1. Overview of Transfer Pricing Regulations in India CA Jinesh R. Bhagdev J. B. Nagar CPE Study Circle

2. Contents Background Identification of Associated Enterprises Identification of International Transactions / Specified Domestic Transactions Functional, Assets and Risk Analysis Methods and Selection of the Most Appropriate Method

3. Background

4. Any income arising to "AEs" from an "International Transaction" shall be computed having regard to "ALP" Preconditions Two or more AEs; Enter into an international transaction Consequence Income (expenses) to be computed having regard to ALP

5. Identification of Associated Enterprises

6. Associated Enterprises Means direct or indirect participation in management, control or capital: by one enterprise into another enterprise; or by the same person in both the enterprises Equity holding, Control of Board of Directors / Appointment of one or more Executive Directors, mutual interest constitute AEs Either or both of the AEs should be non-residents

7. C O M P A N Y A (NR) COMPANYBCOMPANYB (Common) Participation in capital > = 26% Loan > = 51% of book value of assets Guarantee > = 10% of borrowings Appointment > half of the directors Dependence on know-how, patent etc Supply of raw material > = 90% Firm/AOP/BOI>=10% Interest Existence of Mutual Interest Relationship at any time during the year sufficient to constitute AE Associated Enterprises – Deeming Fiction

8. Identification of International Transactions (Specified Domestic Transactions)

9. International Transactions Means "transaction" between two or more AEs: Transaction between two or more AEs (atleast one of which will be non-resident) of purchase, sale or lease of tangible property and / or intangible property, provision of services, financing, cost sharing / cost contribution arrangements Or Affecting profits, losses, income, assets or liabilities of the enterprises

10. International Transactions Prominent Transactions now specifically included Capital Financing including guarantee Any type of advance payment or deferred payments Receivables Transaction of business restructuring or reorganisation with the AE Intangible Property – As clarified Customer Lists Customer Contracts Customer Relationships Human Capital Related intangibles assets, such as, trained and organised work force, employment agreements, union contracts;

11. Prior arrangement relating to quantity and price of goods India Outside India Non - AE XYZ Inc. USA ABC Ltd. India AEs Subsidiary Sale of goods Deemed International Transaction Related prior agreement between XYZ Inc. and Non –AE The terms of the transactions are determined in substance by XYZ Inc. Deemed International Transaction – Section 92B(2)

12. Domestic Transaction under the ambit of Transfer Pricing Regulations Any expenditure in respect of which payment is made or is to be made to a person referred to in Section 40A(2)(b) of the IT Act; Any transaction that is referred to in Section 80A; Any transfer of goods or services referred to in Section 80- IA(8) i.e. applicable to companies operating as industrial undertaking or enterprises engaged in infrastructure development;

13. Domestic Transaction under the ambit of Transfer Pricing Regulations Any business transacted between the assessee and other person as referred to in section 80-IA(10); Any transaction, referred to in any other section under Chapter VI-A or section 10AA, to which provisions of sub- section (8) or sub-section (10) of section 80-IA are applicable; Any other transaction, as may be prescribed by the board. Provided that the aggregate value of the transaction entered into by the assessee with its domestic AE exceeds Rs. 5 crore

14. Most likely transactions under the scanner of the TP Authorities would be: Interest Free Loans to group companies; Granting of Corporate Guarantees / Performance Guarantees by Parent Company to its subsidiaries; Intra-group purchase / sell / service transactions; Payment made to key personnel of the group companies; Payment made to relatives of key personnel of the group companies. Domestic Transaction under the ambit of Transfer Pricing Regulations

15. Functional, Assets & Risk Analysis

16. Functions PerformedAssets UtilizedRisks Assumed Core Business Functions Manufacturing Trading Services, etc. Core Business Assets Factory Shed Office Building Office Equipments Computers Business Risks Market Risks Product Risks Employee Attrition Risk Credit Risks Foreign Exchange Risks Management Functions Strategic Decision Making (Market Penetration / Skimming Policy) Accounting and Preparation of Financial Statements Special Assets Intangible Assets Human Resource Special Risks Risk of Intangible Infringement Legal Risks It is important to note that FAR Analysis of each activity needs to be undertaken separately FAR Analysis is the Heart of Transfer Pricing as on the basis of FAR Analysis, one has to select the comparable companies

17. Based on the FAR Analysis, Tested Party needs to be identified. Based on the FAR Analysis, Each of the Party (parties to the transaction) needs to be Economically Characterized (E.g. Contract Manufacturer, Full- Fledged Manufacturer, Distributor, Full-Fledged Trader, Contract Service Provider, etc.) Functional, Assets & Risk Analysis

18. Methods and Selection of Most Appropriate Method

19. Methodology in Computing ALP Section 92C lays the foundation The ALP in relation to an international transaction shall be determined by applying one of the following method Traditional Methods CUP Method RPM CPM Profit Based Methods PSM TNMM Such other method as may be prescribed by the Board Other method of determination of arm's length price

20. Traditional Methods

21. Comparison ParticularsCUP MethodRPMCPM ComparisonPrices (direct comparison)Gross Profit Margin (gross profit over sales) Gross Profit Mark-up on cost When it can be applied When there is no difference or the difference can be negated through reasonable adjustments When there is direct re- sale by tax-payer to third party – without much value addition When there is a sale of semi-finished goods amongst the associated enterprises Example When Product A is purchased from AE as well as third party When product B is sold to AE as well as third party When goods are purchased from AE and sold to third party without value addition As per Guidance Note issued by institute, RPM is not applicable when goods are purchased from third party and sold to AEs When Raw materials are purchased from third parties and sold to AEs for further processing

22. Comparison ParticularsCUP MethodRPMCPM Strengths Most Direct Method Easy to Apply No Concept of Tested Party Minor Product Difference allowed More closure functional comparability required Easy to apply Suitable in case of transfer of semi-finished goods Weakness May be difficult to find comparable transaction Difference in products not allowed Not applicable for further processing of goods Lack of availability of gross profit margin of comparable companies Estimation of cost may be difficult Cost may not be sole determinant for determination of mark- up Lack of availability of gross profit margin of comparable companies

23. Profit Based Methods

24. Comparison ParticularsPSMTNMM When it can be applied When there are international transactions involving transfer of unique intangibles or there are multiple inter-related transactions which cannot be evaluated separately When all other methods fail the application test (usually considered as the measure of last resort) Strengths Offers solution when both parties contribute unique intangibles; The only method which adopts the two sided approach Requires Broad functional comparability; Operating margins are less affected by transactional difference Difference in functions performed are reflected in financial statements Weakness Difficult to apply in practice; Difficult to estimate costs and revenues for all the entities; Difficult to identify the operating expense associated with international transaction and AE’s other activities Requires information on uncontrolled transactions which may not be available at the time of entering into international transaction Difficult for making reasonable adjustments like Working Capital Adjustments, Risk Assumed, etc

25. Background – Profit Based Method Profit based methods are more appropriate in situations where Each of the parties make valuable and unique contribution in relation to the controlled transaction or when the transactions are highly inter-linked; or Reliable data for application of traditional method is not available Traditional method cannot be applied to every possible situation; Mere difficulty in obtaining data for application of traditional methods should not be the sole criteria for adopting profit based methods in determining ALP

26. Other Method

27. the other method for determination of the ALP in relation to an international transaction shall be any method which takes into account price charged / paid / would be charged / payable for same or similar uncontrolled transaction with or between non-associated enterprises under similar circumstances, considering all the relevant facts Background – Other Method

28. Most Appropriate Method Indian TPR does not provide any hierarchy or priority for selection of MAM MAM is that method which, under the facts and circumstances of the transaction under review, provides the most reliable measure of an arm’s length result Each method needs to be tested on merits depending on the nature of international transaction, availability of comparable data, extent to which reasonable and reliable adjustments can be made, etc.

29. Factors for Selection of MAM Nature and class of international transaction The class or classes of AEs entering into an international transaction Availability, coverage and reliability of data necessary for application of MAM The degree of comparability existing between the international transaction and uncontrolled transaction Extent to which reliable and accurate adjustments can be made Nature, extent and reliability of assumptions required to be made in application of a method

30. Jinesh Bhagdev Jinesh R. Bhagdev & Co. Proprietor #3, Shyam Sadan, Opp. Sairaj Garden, 3 rd Irani Wadi, Kandivli (West), Mumbai – 400 067 India Email: jinesh@jbhagdev.comjinesh@jbhagdev.com Website: www.jbhagdev.comwww.jbhagdev.com Contact No: 99209 22929