TRANSFER PRICING: A REVOLUTION IN THE INDIAN TAXATION SYSTEM

UNDER THE SUPERVISION OF: Mr. SREE PRAKASH PREPARED BY: HIMANSHU DAGA
Assistant Professor
St. Xavier’s College ROLL NO-006 ROOM NO-06

ACKNOWLEDGEMENT
“It is not possible to prepare a project report without the assistance &
encouragement of other people. This one is certainly no exception.”

On the very outset of this project, I would like to extend my sincere & heartfelt
obligation towards all the personages who have helped me in this endeavor.
Without their active guidance, help, cooperation & encouragement, I would not
have made headway in the project. I am extremely thankful and pay my
gratitude to my faculty Prof. Shree Prakash for his valuable guidance and
support and giving his precious time for the completion of this project in his
presence.

I am ineffably indebted to all the Professors for their conscientious guidance

and encouragement to accomplish this assignment. I extend my gratitude to St.
Xavier’s College, Kolkata for giving me this opportunity.

I also acknowledge with a deep sense of reverence, my gratitude towards my

parents and member of my family, who has always supported me morally as
well as economically.

At last but not least gratitude goes to all of my friends who directly or indirectly
helped me to complete this project report.

Any omission in this brief acknowledgement does not mean lack of gratitude.

Thanking You
HIMANSHU DAGA

Abstract

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As the global economy continues to suffer from recession and sluggish growth,
countries are looking for ways to increase tax revenues. So it is no surprise that
in 2012 transfer pricing remained a hot topic of conversation as government
officials publicly condemned the tax practices of many large multinational
corporations, including Amazon, Apple, Facebook, Google, Hewlett Packard,
Microsoft, and Starbucks.

Notable headlines include :“British lawmakers slam Amazon, Google, Starbucks

for ‘immoral’ tax avoidance schemes” and “How Apple Sidesteps Billions in
Taxes.”

Transfer prices play a central role for both managerial accounting and tax
reporting purposes in vertically integrated firms. Common to these purposes is
that transfer prices ultimately determine the distribution of reported income
across different segments (divisions) of the firm. The managerial accounting
literature has long viewed transfer prices as an instrument for coordinating the
production and sales decisions of different business segments. The tax-oriented
literature on transfer pricing, in contrast, has largely viewed the transactions
between business segments of the firm as given.
The major focus in this project is on the provisions, concepts, methods and
documentations of transfer pricing in India and foreign countries , introduction
of Specified Domestic Transactions, impact of GAAR & IFRS, relationship
between Corporate Governance & transfer pricing, management control system,
execution Constraints, measures to be taken for adequate implementation etc.
Moreover it has also been discussed how a firm can minimize its worldwide tax
liability within the confines of the arm’s-length standard.
In this project, we take an integrated view of managerial and tax considerations
by analyzing how the optimal internal transfer prices depends on the admissible
arm’s length price and the applicable tax rates, penalties & consequences for
non- documentation.

CONTENTS PAGE NO:

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1. INTRODUCTION & BACKGROUND OF THE STUDY 5
2. OBJECTIVES OF THE STUDY 8
3. SOURCES OF DATA & RESEARCH METHODOLOGY 8
4. CHAPTERS OF THE STUDY :

Chapter - I: Conceptual & Legislative Framework of Transfer Pricing 9-26

Chapter- II: Recent Changes in Legislative Framework of Transfer Pricing 27-39

Chapter- III: International Practices Relating to Transfer Pricing 40-43

Chapter-IV: Case-lets relating to Transfer Pricing 44-51

Chapter -V: Transfer Pricing & Customs 52

Chapter -VI: Management Control, Execution Constraints & Adequate 53-56

Measures for Implementation of transfer pricing

5. FINDINGS & IMPLICATIONS OF THE STUDY 57-58

6. CONCLUSION 59
7. REFERENCE & BIBLIOGRAPHY 60

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Introduction & Background of the Study
Transfer pricing adjustments have been a feature of many tax systems since the 1930s. Both
the U.S. and the Organization for Economic Cooperation and Development (OECD, of
which the U.S. and most major industrial countries are members) had some guidelines
by 1979. The United States led the development of detailed, comprehensive transfer pricing
guidelines with a White Paper in 1988 and proposals in 1990-1992, which ultimately became
regulations in 1994. In 1995, the OECD issued the first draft of current guidelines, which it
expanded in 1996. The two sets of guidelines are broadly similar and contain certain
principles followed by many countries. The OECD guidelines have been formally adopted by
many European Union countries with little or no modification.
The OECD and U.S. systems provide that prices may be set by the component members of an
enterprise in any manner, but may be adjusted to conform to an arm's length standard. Each
system provides for several approved methods of testing prices, and allows the government to
adjust prices to the midpoint of an arm's length range. Both systems provide for standards for
comparing third party transactions or other measures to tested prices, based on
comparability and reliability criteria.
Moreover, increasing participation of multi-national groups in economic activities in India
has given rise to new and complex issues emerging from transactions entered into between
two or more enterprises belonging to the same group. Hence, there was a need to introduce a
uniform and internationally accepted mechanism of determining reasonable, fair and
equitable profits and tax in India in the case of such multinational enterprises.
Accordingly, the Finance Act, 2001 introduced law of transfer pricing in India through
sections 92A to 92F of the Indian Income tax Act, 1961 which guides computation of the
transfer price and suggests detailed documentation procedures. Transfer pricing deals
with the technique where parent companies sell goods and services to subsidiary
entities at an inflated price to deliberately reduce profits and tax liability. It refers
to the setting, analysis, documentation, and adjustment of charges made between related
parties for goods, services, or use of property (including intangible property). Transfer prices
among components of an enterprise may be used to reflect allocation of resources among
such components, or for other purposes.
As per the article published in The Economic Times on 5th April, 2012 : Mr. Pranab
Mukherjee, the current President of India has been ranked fifth in the list of top forces that
effectively deal with transfer pricing, prepared by UK-based newsletter TP Week.

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Evolution of Transfer Pricing Regulations in India:
The evolution of transfer pricing regulations in India can be understood from the table given
below:

Year Events Occurred

1991 Integration of Indian economy with Global economy
leading to increased cross border transactions
March 1999 The Standing committee on Finance realised that existing
tax provisions (Section 92) may not be effective to curb
transfer Pricing abuse in India
November 1999 Central Board of Direct Taxes ('CBDT') constituted an
Expert Group on TP for Suggesting necessary
amendments in the Act and regulatory Framework
January 2001 Expert Group submitted its report to CBDT
February 2001 Finance Ministry introduced Chapter X to deal with
transfer pricing issue.
February 2012 Finance Act Introduced the concept of Specific Domestic
Transaction

It is worth noting that prior to introduction of Chapter X (containing sections 92 to 92F) by

the Finance Act, 2001, there was section 92 in the Income Tax Act to keep a check over
manipulation of profit in intra group cross border transactions. However, it was realized
that section 92 was not effective enough to curb TP abuse in India and hence, detailed
transfer pricing regulations were introduced by the Finance Act, 2001.

Broadly there are three objectives of transfer pricing:-

Objective of Transfer Pricing

Goal CongruencePerformance Appraisal
Division Autonomy
1. Goal congruence:-while designing the mechanism for transfer pricing , the interest of
individual profit centers should not supersede those of the organization as a whole.
The division manager in maximizing the profits of his/her division should not engage
in decision making that fails to optimize the organization’s performance.

2. Performance appraisal:- transfer pricing should aid in reliable and objective

assessment of the activities of profit centers. Transfer prices should provide relevant
information to guide decision making , assess the performance of divisional manager
and also assess the value added by profit center toward the organization as a whole.

3. Divisional autonomy:-the transfer pricing should aimed at providing optimum

divisional autonomy , thereby allowing the benefits of decentralization to be retained .
Each divisional manager should be free to satisfy the requirements of his/ her profit
center form internal or external sources. There should be no interference in the
process by which the buying center manager rationally strives to minimize the costs
and the selling center manager strives to maximize revenues.

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 Intent of Indian TP Regulations
(International transactions)
Shifting of Profits
India Overseas
Associated
Indian Co. Enterprise
(AE Co.)
Tax @ 32.45% Tax @ lower
rate approx
Shifting of Losses 10%

Tax Saving for the Group – Loss to

Indian revenue
OECD Transfer Pricing Guidelines state, “Transfer prices are significant for both
taxpayers and tax administrations because they determine in large part the income and
expenses, and therefore taxable profits, of associated enterprises in different tax
jurisdictions.”Commonly controlled taxpayers often determine prices charged between such
taxpayers based in part on the tax effects, seeking to reduce overall taxation of the group.
OECD Guidelines state: “When independent enterprises deal with each other, the conditions
of their commercial and financial relations (e.g., the price of goods transferred or services
provided and the conditions of the transfer or provision) ordinarily are determined by market
forces. When associated enterprises deal with each other, their commercial and financial
relations may not be directly affected by external market forces in the same way.”
Recognizing this, most national and some sub-national income tax authorities have the legal
authority to adjust prices charged between related parties.
Tax rules generally permit related parties to set prices in any manner they choose, but permit
adjustment where such prices or their effects are outside guidelines. Transfer pricing rules
vary by country. Most countries have an appeals process whereby a taxpayer may contest
such adjustments. Some jurisdictions, including Canada and the United States, require
extensive reporting of transactions and prices, and India requires third party certification of
compliance with transfer pricing rules.

Some of the main factors that led to be focused on such a latest buzz word of market can be
pointed out as:

 Tax evasion by MNC’s

 Higher volume of transactions between the related parties
 Recent domestic transfer pricing involvement
 Non-awareness of the transfer pricing laws

Objectives of the Study

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  To understand the provisions, concepts, methods and documentations of transfer
pricing in India.

 To come through the Recent Introduction of Specified Domestic Transactions and

Amendments in the existing transfer pricing laws in India.

 To understand the provisions, concepts, methods and documentations of transfer

pricing at International Level

 To understand the impact of GAAR & IFRS on transfer pricing.

 To understand the Relationship between Corporate Governance & Transfer Pricing

 To understand the practical issues & highlighted Case–Studies relating to transfer

pricing.

 To understand the need of convergence between transfer pricing and Customs.

 To understand the management control system, Execution Constraints & Measures to

be taken for adequate implementation of transfer pricing laws.

Sources of the data & Research Methodology

The main source of data for the study is Secondary data comprises of online articles,
newspaper columns, magazines, journals issued by different Institutes, news channels, text
books, posts by various renowned authors etc.
The research is conducted for the purpose of Curriculum College Project. General methods
are adapted during the research and research design like flowcharts, graphs, charts, trend
analysis, tabular forms, Statistical tools, Numerical illustrations with real life Case Studies
has been tried to incorporate in the project during the research.

As no person is perfect in this world , in the same way no study can be considered as fully
reliable at one glance , there are a number of uncontrollable factors acting as limitations in
conducting the study: one of such limitation encountered by me in our study is Non -

Transfer Pricing Study

availability of primary data due to lack of time and complication of the topic itself.

Involves: Manage
Functionalthe
process
Analysis
Benchmarking

3
2 4
Documentation
1 5
Gathering Accountant’s
Background Report
Information

Chapters of the Study

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Chapter - I Conceptual & Legislative Framework of Transfer Pricing
A separate code on transfer pricing under Sections 92 to 92F of the Indian Income Tax Act,
1961 (the act) covers intragroup cross-border transactions and is applicable from 1 April
2001. Since the introduction of the code, transfer pricing has become the most important
international tax issue affecting multinational enterprises operating in India. The regulations
are broadly based on the OECD Guidelines and describe the various transfer pricing methods,
impose extensive annual transfer pricing documentation requirements, and contain harsh
penal provisions for noncompliance.

The Indian Transfer Pricing Code prescribes that income arising from international
transactions between associated enterprises should be computed having regard to the arm’s-
length price. It has been clarified that the allowance for any expense or interest arising from
an international transaction also shall be determined having regard to the arm’s-length price.
The act defines the terms “international transactions”, “associated enterprises” and
“arm’s-length price”.

Sec 92: Introduction

Transfer pricing provisions primarily require any income arising from an International
transaction between two or more Associated Enterprises (‘AE’) to be at Arm’s length price
and comparable to similar transactions between unrelated enterprises.

Applicability:
 International Transaction

 Between two or more associated enterprises

 Either or both of whom are non residents.

 TP Provision application can’t reduce income in India.

Sec 92B (1): International Transaction

The term 'International Transaction' has been exhaustively defined to mean a transaction
between two or more AEs, of which at least one is Non Resident, in nature of:

a) Purchase, sale or lease of intangible property; or

b) Provision of services; or

c) Lending or borrowing money; or

d) Any other transaction having a bearing on the profit, income, losses or

assets of such enterprise; and

e) Includes a cost sharing arrangement.

A flow chart of which is Shown below:

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 International
A transaction between two
Transaction
Associated Enterprises,
Either or both of whom are
Non - Residents,
in the nature of

Purchase, sale, lease of Provision of Services

Borrowing/Lending of money
Tangible/intangible property Cost Sharing arrangements

Sec 92B (2): Deemed International Transaction

In addition to the above, a transaction entered into by an enterprise with an independent
third party can also be deemed to be an international transaction entered into between two
AEs if either of the following condition is satisfied:

a) There is a prior agreement in relation to the relevant transaction between such

independent third party and the AE; or

b) The terms of the relevant transaction are determined in substance between such
independent third party and the AE.

Example of Deemed IT:

An agreement entered by XYZ Bank of US ( Parent company) with ABC Finance (unrelated
party) for supply of finance to all its global subsidiaries.

In such a case, transaction by XYZ Bank of India (Indian subsidiary) with unrelated party
will be considered as international transaction since the price of such transaction is
determined as per the agreement between Parent Company and unrelated party as shown
below:

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 Deemed International
Transactions
XYZ Bank US
Arrangement ABC Finance
(non-related Corporation

parties)

XYZ Branch
India

Benchmarked at Arm’s
Length as “Deemed
International Transaction”

Cross Border Transactions

A transaction is considered as a Cross-border transaction if it originates in one country and it
gets concluded in another country. Thus, it is not necessary that every international
transaction within the meaning of sec 92B is a cross border transaction.

Sec 92F (iii) Enterprise

The term 'Enterprise’ has been exhaustively defined in section 92F(iii) of the Act and covers
almost every business activity. The term 'Enterprise' also includes Permanent
Establishment ('PE') of such person. The term PE for this purpose is defined to include a
fixed place of business through which the business of enterprise is wholly or partly carried
on. Thus, Indian branch of a foreign bank will be treated as Enterprise (Fixed place PE).

Sec 92A (1): Associated Enterprises

Associated Enterprises will include:

 An Enterprise which participated directly or indirectly in Management or Control or

Capital of Other Enterprise Or
 Where one or more persons participate directly or indirectly in Management Control
or Capital of two enterprises. These Two Enterprises shall be associated enterprises
Or
 Includes Deemed Associated Enterprises.

Sec 92A (2): Deemed Associated Enterprises

An associated enterprise will be considered as Deemed associated enterprise If at any time
during the previous year any of the following 13 criteria is satisfied:

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 1) Holding 26% or More shares carrying Voting Rights.

2) Any Person Hold 26% or more shares in two enterprises .These two
enterprises will be AEs.

3) Advancing Loans > 51% of Book Value of Total Assest of Borrower.

4) Providing Guarantee for at least 10% borrowing of other enterprises.

5) Appointment (Actual) of more than Half of BOD or Ex Director of Other

Enterprise.

6) Appointment of specified directorship of both enterprise by same person

7) Manufacturing or Processing wholly dependent on Intangible of other

enterprises.

8) Supply of 90% or more of raw material or consumables to other enterprise or

its specified persons where prices are influenced by the former.

9) Sale of Mfd. goods of other enterprise to such enterprise or its specified

persons and the prices are influenced by Former.

10) An individual control one enterprise and other enterprise is also controlled by
such individual or its relatives.

11) An HUF control one enterprise and other enterprise is also controlled by such
HUF or its members.

12) An Enterprise holding more than 10% interests in any Firm, BOI and AOP.

13) Existence of Any Mutual Interest as may be prescribed.

Arm’s-length Principle and Pricing methodologies

The term “arm’s-length price” is defined by Section 92F of the act to mean a price that
is applied or is proposed to be applied to transactions in uncontrolled
conditions between persons other than AEs. The following methods have been
prescribed by Section 92C of the act for the determination of the arm’s-length price:

• Comparable uncontrolled price (CUP) method;

• Resale price method (RPM);

• Cost plus method (CPM);

• Profit split method (PSM);

• Transactional net margin method (TNMM); and

• Such other methods as may be prescribed.

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 No particular method has been accorded a greater or lesser priority. The most
appropriate method for a particular transaction would need to be determined having regard
to the nature of the transaction, class of transaction or associated persons and functions
performed by such persons, as well as other relevant factors.

1. Comparable uncontrolled price method

 Widely considered the most reliable measure when a comparable uncontrolled

transaction exists.

 Transfer price is determined based on reference to the company’s sales of the same
product to an unrelated buyer.

 Reference to transactions between two unrelated parties for the same product is
acceptable.

 If an uncontrolled transaction is not exactly comparable, an adjustment is allowable.

Steps in Computation

Step 1: Identify the price charged for similar goods or services provided in comparable
uncontrolled transactions

Step 2: Provide for adjustments in above price for various factors like: • Quantity
discount • Insurance charges • Freight Cost etc

Step 3: Step 1 price after Step 2 adjustments will be arm's length price:

a. If arm's length price > transfer price – arm's length price will be considered for
income calculations.
b. If arm's length price <= transfer price – transfer price will be considered for
income calculations

Illustration:

Nissan India supplies engines to its holding company in Germany @ Rs 3 lacs per engine.
The parent company procures 50,000 engines per year. The company also supplies engines to
Toyota in Japan @ Rs 4 lacs per engine. Toyota procures 15,000 engines per year. The
company claims to give a volume discount of 10% for the bulk purchase by the parent
company. Compute arm's length price.

Solution:

Particulars Amount

Sale price per engine to Toyota 400000

Less :Volume Discount @ 10% 40000
Arm's length price 360000
Less : Transfer price to Nissan Germany 300000
Additional Income per engine 60000

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2. Resale price method

 Generally used when the affiliate is a sales subsidiary and simply distributes finished
goods.

 Transfer price is determined by deducting gross profit from the price charged by the
sales subsidiary.

 Gross profit is determined by reference to uncontrolled parties.

 The most important factor in choosing this method is the similarity in function of the
affiliated sales subsidiary and the uncontrolled reference company.

Steps In Computation:

Step 1: Identify international transactions involving purchase of similar property or

services.

Step 2: Identify the price charged on resale of such goods or ser vices to an unrelated
person

Step 3: Deduct standard/normal gross profit margin from the above resale price

Step 4: Provide for adjustments in above price for various factors like: • Quantity
discount • Insurance charges • Freight Cost etc

Step 5: Step 2 price after Step 3/4 adjustments will be arm's length price.

Illustration:

Skoda India is engaged in the business of selling premium cars. The company imports the car
Skoda Octavia from its parent company in Czechoslovakia as completely built units for sale
in India. The company imports the cars @ Rs 12 lacs and sells @ Rs 13.5 lacs in India.
Transcar India is a dealer for Volkswagen Jetta. Transcar imports the car from Germany @
Rs 11.5 lacs and sells at Rs 14 lacs. Both Skoda Octavia and Jetta compete in the same
category. Compute arm‘s length price.

Solution:
Particulars Amount

Sale Price of Jetta 14

Purchase Price 11.5
Gross Margin 2.5
Gross Margin Ratio 18%
Sale Price of Skoda 13.5
Gross Margin @ 18% 2.43

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 Arm's length purchase price (A) 11.07
Actual Purchase Price (B) 12
Additional Income (B-A) per car 0.93

3. Cost-plus method

 Most appropriate when comparable uncontrolled transactions don’t exist and sales
subsidiary does more than simply distribute finished goods.

 Transfer price is determined by adding gross profit to the cost of production.

 Gross profit is determined by reference to uncontrolled parties.

 Factors influencing the comparability of uncontrolled transactions include:

complexity of manufacturing process, procurement activities, and testing functions.

Steps In Computation:

Step 1: Determine the total Direct and Indirect cost of production of goods/ services .

Step2: Identify a similar comparable uncontrolled transaction.

Step 3: Determine the gross margin in Step 2 transaction.

Step 4: Adjust the gross margin for functional and other differences in the international
transaction and step 2 transaction.

Step 5: The total direct and indirect cost of manufacture of the international transaction
shall be increased by adjusted gross margin in Step 4 to arrive at arm's length price.

Illustration:
GE Health Care is engaged in providing call centre facilities for US based companies
including its parent GE Insurance. The company bills GE Insurance @ USD 25 per hour. The
company also works on a similar transaction with Torrent Pharma where it bills @ USD 36
per hour. How- ever GE Insurance makes an immediate payment while Torrent takes a credit
period of 45 days. The total cost to GE India per man hour is USD 15 per hour and USD 2
per month for credit payment. Compute arm's length price assuming the cost of manpower to
GE cost 40%

Solution:

Particulars Amount

Hourly billing rate to Torrent 36

Cost of billing -
Direct and Indirect Cost 15
Add : Finance cost @ USD 2 p.m 3

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 Total Cost 18
Mark up on Cost 18
Mark up Ratio on Cost 100%
Cost of billing to GE -
Direct and Indirect Cost (40% more) 21
Mark up @ 100% 21
Arm's length price (A) 42
Less : Transfer price (B) 25
Additional Income (A - B) 17

4. Profit split method

 Treats the two related parties as one economic unit.

 Profit from the eventual sale to an uncontrolled party is allocated between the related
parties.

 Allocation is based on relative contribution of each party.

 Contribution is determined by functions performed, risk assumed, and resources

employed.

 There are actually two versions: comparable profit split method and residual profit
split method.

Steps In Computation:

Step 1: Determine the combined net profit of associated enterprises engaged in the
international transaction

Step 2: Evaluate the relative contribution by each enterprise with respect to (FAR
Analysis): Functions performed − Assets employed − Risks assumed

Step 3: Split the combined net profit in proportion to relative contribution ratio to
arrive at arm's length price

Alternative Approach –

Step 1: Partially allocate profit to each of the enterprises to arrive at a basic return
appropriate to the type of the transaction.

Step 2: The remaining profits shall be allocated on the basis of relative contribution
Step3: Step 1 plus Step 2 shall be the total net profit of the enterprise.

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Illustration:

Gold Man Sachs Europe has bagged the con- tract for syndicating the merger between
Arcellor and Mittal steel. For the purpose, the company involved its subsidiaries in India,
US and Europe. The total deal size was USD 100 M. The cost incurred by the Indian arm is
USD 2 M. The total profits earned by Gold Man in the entire deal were USD 35 M. The
company apportioned a revenue of USD 2.6 M. The relative effort put in by group companies
are 10%, 40% and 50% respectively. Compute arm's length price.

Solution:

Particulars Amount

Total Profits of Gold Man 35

Share of Indian Operations @ 10% 3.5
Add Cost incurred by Indian Operations 2
Arm's length price (A) 5.5
Less :Transfer price (B) 2.6
Additional Income (A - B) 2.9

5. Transactional net margin method (TNMM)

 It compares the net profit margin of a taxpayer arising from a non-arm's
length transaction with the net profit margins realized by arm's length parties from
similar transactions; and examines the net profit margin relative to an appropriate base
such as costs, sales or assets.
 This differs from the cost-plus and resale price methods that compare gross
profit margins.
 However, the TNMM requires a level of comparability similar to that required for the
application of the cost plus and resale price methods. Where the relevant information
exists at the gross margin level, taxpayers should apply the cost plus or resale price
method.
 Because the TNMM is a one-sided method, it is usually applied to the least complex
party that does not contribute to valuable or unique intangible assets.
 Since TNMM measures the relationship between net profit and an appropriate base
such as sales, costs, or assets employed, it is important to choose the appropriate base
taking into account the nature of the business activity.

Steps In Computation:
Step 1: Identify the net margin to the enterprise from the inter- national transaction.

Step 2: Identify net margin from a comparable uncontrolled transaction.

Step 3: The net margin as per Step 2 shall be adjusted for between the international
transaction and comparable uncontrolled transaction.

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Step 4: The adjusted net margin in Step 3 shall be considered to arrive at arm's length
price.

Illustration:

Microsoft India procures software packages from its parent in US @ Rs 650 per pack.
Subsequent to purchase the company incurs an additional expenditure of Rs 200 per pack on
labeling and marketing. The product is ultimately sold for Rs 1000 per pack. Microsoft India
also procures antivirus software from Nor ton Germany @ Rs 3000 per pack. The company
incurs an additional expenditure of Rs 400 per pack and the product is ultimately sold for Rs
5000 in India. Microsoft pack is a mass product where the volumes are 3 times higher. Hence
there may be a lower net margins to the tune of 5% which is compensated by increased
volumes. Compute arm‘s length price.

Solution:

Particulars Amount

Sale price of Norton 5000

Less: Purchase Price 3000
Additional Expenditure in India 400
Net Margin 1600
Net Margin ratio 32%
Sale price of Microsoft (A) 1000
Net margin ratio 27% 27%
(after factoring for volume discount @ 5%)
Net margin(B) 270
Total Cost ( A-B) 730
Less: Additional Expenditure in India 200
Arm’s length price (C) 530
Transfer Price (D) 650
Additional Income (D - C) 120

Thus the appropriate base that profits should be measured against will depend on the
facts and circumstances of each case.

Comparability Rule
Most rules provide standards for when unrelated party prices, transactions, profitability or
other items are considered sufficiently comparable in testing related party items. Such
standards typically require that data used in comparisons be reliable and that the means used
to compare produce a reliable result. The U.S. and OECD rules require that reliable
adjustments must be made for all differences (if any) between related party items and
purported comparables that could materially affect the condition being examined. Where such
reliable adjustments cannot be made, the reliability of the comparison is in doubt.
Comparability of tested prices with uncontrolled prices is generally considered enhanced by
use of multiple data. Transactions not undertaken in the ordinary course of business generally

18
are not considered to be comparable to those taken in the ordinary course of business. Among
the factors that must be considered in determining comparability are:

 the nature of the property or services provided between the parties,

 functional analysis of the transactions and parties,
 comparison of contractual terms (whether written, verbal, or implied from
conduct of the parties),and
 comparison of significant economic conditions that could affect prices,
including the effects of different market levels and geographic markets.

Nature of property or services

Comparability is best achieved where identical items are compared. However, in some cases
it is possible to make reliable adjustments for differences in the particular items, such as
differences in features or quality. For example, gold prices might be adjusted based on the
weight of the actual gold (one ounce of 10 carat gold would be half the price of one ounce of
20 carat gold).
Functions and risks: Buyers and sellers may perform different functions related to the
exchange and undertake different risks. For example, a seller of a machine may or may not
provide a warranty. The price a buyer would pay will be affected by this difference. Among
the functions and risks that may impact prices are:

 Product development
 Manufacturing and assembly
 Marketing and advertising
 Transportation and warehousing
 Credit risk
 Product obsolescence risk
 Market and entrepreneurial risks
 Collection risk
 Financial and currency risks
 Company- or industry-specific items

Best method rule

Some systems give preference to a specific method of testing prices. OECD and U.S.
systems, however, provide that the method used to test the appropriateness of related party
prices should be that method that produces the most reliable measure of arm's length results.
This is often known as a "best method" rule. Under this approach, the system may require
that more than one testing method be considered. Factors to be considered include
comparability of tested and independent items, reliability of available data and assumptions
under the method, and validation of the results of the method by other methods.

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Establishing Most Appropriate
Method
Methods
Functions

CUP: Comparable Uncontrolled Price TNMM:

Transactional Net Margin Method

The above table shows the applicability of a particular method in different functions and
systems.

Tolerance Band of Arm’s Length Price

In case Arm’s Length Price is computed under more than one method, then Arm’s Length
Price shall be the average of Several ALP. ALP, so computed if varies from the transaction
price , then if such variation is within tolerance Band as notified by Central govt. , then sec
92 will not be applicable. The maximum tolerance band as notified by Central Government
is +/-5%

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TRANSFER PRICING LITIGATION STATISTICS
The following table shows the transfer pricing litigation statistics as gathered during the
survey made by BDO Haribhakti :

For Number of Percentage of

Assessment Transfer Pricing Number of adjustment Adjustment
Year audits completed Cases adjusted cases amount

(%) (INR CRORES)

2002-03 1081 238 22 1373

2003-04 1501 345 23 2575

2004-05 1768 477 27 3861

2005-06 1479 370 25 4950

2006-07 1717 1019 59 9743

2007-08 2102 1089 52 24000

2008-09 2589 1338 52 44500

Generally two broad categories of TP litigation –

A. Pure comparability issue (IT & ITeS companies) è requires fundamental reforms
in Indian TP regulations [“inter-quartile range” & “multiple year data” concepts]
B. Complex transactions on fundamentals of TP è requires significant improvement
for all constituents [taxpayers, to start with]

Burden of Proof
The burden of proving the arm’s-length nature of a transaction primarily lies with the
taxpayer. If the tax authorities, during audit proceedings on the basis of material, information
or documents in their possession, are of the opinion that the arm’s-length price was not
applied to the transaction or that the taxpayer did not maintain/produce adequate and correct
documents/information/data, the total taxable income of the taxpayer may be recomputed
after a hearing opportunity is granted to the taxpayer.

Tax Audit & Assessment Procedure

A certain percentage of tax returns are selected for detailed audit. A notice to this effect
has to be statutorily dispatched to the taxpayer within six months from the end of the
financial year in which the return is furnished.

Such notice specifies the records, documents and details that are required to be produced
before the tax officer. Once an audit is initiated, the corporate tax assessing officer (AO)
21
may refer the case to a specialized transfer pricing officer (TPO) for the purpose of
computing the arm’s-length price of international transactions. Such reference may be
made by the AO wherever he or she considers it necessary.

However, this can be done only with the prior approval of the commissioner of income
tax. In accordance with prevailing internal administrative guidelines of the Department
of Revenue, all taxpayers having an aggregate value of international transactions with
AEs in excess of INR50 million are referred to a TPO for detailed investigation of
their transfer prices. The threshold of INR50 million may be reviewed on an ongoing
basis.

The TPO would then send a notice to the taxpayer requiring the production of necessary
evidence to support the computation of the arm’s-length prices of the international
transactions.

The prescribed documentation/information maintained by the taxpayer in respect of its

transfer pricing arrangements would have to be produced before the tax authorities
during the course of audit proceedings within 30 days after such request has been
made. The period of 30 days can be extended to 60 days at most.

The TPO would scrutinize the case in detail, taking into account all relevant factors such
as appropriateness of the transfer pricing method applied and correctness of data. TPOs
are vested with powers of inspection, discovery, enforcing attendance, examining a
person under oath and compelling the production of books of account and other
relevant documents and information.

SOURCE: E & Y SURVEY REPORT 2010

22
NOTE: with effect from 1 June 2011, TPOs have been empowered to conduct surveys for
spot inquiries and verification for subsequent investigation and collation of data. In
addition, TPOs have been instructed to seek opinions of technical experts in the relevant
field to enable them to analyze technical evidence in complex cases.

After taking into account all relevant material, the TPO would pass an order determining
the arm’s-length prices of the taxpayer’s international transactions. A copy of the order
would be sent to the AO and the taxpayer. On receipt of the TPO’s order, the AO would
compute the total income of the taxpayer by applying the arm’s-length. prices determined
by the TPO and pass a draft order within the time limit prescribed for completion of
scrutiny assessments.

Normally, scrutiny assessments are required to be completed within an upper time limit
of 33 months from the end of the relevant tax year. However, scrutiny assessments
involving transfer pricing audits would have to be completed within 45 months from
the end of the relevant tax year.

Appeals Procedure

 A taxpayer that is aggrieved by an order passed by the AO may appeal to the

commissioner of income tax, also called the appellate commissioner, within 30 days of
the date of receipt of the scrutiny assessment order.

 The office of the appellate commissioner is a type of quasi-judicial authority, where

both Revenue and the taxpayers make representations in support of their claims. The
decision of the appellate commissioner is reflected in an appellate order.

 An alternative dispute resolution mechanism has been instituted by the Finance Act
(2009) to facilitate expeditious resolution of disputes in all cases involving transfer
pricing and foreign company taxation. It has introduced the concept of draft assessment
orders, which would be issued by the AO pertaining to the order of the TPO that is
prejudicial to the taxpayer.

 In cases involving foreign companies or companies suffering transfer pricing

adjustments, the AO is required to forward a draft assessment order to the taxpayer
which would ordinarily include the order of the TPO. A dispute resolution panel
(DRP), comprising a collegium of three commissioners of income tax, is constituted
to which the taxpayer would have recourse on receiving the draft assessment order from
the AO.

 At this stage, the taxpayer has two choices: It could either accept the draft order as it is,
or seek to refer the matter to the DRP. The taxpayer has to communicate its decision to
the AO within 30 days of the receipt of the draft order.

 If the order is accepted by the taxpayer as it is, the draft would be finalised by the AO
and served to the taxpayer. If the matter is referred to the DRP, the panel would have
nine months, from the end of the month in which the draft order is forwarded to the
taxpayer by the AO, to decide the matter.

23
  The panel would take into consideration the draft order of the AO, the order of the TPO
and the taxpayer’s objections and evidence. The draft assessment order would be
finalised after the DRP has rendered its decision to the AO.

 If the taxpayer does not communicate its decision to refer the draft order to the DRP
within 30 days, the AO would finalise the assessment order without modification of
the draft assessment order.
 However, an order of the AO that is based on the direction of the DRP would be
appealable directly to the income tax appellate tribunal (Appellate Tribunal). The
orders passed by the AO pursuant to the directions of the DRP are binding on Revenue.

 It is also clarified that the taxpayer would have to take a call as to whether to opt for the
dispute resolution mechanism based on the draft assessment order or file an appeal in
the normal course with the appellate commissioner against the assessment order. Thus,
the order of the AO can be agitated before the appellate commissioner in the ordinary
course (i.e. if it is not referred to the DRP).

 Taxpayers that still feel aggrieved by the order of the appellate commissioner or, as
the case may be, the order of the AO passed in conformity with the directions of the
DRP have the right to appeal to the Appellate Tribunal, which is the final fact-finding
authority in India.

 However, in case any question of law is involved, the taxpayer can appeal to the
jurisdictional High Court, and finally to the Supreme Court. A similar right to appeal
also rests with Revenue, except in cases where the DRP issues directions. In cases of
the latter, these directions are binding on Revenue, and Revenue consequently loses
its right to appeal.

Penalties

The following stringent penalties have been prescribed for noncompliance with the
provisions of the transfer pricing code:

For failure to maintain For failure to furnish For adjustment For failure to
the prescribed information/document to taxpayer’s furnish an
information/document s during audit: income: accountant’s
: 2% of 2% of 100% to 300% of report:
transaction value transaction value; the total tax on INR 100,000.
the
adjustment
amount

Further, taxable income enhanced as a result of transfer pricing adjustments does not
qualify for various tax concessions/holidays prescribed by the Income Tax Act.

24
Chapter - II Recent Changes in Legislative Framework of Transfer
Pricing
Income Tax authorities having gained significant experience in transfer pricing related to
international transactions, now Finance Act, 2012 has cast wider and deeper net to cover
domestic transactions between related parties. Therefore it could not be limited to large
corporate houses but now many midsized groups would be get covered. Is time ripe to say
now Pandora’s box is wide “open.”?

Introduction
The Indian Union Budget for 2012-13 containing the tax proposals of the Government was
presented by the Finance Minister to the Parliament on 16 March, 2012. The Finance Bill,
2012 (FB 2012) that was introduced as part of Budget Proposals includes a number of far
reaching amendments to the transfer pricing (TP) provisions of the Indian Tax Law
(ITL). A number of the amendments are likely to apply with retrospective effect and could
therefore have an impact for prior years as well. Taxpayers would need to assess the impact of
the budget proposals on their past and future transactions.

Some of the key transfer pricing proposals in the FB 2012:

 TP was earlier limited to ‘International Transactions’. In addition, the ambit and scope
of TP provisions would be widened under the proposals by expanding the definition of
“international transaction” to cover business restructuring or reorganization between
associated enterprises.

 The Finance Act 2012, extends the scope of TP provision to ‘Specified Domestic
Transactions’ between related parties w.e.f. 1 April 2012

 The SC in the case of CIT vs Glaxo Smithkline Asia Pvt Ltd (SC) recommended
introduction of domestic TP provisions

 SDT previously reported/certified but onus on revenue authorities

 Obligation now on taxpayer to report/ document and substantiate the arm’s length
nature of such transactions

 A definition of the term “intangible property” is proposed to be introduced. The

definition, in addition to covering generally accepted marketing and technology related
intangible assets, also includes customer lists, customer relationships and trained and
organized work force.

 Proposes amendments to provisions relating to computation of the arm’s length price

(ALP), procedural and penalty provisions relating to TP.

 Introduce provisions to enable Advance Pricing Agreements (APAs)

 Shift from generic FMV concept to focused ALP concept

25
These new provisions would have ramifications across industries which benefit from the said
preferential tax policies such as SEZ units, infrastructure developers or operators, telecom
services, industrial park developers, power generation or transmission etc. Apart from this,
business conglomerates having significant intra-group dealing would be largely impacted.

Intent of Indian TP Regulations…

(Domestic
India transactions)
Shifting of expenses/losses India
Related
Indian Co. Enterprise in
Tax Holiday Domestic
undertaking Tariff Area
Tax Exemption Tax
(DTA)
@32.45%
Shifting of income/profits

Tax Saving for the Group – Loss to

Indian revenue

Section 92BA – Meaning of Specified Domestic Transaction SDT)

[inserted by Finance Act, 2012 w.e.f. AY 2013-14 i.e. current FY]

The Intent of Introducing the concept of specified transaction mainly focuses on:

 Bringing in objectivity in the interpretation and governance – Introduction of ALP

mechanism.
 Doing away with tax arbitrage abuse that stems from differential tax rate, tax
holiday/benefits availed by undertaking and presence of accumulated losses.
 Protecting the revenue of the Indian Government.

For the purposes of this section and sections 92, 92C, 92D and 92E, “specified domestic
transaction” in case of an assessee means any of the following transactions, not being an
international transaction, namely:-

(i) any expenditure in respect of which payment has been made or is to be made to a
person referred to in section 40A(2)(b);
(ii) any transaction referred to in section 80A;
(iii) any transfer of goods or services referred to in sub-section (8) of section 80-IA;
(iv) any business transacted between the assessee and other person as referred to in
section 80-IA (10);
(v) any transaction, referred to in any other section under Chapter VIA or section 10AA,
to which provisions of section 80-IA(8) or section 80-IA(10) are applicable; or
(vi) any other transaction as may be prescribed,

and where the aggregate of such transactions entered into by the assessee in the previous year
exceeds a sum of five crore rupees.

26
 Overview of Provisions
Interof Section
unit transfer92BA
of goods &
Expend services by undertakings to
iture which profit-linked deductions
incurre apply Any
d other
betwee transac
n SDT tion
related that
parties may be
defined specifi
Transactions between
under ed
undertakings, to which profit-
section
linked deductions apply,
40A
having close connection
Illustrative transactions for the purpose of Sec 92BA:

Interest on loans from and to Directors and related persons

Remuneration to directors, shareholders and related persons
Purchase and sale of goods and services between related parties and concerns
Payment of rent
Asset purchase transactions from related persons specified u/s 40A(2)(b)

Section 40A(2) – Transactions covered

 Mapping to be done for the company’s transactions with domestic Related Parties
 Primary reliance on disclosures u/s 40A(2)(b) and Related Party Schedule
 Different divisions enter into different transactions with various group companies

Broad categories of transactions likely to be covered:

27
Section 40A(2) – Payments to related parties

1. Payments by taxpayers to certain specified persons covered within the ambit

of section 40A(2)

2. Where the taxpayer/ assessee is a company, following persons regarded as

‘specified persons’:
► Directors of the taxpayer company or any relative of such directors
► Individuals having Substantial Interest (SI) in the business of
taxpayer company or any relative of such individual
► Persons having a SI in the business of the taxpayer company
► Directors of the entities having SI in the business of the taxpayer
company or any relatives of such directors
► Any company having the same holding company (which holds a SI)
as that of the taxpayer company
► A company of which a director has a SI in the business of the
taxpayer company, any director of such company or any relative of such
director.
► Persons/entities in which taxpayer company/its directors/ their
relatives have a Substantial Interest.

3. Payments by an individual, firm, AOP and HUF to certain specified persons

are also covered within the ambit of section 40A(2)

Substantial Interest: A person shall be regarded as having a SI in a business if at any time

during the previous year:

 Such person is the beneficial owner of shares carrying not less than

20% of the voting power (in case of a company)

 Such person is beneficially entitled to not less than 20% of the

profits of such business (in any other case)

Beneficial ownership: Term not defined but can be understood as a person who ultimately

28
enjoys the income/asset and also controls it. While a registered shareholder may generally be
presumed to be the beneficial owner, under certain circumstances, an indirect shareholder
could be regarded as beneficial owner. Need not be in existence for the entire year but is
sufficient if it is in existence for only part of the year.

Thus for Company A payments to following persons ar

1wer;CompanyBhvig20%tAcsfd3lu&.
Tax holiday Eligible Business
1. SDT provisions apply to business transactions/transfers referred to in section 80A,

80IA(8), 80IA(10), 10AA, Chapter VI-A provisions

2. Section 80A(6) and Section 80IA(8) require adjustment to tax holiday profits where:

 Goods and services of eligible business are transferred to any other business

carried on by the same taxpayer and vice versa.

 Consideration for such transfer as recorded in the accounts of eligible

business does not correspond to market value of such goods/services.

 In such cases, tax authorities/ taxpayer required to recompute tax holiday claim

by reference to ALP of such goods/services.

3. Overlap between 80A(6) and 80IA(8) not of much consequence.

4. Applies to all tax holiday claims under Chapter VI-A/ Section 10AA.

5. Applicability to investment-linked tax incentives under Section 35AD

29
General scope of Section 80A(6)/ 80IA(8)
A. Covers transfer of goods/ services held by “eligible business” to another business or vice

versa:

 Existence of two or more separate businesses of the same taxpayer.

 Transfer of goods/ services between the businesses.

 Does not contemplate an artificial or hypothetical segregation of profits between tax

holiday unit and the rest of the enterprise.

 Once threshold is satisfied, inter-unit transfer price may be need to be determined by

hypothesizing the businesses as separate & distinct enterprises for determining ALP.

B. Provides for a “two-way” adjustment (both favorable as well as adverse) and is a

mandatory provision.

C. Is in the nature of notional adjustments for determining profits eligible for tax holiday.

General scope of Section 80IA(10)

Tax officer empowered to re-compute tax holiday profits if: more than “ordinary

profits” have arisen in the eligible business due to transactions between closely

connected persons or for other reasons.

Provides for only “one way” adjustment i.e. only adverse adjustment at the

discretion of the tax officer.

Is in the nature of notional adjustment for determining profits eligible for tax holiday.

Tax officer may invoke the provision in case of SDT on the basis of ALP

determination.

Onus still on tax officer to establish that the course of business was arranged to

produce more than ordinary profits.

30
Tax burden, if transaction not at ALP

Sale at `
X Ltd. Y Ltd. Disallowance of ` 20 to Y
120 v/s Ltd
(non-tax ALP i.e. ` (non-tax
holiday) 100 holiday) [40A(2)(b)]
Double Adjustment
Tax holiday on ` 20 not
allowed to X Ltd –
X Ltd. Sale at ` Y Ltd. [80IA(10)] (more than
(tax 120 v/s (non-tax ordinary profits)
ALP i.e. `
holiday) 100 holiday) Disallowance of ` 20 to Y
Ltd -
[40A(2)(b)]
Sale at ` Inefficient pricing
X Ltd. 80 v/s Y Ltd. structure – reduced tax
(tax ALP i.e. ` (non-tax holiday benefit since sale
holiday) 100 holiday) price is lower than ALP

Important Observations:
1. Transfer pricing provisions are not applicable in case where income is not chargeable
to tax at all.
[Amiantit International Holding Ltd., (2010) 322 ITR 678 (AAR)]

2. Provisions of section 40A(2) are not applicable to a co-operative society.

[CIT vs. Manjara Shetkari Sahakari Sakhar Karkhana Ltd.(2008) 301 ITR 191

3. Payment made by holding co. to subsidiary co. is not covered u/s 40A(2)(b), as the
relationship does not fall under sub-clause (ii) nor under sub-clause (iv) of sec.
40A(2)(b). [CIT vs. V.S.Dempo & Co. (P) Ltd. (2011) 336 ITR 209 (Bom.)

Note: In this decision, clause (vi) of s. 40A(2)(b) was not considered.

4. When a person commits an offence by not maintaining the books of accounts as

contemplated by section 44AA, the offence is complete. After that there can be no
possibility of any offence as contemplated by section 44AB and therefore, the
imposition of penalty is erroneous.
[Surajmal Parasmal Todi vs. CIT (1996) 222 ITR 691 (Gauhati)]

Note : This decision may be helpful in the context of sections 271AA, 271G and 271BA.

5. Correlative adjustments - if excessive or unreasonable expenses are disallowed in

the hands of tax payer at time of the assessment then corresponding adjustment to the
income of the recipient will not be allowed in the hands of recipient of income.
Hence, it would lead to double taxation in India.

31
 Tabular Illustration:

Interpretation of the table: By shifting of income from a profit making company to a loss
making company, the group could reduce its tax liability by 16.23 for the current year, though
the impact will be reversed in future years given carry forward of losses.

Minimum value of transactions

Transfer pricing will be applicable to taxpayer, if aggregate value of all above specific domestic
transactions exceeds INR 5 Crores.
.
Computation of Arm’s length price
The arm’s length price (ALP) in relation to specified domestic transaction would be determined
by any of the following methods:

a) Comparable uncontrolled price method: Arm’s length price is determined by

comparing the price charged for goods or servicestransferred in a controlled transaction
with the price charged for goods or services transferred in a comparable uncontrolled
transaction in comparable circumstances.

b) Resale price method: Arm’s Length Price is determined by comparing resale price
margin (i.e.the gross margin) that the reseller earns from the controlled transaction with
the gross margin from comparable uncontrolled transactions.

c) Cost plus method: Arm’s Length Price is determined by comparing the mark-up on
costs that the manufacturer or service provider earns from the controlled transaction with
the mark-up on costs from comparable uncontrolled transactions.

32
 d) Profit split method: Arm’s Length Price is determined by evaluating the allocation of
the combined profit or loss attributable to one or more controlled transactions with
reference to the relative value of each controlled taxpayer’s contribution to that
combined profit or loss.

e) Transaction net margin method: Arm’s Length Price is determined by comparing the
net profit on costs or sale that the manufacturer or service provider earns from the
controlled transaction with net profit on costs or sale from comparable uncontrolled
transactions.

Section 92CA - Reference To TPO

The word “specified domestic transaction” inserted in various sub-sections.

 (1) AO may refer the computation of ALP to TPO
 (2) TPO to issue notice to Assessee to produce evidence in support of ALP
 (2A) Any other international transaction coming to notice of TPO*
 (2B) Non-furnishing of CA’s report and TPO’s power *
 (3) TPO shall pass the order determining ALP
 (4) AO to compute total income accordingly
 (7) TPO’s power of summons (s.131), survey (s.133A) and collecting
information u/s 133(6)applies even in Domestic Transaction

Sec. 144C (15)(b)…..Reference to DRP

• AO to forward draft of proposed order to eligible assessee
• eligible assessee means – any person in whose case order u/s 92CA is passed
* 92CA (2A ) & (2B) do not cover specified domestic transactions and hence the TPO
cannot suo moto upon the transaction coming to his notice apply the TP provisions.

Maintenance of documents for specified domestic transactions

Taxpayer needs to maintain mandatory detailed transfer pricing documents for all specified
domestic transactions. Further, taxpayer needs to obtain report from Chartered Accountant
u/s 92E and furnish the same to tax authorities.

Penalties applicable on Non-compliance

 If adjustment is treated as concealment of income: Penalty will be 100% to 300% of
the tax on adjustment
 Failure to maintain required set of documents: 2% of value of transactions
 Failure to report transaction in report from Chartered Accountant: 2% of value of
transaction
 Failure to furnish documentation: 2% of value of transactions
 Failure to furnish report by due date: INR 1,00,000

In a nut shell, analysis of Sec 92BA:

33
* Sec 92F – Definitions does not define terms relevant for domestic TP tran

Some Recent Amendments in transfer pricing made by

Finance Act 2012
1. ‘Business Restructuring’ and ‘Intangibles’ an area of increased
attention of the Indian tax authorities
In recent times, there has been some controversy over whether the Indian TP regulations
extend to the unique transaction fact patterns involved in business restructurings, intangibles
or services, particularly in situations where the profit or loss may not be
determinable under normal circumstances. The legislature clarifies that the scope of Indian
TP regulations has always intended to cover such transactions. In this regard, the
term ‘international transactions’ has been defined to include business restructuring (even if
there is no bearing on income, profits, losses or assets at the time of the transaction or at any
future date),purchase/sale/lease/use of tangible property or intangible
property, capital financing, guarantees, inter-company receivables/payables etc. Further, the
term intangible property has been defined to include:

 marketing related intangible assets (e.g. trademarks, trade names, brand names or
logos);
 technology related intangible assets (e.g. process patents, technical documentation
etc.);
 artistic related intangible assets;
 data processing related intangible assets;
 engineering related intangible assets;

34
  customer related intangible assets (e.g. customer lists, relationship, open purchase
orders, etc.);
 contract related intangible assets;
 human capital related intangible assets (e.g. trained and organized work force,
employment agreements, union contracts, etc.;
 location related intangible assets (e.g. leasehold interest, mineral exploitation rights,
easements, air rights, water rights, etc.);
 goodwill related intangible assets (e.g. institutional goodwill);and
 methods, programmes, systems, procedures, campaigns, surveys, studies, forecasts,
estimates, customer lists or technical data.

In light of the above amendments, we believe that issues involving extended credit period for
intra-group services, situs of intangible property and location savings will become matters of
increased scrutiny.

2. ‘Dispute Resolutions Panel’ no longer a final resolution

Dispute Resolution Panel (“DRP”) directions shall no longer be binding on the tax officer.
Hence, the tax officer will have the right to file an Appeal before the Income Tax Appellate
Tribunal (“ITAT”) against the direction of the DRP in respect of an objection filed
on or after July 1, 2012.

3. The Range benefit for arm’s length price restricted

Until October 2009, the taxpayer had an option to choose a price within a 5% variation
from the arithmetic mean price, which was considered as standard deduction i.e. even in case
of transfer pricing audits, the transfer pricing adjustment would be reduced for
the 5% tolerance band. The interpretation of the provisions as a standard deduction has been a
matter of debate between taxpayers and the revenue authorities. Now the option of 5%
standard deduction has been removed with retrospective effect from April 1, 2001.
Consequentially, it is now clarified by the legislature that the benefit of the 5% variation from
the arithmetic mean price as a standard deduction will no longer be available to the taxpayer.
Further, the law was amended in 2011 to remove the tolerance band of +/-5% variation, and
provide that the Government will notify industry/transaction-specific thresholds for
computing the range benefit. Now, it is further provided that the thresholds for
computing the range benefit shall not exceed 3% of the transaction value.

4. Introduction of Concept of Advance Pricing Agreement (APA)

APA is an arrangement that determines, in advance of controlled transactions, an appropriate

set of criteria (e.g., method, comparables and appropriate adjustments thereto, critical
assumptions as to future events) for the determination of the transfer pricing for those
transactions over a fixed period of time. The ITL currently does not provide a mechanism for
APAs. The FB 2012 proposes to introduce a scheme of APAs by empowering the
Central Board of Direct Taxes (Board), the tax administration body, to enter into an
APA with any person undertaking an international transaction. The FB 2012 proposes to
empower the Board to formulate a scheme providing for the manner, form, procedure and any
other matter generally with respect to the APA mechanism.

The APA mechanism proposed in the FB 2012 would broadly be as follows:

35
  The taxpayer can approach the Board for determination of the arm’s length price in
relation to an international transaction that may be entered into by the taxpayer.

 The ALP in an APA shall be determined using any method including the prescribed
methods, with necessary adjustments or variations.

 The ALP determined under the APA shall be deemed to be the ALP for the
international transaction with respect to which the APA has been entered into.

 The APA shall be binding on both the taxpayer and the revenue authorities as long as
there are no changes in law or facts that served as the basis for the APA.

 The APA shall be valid for the period specified in the APA subject to a maximum
period of five consecutive financial years.

 The proposed APA mechanism requires a person entering into an APA to necessarily
furnish a modified return, for previous years to which the APA applies, within three
months of the end of the month in which the said APA went into effect. The modified
return has to reflect the modification to the income only with respect to the issues
arising from the APA and should be in accordance with it.

 The mechanism also requires the revenue authorities to complete the assessment or
reassessment (audit proceedings) in accordance with the APA and any modified
return, if applicable. The period of limitation for completion of audit proceedings is
extended by one year where a modified return has been filed and where the audit
proceedings are pending completion. Where the audit proceedings have been
completed before the expiry of the modified return, the mechanism requires the
revenue authorities to re-compute the total income based on the APA and the
modified return. The period of limitation for completing the audit proceedings in
such cases is one year from the end of the financial year in which the modified
return is furnished.

 The mechanism empowers the Board to declare, with the approval of Central
Government, any APA to be void ab initio, if it finds that the agreement has been
obtained by the taxpayer by fraud or misrepresentation of facts. Once an agreement is
declared void ab-initio, all the provisions of the ITL shall apply to the taxpayer as if
such APA had never been entered into.

Advantages of APA
 Certainty

 Reduced Documentation burden

 Time and Cost saving

 Preferred by Tax Authorities

 Reduces risk of double taxation

 Mandatory pre-filing

36
  Unilateral can be pursued in case bilateral fails

 Conjunctive relationship with the tax authorities

 APA can be guide to the past litigation

 APA process is able to resolve transfer pricing issues early on in a more efficient,
consistent and comprehensive manner than the Standard Audits, appeals and
litigation processing which are more of adjudication processes.

Disadvantages of APA
 High – upfront Cost

 Time frame

 Pre-filing forms is too much technical

 Onerous details required in pre-filing / APA Application

 No Rollback provisions [APA in resolving open years]

 Annual compliance Audit

 Impact of the past litigation

 Inadequate infrastructure

 Wide Powers of the Board

Note: India is the third highest jurisdiction with pending transfer pricing disputes,
as per Ernst & Young Survey: 1,500 transfer pricing disputes were pending in litigation, as
of February 2011 - This number has more than doubled in the last 18 months. Ernst & Young
recommends Advance Pricing Agreements (APAs) as the most favourable tool for transfer
pricing adjustments.

Commenting on APA as a favourable tool, Vijay Iyer, Partner & Transfer Pricing
Leader, Ernst & Young, said, "As per the Directorate of Transfer Pricing, there is a
mispricing of Rs. 67,768 crore in 2010-11 and Rs. 43,531 crore in 2011-12. In such a
scenario, APAs will help in offering taxpayers an opportunity to resolve their transfer pricing
issues with the tax authority in a cooperative and mutually beneficial manner and provide
certainty on this aspect. APAs have been successfully implemented in a number of countries
across the world and provide significant benefits to the tax administration and the taxpayer."

37
Chapter - III International Practices Relating to Transfer Pricing
As multinational companies continue to globalize their supply chains, transfer pricing is
increasingly at the forefront of business transformation initiatives. Organizations recognize that
transfer pricing strategies can add significant value to business projects and help fund future
growth as they look to maximize efficiencies and minimize their global tax liabilities.

Any related party transaction undertaken from 1st April 2001 onwards covered

Currently 60% of world’s cross-border trade is between related parties –

Indian tax authorities have taken the cue!
UK –every £1 spent on TP investigation has fetched £120 to UK Inland
Revenue
Japan –transfer pricing has been a major revenue churner- individual cases
exceeds $100 m!

60% of international exchanges are Intra-industry trade

The transfer price is an accounting technique which allows for the exchange of products
belonging to the same industry, produced in country A and sold to country B. It’s used to
calculate the tax of these goods which is then distributed by the countries, based on recent
transactions. Let’s look at an example:

A bullet (country A, cost 1 euro, taxed at 30%) Sold for 2 euros (Country X, taxed at 0%)
and resold for 10 euros (country B, taxed at 30%)

Result: tax paid in country A in country X + tax + tax in country B

38
Of the “taxable” 10 euros, 8 euros will escape to any kind of tax and the two other countries
(A and B) will just have 2 euros to charge to their income tax. This phenomenon has become
a popular trend in the international market, since 60% of today’s exchanges are intra-industry
trade.

Global TP Enforcement

First level
Second level
Third level
Fourth level

The transfer pricing environment is constantly changing, in terms of both risks and
opportunities. Multinational companies need to ensure they stay up-to-date with the latest
developments and transfer pricing best practices. In doing so, they can optimize the
opportunities to reduce their global effective tax rate and ensure they remain compliant with

39
changing guidelines and regulations, while at the same time minimizing the risks associated
with a transfer pricing audit.

Enhanced Audit Exposure

Percentage of completed scrutiny assessments resulting in an adjustment (E & Y Survey):

Country No. of cases %of Adj

USA 133 40
UK 110 33
Korea 23 54
Germany 113 41
Belgium 18 28
Canada 56 45

E&Y Transfer Pricing Survey

86% of parent and 93% of subsidiary respondents identified TP as most important

international tax issue

1/3 rd of audits concluded in TP adjustments

Penalty actually imposed in 50% of cases in which penalty threatened by TP

authorities

40% of TP adjustments have resulted in double taxation

It is seen that fixation of TP has become a great headache across the corporations in the globe.
It is ideal to scan through the problematic areas of TP in different countries whether there is
uniformity in the problems and approaches in TP. As case study, countries such as Argentina,
USA, Canada, U.K.,France, Germany, Russia, India, China, Indonesia, Japan and Australia are
taken up to pinpoint thedivergence in dealing TP issues and presented in the Table as shown
below:

40
Divergent approaches in dealing TP issues by different countries across the Globe

Table high lights that there is no uniformity in the applicable variables tested such as legal
position, pricing method applied, documentation and penalty. Each country is having its own
approach and hence it becomes further headache for CG dealing in fixation of TP applicable (or
suitable) in another country. Even, within the same country, the rules and regulations are
confusing and contradicting. This confusion has given rise to many court cases. In order to
stream line the TP regulations, Government of India appointed an Expert Group which drafted
TP regulations.

As per the survey made by Ernst & Young in 2010, 30% of tax directors in parent firms
worldwide identify transfer pricing as their most important tax issue. Ernst & Young's
2010 Survey continues to demonstrate the high degree of importance tax departments assign to
transfer pricing. More parent company respondents identified transfer pricing as the most
important tax issue they face.

41
Most important tax issues for tax directors (parents):

Importance of transfer pricing in the next two years (parents):

IMPORTANCE 2010 2007

Absolutely critical 32% 29%

Very important 42% 45%

Fairly important 21% 18%

Not very important 4% 5%

Not at all important 1% 1%

Comment: 74% percent of parent respondents and 76% of subsidiary respondents believe
that transfer pricing will be "absolutely critical" or "very important" to their organizations
over the next two years.

Percentage of respondents ranking transfer pricing as their most important

tax issue (parents and subsidiaries):
42
Respondents confirm ongoing interest of tax authorities in a small number of concentrated
industries. This will change in the coming years.

Chapter - IV Case-lets Relating to Transfer Pricing

43
 CASE-1 Recent Case of Transfer Pricing- “VODAFONE”

Sr. No. Topics Covered

1. Introduction.

2. Analysis of the Case.

3. Consequences of the Case.

4. Judicial decision on the Case

I. Introduction.
In this case two issues are involved :

i. Taxability of the transaction.

ii. Vodafone’s liability to deduct tax at source.

The income is taxable in India and Vodafone is liable to deduct tax at source. For failing in
its duty to deduct the tax – despite advance warnings, Government is entitled to proceed
against Vodafone.

Since Honourable Supreme Court (SC) has decided differently, today the law prevalent in
India is that the income is not taxable and hence Vodafone is not liable to deduct the tax at
source. In our humble submission, with respect to the Honourable Supreme Court, the
decision is incorrect. Income is taxable & hence Vodafone is liable to deduct tax at source.
This is a best case for retrospective amendment in law. Not doing so has serious
consequences. Wide scale aggressive tax avoidance through tax heavens and their approval
by honourable SC creates a risk of equally wide & harsh tax provisions. These will affect all:
aggressive tax planners as well as honest tax payers.

The main companies involved were as under :

HTIL Hutchison Telecommunications International Ltd. – a company incorporated

in Cayman Island in 2004. It was listed on Hong Kong and New York Stock

44
 Exchanges. It was the seller and earner of Capital Gain.
VIH Vodafone International Holdings BV – a company incorporated in Netherlands.
It was the purchaser of one share of CGP.
CGP CGP Investments (Holdings) Ltd. (CI) – a company incorporated in Cayman
Islands in 1998. It is the company whose share has been transferred.
HEL Hutchison Essar Ltd. – a company incorporated in India. It is the main business
company. Controlling share holding in the same has been transferred by
virtue of Share Purchase Agreement and several related documents. Transfer
of CGP share was one of several documents.

II. Analysis of the Vodafone Case

Normal view / Assessee’s view: A normal view would be that if one non-resident sells
shares of a foreign company to another non-resident of India; and the transaction takes place
outside India, there can be no tax on the same.

Department’s view – in brief: Department’s claim, in essence was: CGP is a nullity, a

sham entity. Transfer of CGP’s shares has no substance. The parties to the transfer
themselves laid bare the real transaction – that of sale of HEL stake.

Real transfer is: The transfer of substantial interest (67% stake) in HEL. This controlling
shareholding has its situs in India. Since the transferred asset is situated in India, the capital
gains arising on the same is liable to tax in India. VIH was therefore required to deduct tax
at source.

Honourable Supreme Court has given a ruling that – only the legal transaction –sale of
CGP share - is to be considered. By selling CGP share, the seller may have transferred its
interests in HEL. However, Indian interest arises due to sale of CGP share. It does not arise
out of the SPA (which recorded the real facts). All the arguments of the revenue were
rejected.

Crux of the matter : Should one simply consider the legal form of the transaction (i.e.,
sale of one share in CGP); or should one consider real form - the entire set of facts as
stated by the parties themselves in the SPA and various other correspondences? Is the
case fit for considering “Substance over Form”? Is the case fit for lifting the Corporate
Veil?

Tax Heavens are designed to help the rich people and MNCs evade/ avoid taxes in regular
countries like India, Germany, France etc. During the American & European financial crisis
(September, 2008 onwards) there has been a huge uproar that these tax heavens are bleeding
the tax revenues of regular countries. Global attempts are being made to curb this tax
evasion and avoidance.

In Vodafone’s case, clearly a series of tax heavens and SPVs have been used to avoid Indian
taxes. By holding this transaction as a tax free transaction, Honourable SC has given a
licence to the tax payers to use tax heavens, abuse treaty shopping and bleed India’s
tax revenue.

Department had presented massive documentary evidence about the real conduct of the
assessee. Correctness of this evidence was admitted by Vodafone before Bombay High
Court. SC has ignored/ glossed over these facts. Vodafone refused to give the Share

45
 Purchase Agreement (SPA) to the department and initially, even to Bombay HC. On
insistence by Honourable SC , Vodafone relented and submitted the document.

SPA establishes beyond any doubt that the assessees themselves had ignored CGP’s
existence. Vodafone & Hutchson’s conduct established that they have directly sold the
67% stake in the Indian Company – HEL.

The issue is : Does the non-resident have sufficient nexus with India? In this case
Vodafone had sufficient nexus and it had agreed to abide by the Indian law. In our view,
Vodafone is liable to comply with Indian TDS provisions.

Conclusion: Hutchison’s income is taxable in India. Vodafone is liable to deduct tax at

source and pay to the Government of India.

III. Consequences of the case

Hutchison’s tax planning, Vodafone’s execution and Honourable Supreme Court’s decision
pause a serious risk to the tax paying people of India. Let us elaborate the risk.
To grasp real impact of this risk, we should consider development of Income-tax Act over
past several decades. Look at the flow, the process of development rather than trying to
interpret an individual section. How simple was the earlier Act, how complex it is now and
how much more complex it will be in near future. Who is responsible for constantly
increasing complexity of the law?

IV. Judicial decision on the Case:

The Bombay high court adjourned the hearing of the Rs.8,500 crore transfer pricing case
involving Vodafone India Services Pvt. Ltd and the Union government to 5 October 2012,
when the court will deliver it’s ruling.

The dispute resolution panel (DRP), which hears appeals in transfer pricing cases, is
simultaneously hearing Vodafone’s appeal against the quantum of tax liability. DRP will pass
an order by 30 September 2012 but has been directed by the high court to keep it in abeyance
until the matter is decided by the court.

In February 2012, through a writ petition, Vodafone challenged the jurisdiction of the
tax department in issuing a draft transfer pricing order that sought to add Rs.8,500
crore to the taxable income of Vodafone.

The income-tax department’s draft transfer pricing order, issued in December 2012, related to
a transaction on Vodafone’s call centre business.
It is to be noted that On 20 March 2012, the SC also dismissed the review petition filed by
the Union of India and the Tax Authority in February 2012. The review petition was filed
on the basis that the Vodafone decision “suffered” from many errors apparent on record and
had failed to consider the case submitted by the Tax Authority.

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The Finance Act 2012 enacted on 28 May 2012 includes a 'clarificatory' amendment
on taxation of such transfer of shares if its value is substantially from assets located in
India. This amendment is effective retrospectively from 1 April 1961. It would thus
appear that the litigation on this issue is far from over.

CASE-2 CIT Vs. Glaxo Smith Kline Asia (P) Ltd

In CIT Vs. Glaxo Smith Kline Asia (P) Ltd. (SC), it so happened that the assessee did not
have any employee other than a company secretary and all administrative services relating to
marketing, finance, HR etc were provided by Glaxo Smith Kline Consumer Healthcare Ltd
(GSKCH) pursuant to an agreement under which the assessee agreed to reimburse the costs
incurred by GSKCH for providing the various services plus 5%. The costs towards services
provided to the assessee were allocated on the basis suggested by a firm of CAs.

The AO disallowed a part of the charges reimbursed on the ground that they were excessive
and not for business purposes which was upheld by the CIT (A). However, the Tribunal
deleted the disallowance on the ground that there was provision to disallow expenditure on
the ground that it was excessive or unreasonable unless the case of the assessee fell within
the scope of s. 40A (2).

It was held that as it was not the case of the Department that 40A (2) was attracted, the
disallowance could not be made. The department challenged the deletion before the Hon’ble
Supreme Court by filing a Special Leave Petition (SLP).

The Hon’ble Supreme Court dismissed the SLP on the following grounds:

a. The Authorities below have recorded a concurrent finding that the said
two Companies are not related Companies under s. 40A (2) and
b. Since the entire exercise was a revenue neutral exercise.

The Hon’ble Supreme Court went a step ahead in suggesting transfer pricing provisions to
domestic transactions to minimize litigation. In the process of giving suggestion, it has
identified specific transactions where transfer pricing provisions should apply in respect of
domestic transactions.

In domestic transactions, the under-invoicing of sales and over-invoicing of expenses

ordinarily will be revenue neutral in nature, except in two circumstances having tax
arbitrage such as where one of the related entities is ;

(i) loss making or

(ii) liable to pay tax at a lower rate and the profits are shifted to such entity

With this suggestion from the Hon’ble Supreme Court, the Finance Minister has introduced
the transfer pricing provisions in respect of specified domestic transactions as well.

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SOME OTHER CASE- STUDIES SHOWING THE EFFECTS OF
TRASFER PRICING:
CASE LAW: 1 Commissioner Income Tax vs. EKL Appliances Limited
(Taxpayer)
The Delhi High Court, in its ruling on the case of Commissioner Income Tax vs. EKL
Appliances Limited (Taxpayer), has given its decision on the transfer pricing aspects of a
royalty payment by the Taxpayer to its associated enterprise. In its judgment, the High Court
ruled that royalty payments cannot be prohibited on instances of continuous loss where the
spending was proven to be incurred wholly and exclusively for the purpose of the business of
the Taxpayer.

The honorable High Court said that it is not for the tax authorities to inquire into the
commercial feasibility of a transaction. While ruling in favour of the EKL Appliances, the
honorable High Court observed that it is suitable to rely on the OECD Transfer Pricing
Guidelines to evaluate the situation adopted by the Tax Authority, since these guidelines have
been recognized in the tax jurisprudence of India.

Relying on the OECD Transfer Pricing Guidelines, the honorable High Court stated that re-
characterization of lawful business transactions by the tax authorities is not allowed.

Background of the case

EKL is a subsidiary of AB Electrolux Sweden involved in the business of manufacturing
refrigerators, washing machines, comprressors and spares thereof, and dealt in all these items
as well as microwave ovens, dishwashers, cooking ranges, and air conditioners. During the
applicable evaluation years, EKL had entered into a range of worldwide transactions
including the payment of royalty. Except for the brand fee/royalty paid by EKL to its out of
country associated enterprises, the transfer pricing officer (TPO) acknowledged all the other
transactions to be at arms length. The TPO illustrated that EKL had been again and again
incurring huge losses and, as a result, the benefits received by EKL from the payment of
brand fee/royalty were inquired by the TPO.

Reasons of loss
The honorable High Court held that even on the merits of the case, the disallowance was not
acceptable as the Taxpayer had provided numerous substance and valid reasons as to why it
was suffering losses. The honorable High Court also stated that full explanation supported by
facts and figures were given by the Taxpayer to reveal that the increase in employee costs,
finance charges, administrative expenses, depreciation costs and capacity increases had
contributed to the continuous losses.

The taxpayers have been facing a tough time to state that the losses are commercial in nature
and not the result of transfer pricing. In few cases, the tax authorities need taxpayers to show
the economic and commercial benefits resulting from the use of intangible property owned by
the associated enterprises. There is repeatedly a propensity to gauge the advantage having
regard to the profitability of the intangible property user.

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The ruling also emphasizes the significance of maintaining credentials that outline the non-
transfer pricing issues such as start-up or market access strategies, downturns in the business
cycle, the materialization of more competition or new technologies in the market, or
unfavourable economic conditions that have contributed to losses.

The honorable High Courts position to the OECD Transfer Pricing Guidelines and the courts
acknowledgement of the significance of the guidelines has also been received in a positive
way in light of the new account that the Indian government has expressed its difference with
the use of the OECD Transfer Pricing Guidelines by the United Nations as it does not take
into account the issues of developing nations.

CASE- LAW: 2 ABUSE OF THE TRANSFER PRICE: A SCANDAL IN

ZAMBIA

Is it possible that mere accountants have become the most successful money launderers
in the business world, far ahead of other traffickers? In an analysis of the audit reports
concerning Zambian mines in Mopani, several financial methods used by the shareholders
raises questions about the quality of international regulations.

In summary, Glencore International AG and First Quantum Minerals Ltd have been
accused of using the following accounting strategies to conceal their true records:

 Overstating their operational costs: In 2007 alone, auditors estimated the cost at $381
millions (Out of $804 million).
 Understating the amount of copper production: The revenue data from the Mopani mines
states that it’s producing at half the rate in comparison to other mines in the area.
 Manipulating the transfer price: Between 2003 and 2008 auditors estimated $700 million
were lost, which is suspicious when compared with traditional accounting practices.
Those three maneuvers have a common objective: pay the least amount of taxes as possible
by leveraging the differences in international tax rules. Yet it has been 15 years since the
OECD blew the whistle that these large companies are manipulating the transfer price. The
rule is simple: if these exchanges are in line with the market price, they are legal – if they
are over or under the international market price, then they are illegal. The OECD refers to
this as the arm’s length principle.

CASE LAW: 3 Maruti Suzuki India Ltd. vs ACIT [2010]

Brief Facts:
 The assessee-company (Maruti) was engaged in the business of manufacture and sale
of automobiles, besides trading in spares and components of automotive vehicles.
 Maruti, entered into a licence agreement with Suzuki with the approval of the
Government of India for using the trademark Suzuki.
 As per the terms of the agreement Maruti would use the logo of Suzuki on certain
models of cars manufactured.
 Maruti was paying royalty to Suzuki for the use of the logo.
 Department considered this transaction as a sale of the logo of Maruti to Suzuki.
49
  Maruti had in turn spent over 4092 crores towards advertisement cost. Depar tment
added a mark up of 8% over the expenditure and determined a sum of Rs 4420
crores as deemed sale consideration.
 Department also held that Maruti was indirectly promoting the brand of Suzuki and
was not being compensated by Suzuki for the purpose.
After much deliberation the Transfer Pricing Officer held that:
 Trademark Suzuki which was owned by Suzuki Motor Corporation, had
piggybacked on the Maruti trademark, without payment of any compensation by
Suzuki to Maruti.
 The trademark Maruti had acquired the value of super brand, whereas the trademark
Suzuki was a relatively weak brand in the Indian market and the promotion of the co-
branded trademark Maruti Suzuki had resulted in impairment of the value of Maruti
trademark.
 Maruti had paid certain royalty to Suzuki in the relevant year and since it did not give
any bifurcation of the royalty paid to Suzuki towards licence for manufacture and use of
trademark, the TPO apportioned 50 per cent of the royalty paid to the use of the
trademark on the basis of findings of piggybacking of Maruti trademark, use of
Maruti trademark on co-branded trademark Maruti Suzuki, impairment of Maruti
trademark and reinforcement of Suzuki trademark through co-branding process.
 The arm‘s length price of royalty paid by Maruti to Suzuki was held as nil using CUP
Method.
 He also held that Maruti had developed marketing intangibles for Suzuki in India at its
cost and it had not been compensated for developing those marketing intangibles for
Suzuki.
 He also concluded that non-routine adver tisement expenditure amounting to Rs.
107.22 crores was also to be adjusted.
Upon a writ petition filed by the assessee with the High Court of Delhi, the Hon‘ble High
Cour t held that:
If a domestic entity, which is an associate enterprise of a foreign entity within meaning
of section 92A, uses a foreign trademark and/or logo on its products or on containers,
packaging, etc., manufactured and/or sold in India, no payment to foreign entity on account
of such use is necessary in case use of foreign trademark and/ or logo is discretionary for
domestic entity.

However, if such domestic entity is mandatorily required to use foreign trademark

and/or logo on its products and/or containers, packaging, etc., appropriate payment in
this regard should be made by foreign entity to domestic entity, on account of benefit it
derives in form of marketing intangibles obtained by it from such mandatory use of its
trademark and/or logo.

Where expenditure incurred by a domestic entity, which is an associate enterprise of a

foreign entity, on advertising, promotion and marketing of its products using a foreign
trademark/logo does not require any payment or compensation by owner of foreign
trademark/logo to domestic entity on account of use of foreign trademark/logo in
promotion, advertising and marketing under taken by it, so long as expenses incurred by
domestic entity do not exceed expenses which a similarly situated and comparable
independent domestic entity would have incurred.
50
 However, where expenses incurred by domestic company are more than what a
similarly situated and comparable independent domestic entity would have incurred,
foreign entity needs to suitably compensate domestic entity in respect of advantage
obtained by it in form of brand building and increased awareness of its brand in
domestic market.

Where in cases where foreign company is liable to pay to domestic company on account
of benefit it derives in form of marketing intangibles obtained by it from mandatory use of
its trademark and/or logo or in respect of advantage obtained by it in form of brand
building and increased awareness of its brand in domestic market, TPO needs to
determine arm‘s length price in respect of international transaction made by domestic
entity with foreign entity taking into consideration all rights obtained and obligations
incurred by two entities including advantage obtained by foreign entity.

The decision was eventually in favour of the assessee.

Chapter - V Transfer Pricing & Customs

51
Both customs and transfer pricing rules designed to reach arm’s length value, but diverse end-
result creates ambiguity in the manner in which the assessee should report values under the
Customs and the Transfer Pricing.

TP & Customs - Need for harmonious analysis

52
 Chapter - VI Management Control, Execution Constraints & Adequate
Measures for Implementation of transfer pricing
As we know that the following are the objectives of transfer pricing:

Goal Congruence

Performance Appraisal

Division Autonomy

In reality , it is difficult to simultaneously meet all these objectives.There may be the

situation of excess capacity in the industry . It would not be prudent for the selling profit
center to sell to the external market when there is excess industry capacity . However due to
this excess industry capacity the buying profit center would want to buy from external
market to reduce its costs rather than procure the resources available within the
organization. As a result if divisional autonomy is to be retained and transfer prices are
considered for performance appraisal the objective of goal congruence may not be achieved:
 For the organization operating in many countries, internal transfer pricing can be a
determinant of where profits are to be declared and taxes paid.
 The fact that the different countries have different tax and exchange rates has to be
taken into consideration in case of transactions with sister concerns that supply
intermediary products.
 The transfer pricing should enable multinational corporations to minimize tax
liability.

Factors affecting transfer pricing

With the government across the world tightening taxation regulations for import-exports
and foreign exchange remittance , many organization are setting up specialized in house
transfer pricing departments rather than leaving the function to taxation or accounts
departments. Some of the conditions which are necessary for the development of a proper
transfer pricing mechanism are:-
 Role definition
 External advisor
 Competent manager
 Equity
 Information on prevailing market prices
 Proper investment.
1. Role definition:- the role and scope of the team responsible for transfer pricing should
be clearly defined. There should not be any confusion about the functions of the
transfer team. There should be clear demarcation of activities between the transfer
pricing team and the accounts and taxation teams and a document setting out each

53
 team’s responsibility should be circulated to all those involved. This also ensure that
all the necessary tasks are allocated.
2. External advisor:- when necessary the organization must be ready to appoint
external adviser whose knowledge and experience will be valuable to the transfer
pricing team and who can provide resources not available in house. He will help the
organization to see the bigger picture, which in house team may not be able to do.
3. Competent managers:- organization need mangers who can balance long –term and
short term goals . Managers are often accused of sacrificing the long-term gains for
short-term profits. This approach can prove to be disastrous for the organization.
Transfer pricing can be misused for manipulating profits and this gives a wrong picture
of the organization’s position. Hence the organization should have competent people
skilled at negotiation and arbitration, who are capable of determining the appropriate
transfer prices such that long term goals are not sacrificed for shot term gains. There
must be a mechanism for negotiating contracts and the managers who take transfer
pricing decisions should be trained in art of negotiation.
4. Equity:- in order to achieve goal congruency, mangers of profit centers , especially
the buying profit centers, should ensure that the transfer prices charged by the selling
profit centers are fair. This will create atmosphere of trust between the sister concerns .
The managers of the selling profit centers should be give the freedom to sell their goods
in the external market , while mangers of the buying profit centers should have the
option of buying their goods from the external market. The market will thus become the
main determinant of the transfer price.
5. Information on prevailing market prices:-when the product is transferred from one
profit center to another, the normal market price for an identical product can be taken as
basis for establishing the transfer price. While taken the market price of identical
product as a reference , the quality and quantity of the reference product should be
identical to those of product whose transfer price is to be fixed. Demand and supply in
the market during the time of delivery should also be considered. As the product is sold
within the organization , the expenses on advertising and marketing are lower and the
market price can be adjusted to reflect the saving that accrue due to these lower
expenses. Manger should be fully aware of market conditions and should have all t he
necessary information regarding available options and the cost and revenues of each ,
before they take any decision on whether to purchase from outside suppliers or to resort
to in-house sources.

6.Proper investment:- the transfer pricing department must be well funded and should
coordinate well with other departments in the same organization, the transfer pricing
departments of other business units as well as the top management. It is very important
for the enterprise to comply with transfer pricing jurisdiction and to maintain
documentation of transfer pricing in order to deal satisfactorily with any legal issues that
may arise.

Constraints while determining the transfer price

A. External Constraints
54
 These are the constraints which are imposed by the external environment .like
government regulations, climate conditions and those which cannot be controlled by
the organization are called external constraints. Some of these constraints are :-
1. Limited market:-the market for buying and selling the goods of the profit center
may be either very small or even nonexistent. in case of MNC’s , if intra –
organizational trade take place between the divisions or subsidiaries in different
countries, the interest of the organization may be in conflict with the interests of one
or more of the countries. In such cases also the options for the organization to source
internally become limited.
Eg. Consider an organization in US that wants to buy an intermediate product
from its sister concern in UK at a transfer price that is much lower than the
market Price . This transaction will record a very low or even zero profit for the
organization in the UK and thus will reduce its tax liability. Therefore the UK
government might not allow this transactions below market price. In such as case ,
the organization in the US will have no option but to pay a price closer to the market
price.
2. Excess or shortage of industry capacity:- there may be a situation of excess
capacity or shortage of capacity in the industry in which an organization operates. In
such a situation the business unit may not consider all opportunities available to
them.
An example of this situation is when there is a shortage in the industry and the
buying center is not able to procure form outside because the price in the market is
high whereas the selling profit center is selling in the outside market.
The reverse is the situation occurs when there is excess capacity in the industry. The
buying profit center may purchase form outside vendors even though there is
capacity available within the organization.
When there is an excess or shortage of industrial capacity , the sourcing decisions
taken by the organization are of critical importance. An organization may allow its
buying profit center to buy goods from outside if it is getting better deal in terms of
quality, price and service. Similarly a selling profit center may be allowed to sell its
products in the open market if it gets a higher profit by doing so. Otherwise the
organization may appoint a central body to arbitrate on such issues. Whatever be the
case the management should try to take decisions that optimize the profits of the
organization.
B. Internal Constraints
The constraints imposed and controlled by the organization itself are called internal
constraints. An internal constraints may arise when the existence of excess internal
capacity forces the buying division not to purchase from outside sources. Another
situation where an organization makes a significant investment facilities , then it will not
buy the goods from outside sources even though the outside capacity exist.
Because of these constraints , it is very difficult to implement a perfect transfer
mechanism in an organization. So management should be forced to set a cost based price,
which is acceptable to both the selling and buying centers as a transfer price.
The Way Forward
1. Introduction of APA is a positive move towards bringing in a progressive dispute
resolution mechanism However, its success depends upon :

55
  How efficiently and expeditiously it is executed
 Its practical effectiveness
 Confidentiality of the tax payers
 Flexible approach of tax authorities
 Technical competence of APA team
 Competence and capabilities of the consultants/representatives
 Process should be fair and transparent

 Pre-filing application on anonymous basis is likely to give adequate comfort

to the tax payers

2. Taxpayers should recognize that they need more resources with increased geographic
reach and some non-traditional skills. For example, experience with bargaining
theory would help to deal with what the OECD calls “options realistically available.”

3. Companies should pursue tax certainty and evaluate APAs and rulings more than

ever to better manage the growing geographic footprint of transfer pricing

requirements, as well as the additional risk of adjustments and penalties.

4. Companies should continue to adopt new approaches to consistent global

documentation and benchmarking to remain efficient and cost-effective when

preparing transfer pricing documentation.

In a nutshell for an effective Implementation of transfer pricing laws and practices

following should be kept in mind:
 Emphasis on robust documentation
 Emphasis on CUP- should be thoroughly examined before accepting / rejecting
 Surrounding evidence also helpful, for e.g. transactions with other AE’s of the
same MNC Group
 Support entity level TNMM analysis at a transactional level
 Corroborate with a gross margins analysis wherever possible
 Document the search process on database carefully

 Undertake alternate sensitivity analysis under alternate scenarios to fortify the

documentation

Findings of the Study

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1. DANGER OF DOUBLE TAXATION: With introduction of “Specified
domestic transaction provisions”, transfer pricing regulations will now applicable
to all taxpayers including Individuals, Hindu Undivided Families (HUFs).
Assesses will need to evaluate intra-group transactions with greater detail and
will in turn also increase the administrative and compliance burden for the
taxpayer in respect of such transactions. Further, if excessive or unreasonable
expenses are disallowed in the hands of tax payer at time of the assessment then
corresponding adjustment to the income of the recipient will not be allowed in the
hands of recipient of income. Hence, it may lead to double taxation in India
.

2. OPPORTUNITY OF TAX ARBITRAGE: It is important to note that the

Hon’ble Finance Minister has promptly acted upon the suggestion of the Hon’ble
Supreme Court but hasn’t considered the exceptions carved out by the Supreme
Court in entirety. Instead of applying transfer pricing provisions only in respect of
transactions having tax arbitrage, it has been applied on every transaction of
income or expenditure entered into by associated enterprises. Therefore, one has
to see whether the Finance Minister comes out with a clarification that the transfer
pricing provisions will be applicable only to transactions entered into with
persons covered u/s 40A(2)(b) where the assessee has a tax arbitrage or not.

3. LACK IN FRAMING APA RULES: Critical Assumptions are not elaborated

in the APA rules. Critical assumptions should be articulated well and should be
set in a broad manner so as to ensure that every small change in the facts should
not lead to cancellation or revision of an APA.

4. INCREASE IN DOCUMENTATION BURDEN: As transfer pricing standards

have spread beyond the relatively mature markets in the Americas and Western
Europe to more controlled or mixed economies, the arm’s-length standard
continues to hold sway. In fact, there is considerable consistency across countries
in claiming to apply the arm’s-length standard, including years of analysis,
prioritization of methods and views on comparables adjustments.

5. INCREASING BENCHMARKING BURDENS: The viral spread of transfer

pricing requirements poses a new challenge when taxpayers are called upon to
perform benchmarking studies for countries where public reporting of company
financial data is limited or non-existent. Based on our study, it is confirm that tax
authorities have taken a flexible approach to assessing geographic comparability.
One clear finding from the study is that tax authorities do not typically view
technical economic adjustments to comparables as a method of accommodating
geographic differences between comparables and tested parties.

6. LITTLE CO-ORDINATION OF TRANSFER PRICING & INDIRECT TAX

STANDARDS: Although information sharing in general has increased, there is
still only limited coordination and information sharing between the transfer
pricing and indirect tax practices of individual tax authorities, as well as few
official requirements that indirect tax valuations conform to those for transfer

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 pricing . According to our study, only approximately one-third of survey
(conducted by E&Y ) respondents reported cooperation between transfer pricing
practices and their indirect tax counterparts.

7. TARGET HIGH-PROFIT INDUSTRIES & MAJOR TRADING PARTNERS:

Transfer pricing reviews target high-profit industries and major trading partners,
rather than tax heavens specifically. Tax authorities continue to target sectors that
typically report high margins and rely on significant intangible assets, such as the
pharmaceutical industry, or that rely on significant international content in their
production, such as the automotive industry. Consumer products are also an area
of emphasis, perhaps because of the industry’s economic importance and the
thorny issues and differing views on so-called “marketing intangibles.”

8. PENALTIES BECOME MORE FERQUENT & ONEROUS: The imposition of

penalties is increasing, but, surprisingly in light of government revenue shortfalls,
penalties are still applied infrequently in some jurisdictions. Most penalties
remain at a level of 25% or less of the increased tax. . Jurisdictions that impose
penalties for failure to prepare documentation itself or that require
contemporaneous documentation for relief from penalties remain the exception.

9. LACK OF MUTUAL AGREEMENT PROCEDURE: Mutual agreement

procedure (MAP) remains the predominant means of resolving transfer pricing
disputes, and nearly all jurisdictions report that MAP claims are ultimately
resolved without double taxation. Although they are in general ultimately
successful, MAP claims can be lengthy. Litigation and arbitration remain
exceptional means of resolving transfer pricing disputes. Only Argentina, Brazil,
India, Sweden and Venezuela reported a significant use of litigation to resolve
transfer pricing disputes, and only France reported a significant number of
arbitration procedures.

10. HEADACHE TO CORPORATE GOVERNANCE: It has been identified that

CG behavior has a powerful effect on market value in a country where legal and
cultural constraints on corporate behavior are weak and thereby there will be
further headache when dealing with the TP. Suppliers of finance to corporation
require return and the return could be available from the balance profit after tax.
This system added to the problems of CG as less tax (no tax),more return and vice
versa.

CONCLUSION
This past year we have witnessed increased scrutiny of multinational corporations’ transfer
pricing policies by both government stakeholders and the general media. In an attempt to get
multinational corporations’ transfer pricing policies to conform more with the substance of
the law, many countries have engaged in more aggressive auditing activities and passed
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legislation to close existing loopholes. However, despite the changing landscape, transfer
pricing remains the same at its core. Ultimately, transfer pricing is still examined through the
prism of the arm’s length principle—evaluating intercompany transactions by looking at what
third parties would charge in a similar arrangement.

It is widely recognized that transfer pricing can provide excellent tax saving opportunities but
it can also give rise to significant compliance issues. The current global business environment
has created issues for groups such as restricted cash flows, decreased and reduced credit
availability. Transfer pricing solution can play an important role in addressing these issues.
Fiscal authorities are under tremendous pressure to maintain tax receipts in the current
environment increasingly recognize Transfer Pricing possibilities for revenue raising
purposes. There has been a rapid growth in the number of jurisdiction expanding their
transfer pricing capabilities by introducing new legislation and recruiting specialist auditors.

Businesses need to take action to address Transfer Pricing compliance risks or face potential
exposure to challenges which can cost considerable amounts in terms of management time
and reputation as well as additional tax liabilities and penalties. Utilizing opportunities
provided by transfer pricing can provide benefits such as:

 A lower effective tax rate

 Relief for standard losses
 Better cost control
 Improved cash flow

There are a number of documented cases of companies, both U.S. and foreign, deemed to
have underpaid taxes in the U.S. Some of these cases reflect obvious attempts by companies
to evade U.S. taxes by manipulating transfer prices. So , there is a worldwide trend toward
strengthening transfer pricing rules. India has been the most active nation in terms of both
transfer pricing and permanent establishment guidance. The guidance is certainly being
reviewed by many jurisdictions to dealing with similar issues by tax authorities located
elsewhere outside of India.

In summary, with the understanding that tax authorities around the world are increasingly
looking to transfer pricing as a potential source of revenues, taxpayers should ensure that they
have the best protection available through proper documentation. Taxpayers can no longer
wait until audit to prepare comprehensive defensive positions on their global transfer pricing
policies. Proactive analysis and documents will save time and money upon audit. This
phenomenon is gradually becoming more complicated as many countries have their own
specific Transfer Pricing legislation. As a result, the tax authorities in these countries apply
rigorous Transfer Pricing adjustment policies. Therefore many multinationals regard Transfer
Pricing as the most important international tax issue.

REFERNCES & BIBLIOGRAPHY

BOOKS:

1. Chandrasekhar C.P. and Purkayastha P., "Transfer Pricing in the Indian Drug Industry:
An Estimate and its Implications", Social Scientist.

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 2. Lall S., "Transfer Pricing by Multinational Manufacturing Firms", Oxford Bulletin of
Economics & Statistics
3. B. Kate. Tax Watch on Transfer Pricing. BRW,
4. Direct tax for C.S Final by Sanjay Mundhra, published by book corporation
5. Direct tax for C.S Final by Vinod Kr. Singhania, published by taxmann.
6. CA Final materials Issued by ICAI

JOURNALS & ARTICLES:

1. Tax journals.
2. Extracts from the Finance Bill 2012
3. OECD. The TP Guidelines for Multinational Enterprises Centre for Tax
Administration. 2010
4. http://www.transferpricing-india.com/newsletter-april-2012.
5. Maruti Suzuki India Ltd (MSIL), Delhi High Court Case, New Delhi, July 6, 2010
6. Recent Amendments from CA club India

SURVEYS REPORT:

1. Ernst & Young Global Transfer Pricing Survey Report 2003, 2010 & 2012
2. Deloitte Global Transfer Pricing Survey Report 2009 & 2010
3. Global Transfer Pricing Review - KPMG
4. Survey Supplements from BDO Haribhakti

WEBSITES:

1. www.incometaxindia.gov.in
2. www.mazars.com/tp/2010.html
3. wirc-icai.org/wirc_referencer/.../Transfer%20Pricing.htm
4. www.pwc.com/gx/en/tax/transfer-pricing/index.jhtml
5. www.grantthornton.in/html/gt_insight/tag/transfer-pricing-in-india/
6. www.icsi.edu
7. www.taxmann.com/articles/transferpricing.html
8. www.kpmg.com/.../Lists/.../global-transfer-pricing-review-2011

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