1. Transfer Pricing Ensuring the right cost in a multi division company

2. 2 The information contained herein represents personal views of the speaker. The information contained herein is general in nature and subject to change. Applicability to specific situations is to be determined through consultation with your tax adviser.

3. 3 Transfer Pricing – What/ Why/ How Transfer Pricing is used to determine price of a product/ service transferred from one subsidiary to another within a Group or one division to another within a Company Transfer Pricing, if effectively used, helps Groups/ Companies to: Undertake independent performance evaluation of each company/ division Coordinate production, sales and pricing decisions of different companies/ divisions Allocate resources effectively Lower overall tax incidence and reduce tax risks Common ways to set Transfer Prices: Market-based Transfer Pricing Negotiated Transfer Pricing Cost-based Transfer Pricing - Full Cost - Cost-plus - Marginal Cost - Variable Cost plus Opportunity cost

4. 4 International Transfer Pricing Parent Co. Country A 35% tax on Rs. 10 Cost - Rs.120 Sub Co. Country C Sale price - Rs. 190 40% tax on Rs. 20 Sub Co. Country B Zero tax on Rs. 40 Tax Haven Sale price Rs.130 Sale price Rs.170 No direct transaction To prevent profit shifting by transfer price manipulation

5. 5 Domestic Transfer Pricing Loss making company Profit making company Shifting of Expenses Shifting of Income Tax @~33% No Tax due to loss Tax @~33% Reduced tax due to profit shifting Loss to Indian Revenue as a result of the above Tax Holiday Unit Taxable Unit/ company Shifting of Expenses Shifting of Income Tax Exemption Tax @ ~33%

6. 6 Arm’s Length Price Associated Enterprises Sec 92A of the Act International transactions Sec 92B of the Act Specified Domestic transactions Sec 92BA of the Act Arm’s Length Price Sec 92C of the Act Transfer Pricing Sec 92 of the Act Arm’s Length Price Section 92(1) - Any income arising from an international transaction shall be computed having regard to the arm's length price Explanation - For the removal of doubts, it is hereby clarified that the allowance for any expense or interest arising from an international transaction shall also be determined having regard to the arm's length price Section 92(2A) – Any allowance for an expenditure or interest or allocation of any cost or any income in relation to the specified domestic transaction shall be computed having regards to the arm’s length price

7. 7 Arm’s Length Price Section 40A(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the goods, services or facilities for which the payment is made or the legitimate needs of the business or profession of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so considered by him to be excessive or unreasonable shall not be allowed as a deduction : Provided that no disallowance, on account of any expenditure being excessive or unreasonable having regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in section 92BA, if such transaction is at arm's length price as defined in clause (ii) of section 92F Section 80-IA (8) Where any goods or services held for the purposes of the eligible business are transferred to any other business carried on by the assessee, or where any goods or services held for the purposes of any other business carried on by the assessee are transferred to the eligible business and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible business does not correspond to the market value of such goods or services as on the date of the transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible business shall be computed as if the transfer, in either case, had been made at the market value of such goods or services as on that date : Explanation - For the purposes of this sub-section, "market value", in relation to any goods or services, means - (i) the price that such goods or services would ordinarily fetch in the open market; or (ii) the arm's length price as defined in clause (ii) of section 92F, where the transfer of such goods or services is a specified domestic transaction referred to in section 92BA

8. 8 Transfer Pricing Methods Six Prescribed Methods Traditional Transaction Methods Transactional Profit Methods Profit Split Cost Plus Resale Price Comparable Uncontrolled Price Transactional Net Margin No hierarchy or preference of methods prescribed under the Act Other Method

9. 9 Transfer Pricing Methods Price charged or paid for property transferred or services provided in a comparable uncontrolled transaction CUP Method Price at which property or services purchased from AE resold to unrelated enterprise less normal gross profit margin less other expenses incurred in connection with purchase of property or services RPM Direct and indirect costs of production incurred in respect of property transferred or services provided to AE plus normal gross profit mark-up on such costs CPM Net profit margin in relation to costs incurred or sales effected or assets employed or any other relevant base TNMM Split of combined net profit of AEs from international transaction in proportion to relative contribution PSM Price which has been charged or would have been charged for same or similar uncontrolled transaction Other Method

10. 10 Some Examples – International Transfer Pricing  Foreign Parent has a Subsidiary in India engaged in contract manufacturing/ service provision for/ to it  Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a risk insulated captive, for this transaction  Local Subsidiary also has own domestic manufacturing and sale business  India captive segment to be drawn using correct cost pool and appropriate allocation keys Parent Subsidiary (Contract Manufacturer) Subsidiary (Contract Service Provider) Outside India India Local manufacturing and Sale  Indian Parent has Foreign Subsidiary engaged in marketing and distribution of its goods  Parent undertakes all risk bearing entrepreneurial functions while Subsidiary operates as a routine/ low risk bearing distributor  If India export segment is benchmarked – appropriate cost allocation needs to be undertaken  If Foreign Subsidiary is benchmarked, cost details of the Foreign Subsidiary required for India reporting and disclosure  If Foreign Subsidiary also has own local business, correct cost allocation to India buy-sell activity imperative Subsidiary Parent (Full-fledged manufacturer) Outside India India Local Sales

11. 11 Some Examples – Domestic Transfer Pricing Tax holiday unit Other unit Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID) Inter unit transfer of manufactured goods for sale Non Tax holiday unit (HO) Tax holiday unit Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID) Inter unit transfer of services Appropriate allocation keys should be used to allocate common HO costs to tax holiday unit Revenue may challenge use of ad-hoc allocation keys Key to demonstrate arm’s length profits in tax holiday unit and not “More than ordinary profits” Appropriate allocation keys should be used to allocate common HO costs to tax holiday unit Revenue may challenge use of ad-hoc allocation keys Key to demonstrate arm’s length profits in tax holiday unit and not “More than ordinary profits” HO performs R&D, Selling & Marketing and other leadership functions Cost details of the Transferor important while applying methods such as CUP, CPM or TNMM Cost details of the Transferee important while applying methods such as RPM or TNMM Cost details of both while applying methods such as PSM Cost details of the Transferor important while applying methods such as CUP, CPM or TNMM Cost details of the Transferee important while applying methods such as RPM or TNMM Cost details of both while applying methods such as PSM

12. 12 Conclusion Significant interplay between cost records/ details and Transfer Pricing Accurate cost details critical for both multi-unit as well as multi entity groups Verifiability and documentation necessary – Audits/ examination by Revenue Consistency between cost records/ MIS and Transfer Pricing records critical Need for working together!

13. 13 Thank You