1. International accounting
INTERNATIONAL TRANSFER PRICING

3. Transfer Pricing in India- Background
Prior to April 1, 2001
Basic provisions existed but were rarely applied
Expert Group set up in November 1999 to study global transfer pricing practices
April 1, 2001 onwards
Comprehensive legislation introduced in Union Budget 2001
Detailed Rules providing guidance for application of the legislation framed

4. TRANSFER PRICE REGULATIONS
International
OECD formulated “Guidelines on transfer pricing”. They serve as generally accepted practices by the tax authorities
India
The Finance Act introduced the detailed TPR w.e.f. 1st April 2001
The Income Tax Act
AS-18
Other Relevant Acts

5. Transfer Pricing Background
Transfer pricing is the determination of price on the exchange of goods or services between related parties.
These transfers are also referred to as intercompany transactions.
Upstream transfers go from subsidiary to parent, downstream transfers are from parent to subsidiary.
Transfers also occurs between different subsidiaries of the same parent.
A significant proportion of international transactions are intercompany transfers.

6. of TRANSFER PRICING
A price between unrelated parties is known as the “arm’s length” price
Transfer Pricing refers to pricing of international transactions between two associated enterprises (AEs)
Due to special relationship between related parties, transfer price may be different than the price that would have been agreed between unrelated parties

7. DEFINITION
Transfer price is the price established for goods and services sold by one division of the organisation to another division of same organisation. According to HORNGREN & FOSTER The Transfer Price is the price one segment of organisation (sub unit, department, division) charges for product or service supplied to another segment of same organisation. The modern view of Transfer Price is inter company transfers between affiliates.

8. OBJECTIVES WORLDWIDE TAX MINIMISATION REDUCING IMPORT DUTIES
MANAGEMENT OF CURRENCY FLUCTUAION

9. Applicability
The provisions of Section 92 to 92F of the Act are applicable only if:
There are two or more enterprises (defined in Sec 92F)
The enterprises are Associated enterprises (defined in Sec 92A)
The enterprises enter into a transaction (defined in Sec 92F)
The transaction is an International transaction (defined in Sec 92B)
Consequences of these provisions:
Computation of income/ expenses having regard to the Arm’s length price (Section 92(1))
Maintenance of prescribed Documentation (Section 92D & Rule 10D)
Obtaining of Accountant’s report (under Form 3CEB) (Section 92E)
To ensure compliance with the arm’s length principle, stiff Penalties have been prescribed

11. Concept Associated enterprise Independent entity
International transactions
- goods
- services
- intangibles
- loans
Resident
Resident
Transfer price
Arm’s length price

12. ASSOCIATE ENTERPRISE: 92A
Direct Control/Control through intermediary
Holding 26% of voting power
Advance of not less than 51% of the total assets of borrowing company.
Guarantees not less than 10% on behalf of borrower
Appointment of more than 50% of the BOD
Dependence for 90% or more of the total raw material or other consumables

13. Meaning of Associated enterprises (Section 92A)
Direct or indirect participation (through one or more intermediaries) in management, control or capital A
Both A and B are associated enterprises of C B C A D
D and E are also associated enterprises of C since they have a common ultimate parent (A) B E C

14. INTERNATIONAL TRANSACTIONS: 92B
Transactions between two or more associated enterprises, either or both of whom are non-residents
Transaction relates to
purchase, sale or lease of tangible or intangible property; or
provision of services; or
lending or borrowing money; or
any other transaction having a bearing on the profits, income, losses or assets of the enterprises; or
mutual agreements or arrangements for allocation or apportionment of, or any contribution to, any cost or expense incurred

15. RELATED PARTIES
As per Accounting Standard 18, Requires disclosure of ‘any elements of the related party transactions necessary for an understanding of the financial statement
Control by ownership
50% of the voting right
Control over composition of board of directors
Power to appoint or remove the directors
Control of substantial interest
20% or more interest in the voting power

16. ARM’S LENGTH PRICE
Price which two independent firms would agree on.
Price which is generally charged in a transaction between persons other than associated enterprises.

17. FACTORS AFFECTING TRANSFER PRICING
Performance Measurement
Evaluation
Internal factors
Accounting Standard
Custom Duty
Currency Fluctuations
Risk of Expropriation
Income Tax
External Factors

18. HEADQUARTERS SETUP TRANSFER PRICE TRANSFER PRICE SENT TO DIVISION
BASED ON TRANSFER PRICE, DIVISION REPORTS BACK TO HEADQUARTERS WITH THE DEMAND

19. SIGNIFICANCE OF INTERNATIONAL TRANSFER PRICING
Promotes goal congruence and sustained high level of management effort.
It has become an important area of multinational corporate policy.
Management gurus have suggested MNCs that if they have MANAGEMENT problems then MBO, Divisionalisation & Decentralisation are the only solutions.
Transfer pricing is part of DIVISIONALISATION
It helps in evaluation of the performance of each division.
It also helps to guide managers to take best possible divisions.

20. APPROACHES TO TRANSFER PRICING
ECONOMIC ANALYSIS
MATHEMATICAL PROGRAMMING
LINEAR PROGRAMMING
DECOMPOSITION PRINCIPLE
QUADRATIC PROGRAMMING
CONVENTIONAL ACCOUNTING MEASURES OF COST

21. Performance Evaluation, Cost Minimization, and Transfer Pricing
Performance evaluation systems
Transfer prices directly affect the profits of the divisions involved in an intercompany transaction.
Some performance evaluation systems are based on divisional profits.
The effectiveness of these performance evaluation systems is influenced by the fairness of transfer prices.
The effectiveness of performance evaluation systems affects the satisfaction of managers.

22. ECONOMIC ANALYSIS
Problem of interdivisional transfer pricing was solved by implementing techniques and tools of micro-economic analysis by HIRSHLEIFER in 1956.
He said that there are two independent profit centres in a firm i.e. manufacturing division and the distribution division, each wants to maximise the profits.
Both are to work under the rules and restrictions of overall management
He gave a conclusion that in a COMPETITIVE MARKET, marginal cost pricing would be appropriate in producing Goal Congruent Results. But in the imperfect market it would not be suitable.
OPERATIONAL PROBLEMS:
Feasibility of computations
Constraints
No divisional autonomy

23. CONVENTIONAL ACCOUNTING METHODS
ACCOUNTING MEASURES OF COST
COST BASED METHOD
TRUE COST
MODIFIED COST
STANDARD COST
PARTIAL COST
MARKET BASED METHOD
MODIFIED MARKET PRICE
MISCELLANEOUS
NEGOTIATED
TARGET
DUAL

24. Sale of Tangible Property
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 are acceptable.
If an uncontrolled transaction is not exactly comparable, an adjustment is allowable.

25. 1. COST BASED METHOD
THIS METHOD IS SUITABLE :
Most appropriate when comparable uncontrolled transactions don’t exist and sales subsidiary does more than simply distribute finished goods.
Transfer price is determined buy 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.
Form of cost
Full cost
Modified full cost
Standard cost
Partial cost

26. Transfer price can be determined by using any form of cost
Transfer price can be determined by using any form of cost. (A) FULL COST This method of transfer price takes into account the total cost i.e. direct and indirect costs, fixed as well as variable. This method is very simple, easily available & determined in exact terms. (B) STANDARD COST This main reason for using the standard cost is that the inefficiencies of the selling division are passed on to the buying division in form of inflated prices. But if standard cost is used then it will help to reduce this short-coming.

27. (C) PARTIAL COST As the name suggests, it can never be the full cost
(C) PARTIAL COST As the name suggests, it can never be the full cost. So in simple terms, partial is the cost of the unit transferred but it does not cover all the costs. This means only the part of cost is considered like the variable costs. (D) MODIFIED COST Many modifications in the cost can be done to determine the transfer price. So under this model, the product or service is charged by an inflated price. The addition is a fixed amount per unit or a percentage of cost

28. Cost Plus Method Sum arrived above is taken to be arm’s length price
Identification of direct and indirect costs of production incurred in tested party transactions
Identification of normal gross profit with reference to uncontrolled transaction(s)
Normal gross profit adjusted to account for functional and other differences if any
Adjusted gross profit added to total costs identified in step 1
Sum arrived above is taken to be arm’s length price

29. Sale of Tangible Property
Cost-plus method
Learning Objective 5

30. 2. MARKET PRICE METHOD
Market price based on
Price of semi-finished product
On the price of ultimate market price
Market price can only be used when intermediate market exists for the product or service. Selection of market price can solve the problems of the cost based methods. Transfer price based on market price is fair, objective measure of value of product transferred.

31. Sale of Tangible Property
Comparable profits method
Underlying principle is that similar companies should earn similar returns over a period of time.
One of the two related parties in the transactions is chosen for examination.
Transfer price is determined via reference to an objective measure of profit of an uncontrolled company involved in comparable transactions.
Typical measures of profit include: ratio of operating income to operating assets, and operating income to sales.
Learning Objective 5

32. Sale of Tangible Property
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.
Learning Objective 5

33. Sale of Tangible Property
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.
Learning Objective 5

34. Profit Split Method-Rule 10B(1)(d)
Appropriate for transactions which are not capable of being evaluated separately
Calculates the combined operating profit resulting from a whole inter-company transaction based on the relative value of each associated enterprise's contribution to the operating profit
The contribution made by each party is determined on the basis of a division of functions performed, valued, if possible using external comparable data
Applicable for analysing tangible, intangible or services issues

35. Profit Split Method
Determination of combined net profit of the associated enterprises arising out of international transaction
Evaluation of relative contributions by each enterprise on the basis of functions performed, risks assumed and assets employed
Splitting of combined net profit amongst enterprises in proportion to their relative contributions
Profit thus apportioned to the tested party is used to arrive at the arm’s length price

36. 3. OTHER METHODS Negotiated price-
As the name says, it is the price settled after the bargaining between the selling and the buying division.
Target Profit Price-
Under this method, the transfer price is so formed to provide a reasonable profit to the selling divisions say 10% of the standard costs r actual costs.
Dual pricing –
Sometimes in an organisation, it is not possible to have single transfer price for meeting goal congruence divisional autonomy and management effort then those organisation resort to dual pricing method.
OTHER METHODS
Negotiated price
Target profit price
Dual pricing

37. CONDITIONS FOR CHARGING LOW OR HIGH TRANSFER PRICE
Corporate tax rate
Inflation rate
Ad valorem tariffs
Political stability
Export subsidy or tax credit on value of exports.

38. ACCOUNTING ISSUES IN INTERNATIONAL TRANSFER PRICING
SEGMENTAL ACCOUNTS WERE NOT MANDATORY IN INDIA TILL 2001.
COMPARABILITY IN SPECIAL CIRCUMSTANCES
LEGAL ISSUES IN TRANSFER PRICING:
The main legal issue is the taxation related to transfer price. With the growth in the volume of intrafirm trade, the transfer pricing practices of the MNCs have come under the taxation authorities.

39. ADVANCED PRICING AGREEMENTS
MNCs have adopted a mechanism known as the Advances Pricing Agreement (APA) to settle the disputes with tax authorities.
An APA is an agreement between the company and a tax authority under which the company can use a specified method of transfer pricing for a fixed term which shall be accepted by the tax authority.
Such agreements are formal and has set terms and conditions.
Apple computer was the first company to enter into such an agreement in early 1991.

40. Problems faced while setting the Transfer Pricing
Determination of Arm’s length price (ALP)
Bench marking
Data bases
Allegation of Dumping
Sub Optimal Decision Making

41. TRANSFER PRICING IN INDIA
Legal Status- The finance Act 2001 introduces with effect from assessment year detailed transfer pricing regulations vide Section 92 to 92 F of the income tax Act The CBDT has come out with Transfer Pricing Rules-Rule 10 A to 10 E.
Applicability- Transfer pricing provisions are applicable based on some criteria:
There must be an international transaction.
Such transaction must be between two or more
associated enterprises either or both of whom are non-resident.
Comparable Uncontrolled Price
Resale Price Method
Cost Plus Method
Profit Split Method
Transactional Net Margin Method

42. DOCUMENTATION IN INDIA
13 different types of documents are required to be maintained in India which can be categorised into three parts:
Enterprise wise documents
Transaction specific documents
Computation related documents
PENALITIES IN INDIA
Penality for concealment of income or furnishing inaccurate particulars thereof 100% to 300% of the tax sought to be evaded.
Penality for failure to keep and maintain documents in respect of international transaction is 2% of the value each transaction.
Penality for failure to furnish report under sec 92E is Rs. 1,00,000

43. Trend visible in annual reports of companies in India
Amount transferred in crores
Reliance Industries Ltd.
988
Ballarpur Industries Ltd.
194
Century textiles Ltd. 23
Asian Paints (1) Ltd. 10

44. OVERALL MANAGEMENT
DIVISION
MAXIMISE PROFIT
MANUFACTURING
DISTRIBUTION

45. THANK YOU