribed the
board.

SAFE HARBOUR has been defined to mean circumstances

in which the income tax authorities shall accept the
 This makes us clearly understand that how important
Transfer Pricing is in the current Globalized environment with
Enterprises expanding and making the world a global village.

 No country – poor, emerging or wealthy – wants its tax

base to suffer because of transfer pricing.

 That is why the OECD has spent so much effort on

developing its Transfer Pricing Guidelines.

 While they help corporations to avoid double taxation,

they also help tax administrations to receive a fair share of the
tax base of multinational enterprises.

 But abuse of transfer pricing may be a particular

problem for developing countries, as companies might take
advantage of it to get round exchange controls and to
repatriate profits in a tax free form.