This is an attempt to explain the broad concept of and rationale behind Transfer Pricing Regulations. Also gives a high level view of the scheme of Indian Transfer Pricing Regulations as on date. Points out the TP controversies in India. Above all gives a well spirited guidance on dealing with TP in India.

1. TRANSFER PRICING
CONCEPT & PRACTICE
1
12th January, 2014
CA Vijay Goel
98101-29835
vijay@vkgc.com

2. Transfer Pricing – Meaning & Concept
2
The Price at which two related parties transact business
between themselves.
When two related parties decide between themselves the
transaction price, there is a scope for such parties affecting
the price which will be different from the price if transacted
between the unrelated parties. This is mis-pricing.

3. Impact of not regulating
3
Example:
A is US based parent company having B as Indian WOS. B
selling services to A at a price of Rs.100 Cr. and incurs
Rs.90 Cr. as expenses making Rs.10 Cr. PBT. Given
corporate tax of 30%, PAT is Rs.7 Cr. Assuming 100%
distribution as dividend, DDT @ 15% will be Rs.1.05 Cr.
and net Rs.5.95 Cr. Will be repatriated.
Suppose, If the price between the unrelated parties would
have been Rs.120 Cr., the difference will be as follows-

4. Impact of Mis-Pricing
4
Situation 1
Situation 2
Difference
Sales
100
120
20
Less: Expenses
90
90
-
PBT
10
30
20
Less: Corporate
Tax
3
9
6
PAT
7
21
1
DDT
1.05
3.15
2.10
Net Repatriation
5.95
17.85
14.90
Tax Avoidance
Flight of Capital

5. How is this regulated?
-Transfer pricing adjustment
5
Situation 1
Situation 3
(After Transfer
Pricing
adjustments)
Difference
Sales
100
100
-
Less: Expenses
90
90
-
PBT
10
10
-
Less: Corporate
Tax
3
9
6
PAT
7
1
-6
DDT
1.05
0.15
-0.90
Net Repatriation
5.95
0.85
-5.10

6. Areas not addressed?
6
Situation 2
Situation 3
(After Transfer
Pricing
adjustments)
Difference
Sales
120
100
-20
Less: Expenses
90
90
-
PBT
30
10
-20
Less: Corporate
Tax
9
9
0
PAT
21
1
-20
DDT
3.15
0.15
-3
Net Repatriation
17.85
0.85
-17
Secondary Adjustments; Consequent Flight back of Capital

7. Indian TP Regulations
7
International Transactions
Introduced by Finance Act 2001 w. e. f.
01.04.2002. AY 2002-03.
Specified Domestic Transactions
Introduced by Finance Act 2012 w. e. f.
01.04.2013. AY 2013-14.

8. TP- International Transactions
Scheme of Regulations
8
Income from International Transactions to be computed having regard to
Arm’s Length Price.
Cost sharing arrangements also covered.
Not applicable if, reduces tax liability or increases loss.
International transaction defined. Deemed international transactions.
Associated Enterprise (related parties) defined.
ALP defined. Methods prescribed for computation. Most appropriate
method to be used. Guidance provided.
Documentation requirements prescribed.
Filing requirements prescribed.
AO / TPO can re-determine ALP and make adjustments in income.
Option to go to DRP.
Normal appeal route available.
Safe Harbour Rules prescribed.
Advance Pricing Agreement.

9. TP- Specified Domestic Transactions
Origin, Rationale & Scheme of Regulations
9
Observations of Supreme Court in CIT vs. Glaxo SmithKline Asia (P)
Ltd.
Tax arbitrage from loss making concern.
Tax arbitrage from exempted on low tax unit.
Complications where fair market value to be assigned under sec
40A(2).
Documentation requirement.
Applicable to “Specified Domestic Transactions” as defined.
Allowance for expenditure, interest, cost allocation or income in
relation to SDT to be computed on ALP.
Determination of ALP, documentation requirements and filing
obligations similar to those for international transactions.
Safe Harbour and APA not applicable.

10. Practice of Transfer Pricing
10
Check for international transaction - if any transaction with associated
enterprise.
Check for specified domestic transactions, If value is more than Rs. 5 Crore
If Yes, maintain the documentation on contemporaneous basis.
Determine ALP towards the end of financial year and if possible adjust
pricing by true-up or true-down.
While filing the tax return conduct testing by the prescribed methods to
check if within ALP range. If not, volunteer addition to that extent.
Get 3CEB report from a CA and file the same online by the due date (30th
Nov).
When required by AO or TPO, submit the documents maintained and supply
the information called for in support of ALP.
If AO or TPO reject assessee’s ALP and re-determine ALP, insist on show
cause notice before the order.

11. Practice of Transfer Pricing (contd.)
11
Carefully examine the show cause notice and the points raised in the
notice.
Make a thorough research on the comparables used by the AO/TPO
and also on the comparables rejected by the AO/TPO to objectively
evaluate the comparability in light of the guidance given under the
regulations.
Refer to the documentation maintained, relevant provisions of
regulations , guidance available in OECD TPG, decisions of the ITAT,
HC and SC on the relevant issues to respond to the notice.
If adverse order, evaluate option to go for appeal before the CIT(A)
and in case of international transactions to go before the DRP.
See, if in case of international transactions, going forward safe
harbour or APA can be considered.

12. International Transaction - Meaning
12
Transaction between two or more AEs where at least one is a nonresident.
Purchase, sale or lease of tangible or intangible property
Provision of services
Lending or borrowing money
Any other transaction having a bearing on the profits, income, losses or
assets.
Includes mutual cost contribution or cost sharing or cost allocation or
cost apportionment agreements or arrangements.
Deemed International transaction. Prior agreement or terms
determined in substance with AE.
Explanation inserted by Finance Act 2012. Capital financing, provision
of services, business restructuring, intangible property clarified.

13. Associated Enterprise - Meaning
13
Participation in management, control or capital, directly or
indirectly.
Commonality of management, control or capital, directly or
indirectly.
13 situations spelt encompassingCapital or voting power – 26% or more.
Lending in more than 51% of assets value.
Guaranteeing 10% or more of borrowings.
Control on appointment of majority of Directors or ED or governing board
members.
Exclusive control over critical business inputs - intangibles.
90% or more raw material and consumables supply and price controlled.
Common individual /HUF/member, with or without relatives, controls.
10% or more interest in firm, AOP or BOI.
Any relationship of mutual interest, as may be prescribed.

14. Specified Domestic Transactions - Meaning
14
Any of the following, not being an international transaction1.
Expenditure where payment to 40A(2)(b) persons; or
2.
80A transaction; or
3.
80-IA (8) transfer of goods or services; or
4.
80-IA (10) business transactions; or
5.
10AA or any other where 80-IA(8) or 80-IA(10) applicable; or
6.
any other transaction as may be prescribed, and
Where the aggregate value of transactions more than Rs 5 crore.
Note: A. For computing Rs 5 crorea) International transactions value to be excluded.
b) Transactions between 2 units of the same company to be covered when
undertaken with a tax holiday unit.
c)
Inter-company transactions to be covered when undertaken with a
company having a tax holiday unit.
B. If transaction value less than Rs 5 crore, existing tax laws and FMV to
apply.

15. Related parties u/s 40A(2) – Important point
15
SDT would cover shareholding of 20% or more.
International transaction requires shareholding of 26% or more.
Where in case of cross border transactions, shareholding is less
than 26%, it is not covered under International Transactions but
if still it is 20% or more, it will be covered under SDT.

16. Documentation
16
S.
no.
Nature of
document
Contents
1
Assessee Level
-ownership structure or other interest held in
2
Group Level
- Profile of Group with name, address, status, residence of
entities with whom transacted.
3
Business and
industry
- Description of assessee’s and AE’s business and of
assessee’s industry.
4
Transaction Level
-
5
FAR analysis
-of both, assessee and the AE.
6
Economic and
market analysis
Budgets, forecasts or other financial estimates for the
business as a whole and for the divisions or product,
having bearing on the transaction.
7
Record of
Comparables
considered
Record, including nature, terms and conditions, of internal
and external comparables taken into account
Nature, value and terms of transaction, property
transferred or services rendered.

17. Documentation (contd.)
17
S.
no.
Nature of
document
Contents
8
Record of
comparables’
Analysis
Analysis performed to evaluate comparability of
uncontrolled transactions with the tested transaction.
9
Methods and MAM
Methods considered, selected with reasons and also how
applied.
10
Workings of ALP
determination
Details of the comparable data and financial info used in
applying the MAM, adjustments, if any made.
11
Assumptions,
policies and price
negotiations
Which have critically affected the determination of ALP.
12
TP Adjustment
Details of TP adjustment, if any made to align with ALP
determined. Also, the consequent adjustment to the total
income for tax purposes.
13
Any other
Relevant data, information or document of assessee or of
AE relevant for determination of ALP.

18. Methods of ALP computation
18
Method
What is compared?
Appropriateness
1
Comparable
Uncontrolled Price
Method (CUP)
Price of the transaction
Where there is a very close similarity in
product/service and either internal or external
comparable price is available.
2
Resale Price
Method (RPM)
Gross Profit Margin
Where purchases from a related party and sales to an
unrelated party with little value addition.
3
Cost Plus Method
(CPM)
Gross Profit Margin on
direct cost or indirect cost
Where purchase or sale is of semi finished
goods/services
4
Profit Split Method
Relative contribution by
each entity, to total value
addition
Where use of unique intangibles is involved or where
there are multiple inter-related transactions and
cannot be evaluated separately.
5
Transactional Net
Margin Method
(TNMM)
Net Profit Margin with
reference to cost incurred,
sales affected or assets
employed
Residual method.
Where reliable comparable data and broad
functional comparable available
6
Other Method
Price charged
Where none of the above is suitable and info is
available by way of valuation reports, quotes, etc. to
establish price charged or that would be charged.

19. Most Appropriate Method – Factors to consider
19
-best suited to the facts and circumstances of each particular international transaction, and
- provides the most reliable measure of ALP in relation to the international transaction
S.
no.
Factors
1
Nature and class of the international transaction
2
Class of AEs, taking into account their FAR
3
Availability, coverage and reliability of data necessary for application of the
method.
4
The degree of comparability between – international transaction and
uncontrolled transaction; enterprises entering into such transactions.
5
The extent to which reliable and accurate adjustments can be made, if any
between- international transaction and comparable uncontrolled transaction;
enterprises entering into such transactions.
6
Nature, extent and reliability of assumptions required to be made in application
of a method.

20. Comparability factors
20
S. no.
Factors
1
Specific characteristics of the property transferred or services provided in either
transaction
2
FAR of the respective parties to the transactions
3
Contractual terms of the transactions which lay down explicitly or implicitly how the
responsibilities, risks and benefits are to be divided between the respective parties to the
transactions
4
Conditions prevailing in the market in which respective parties operate, including –
• the geographical location and size of the markets,
• the laws and Government orders in force,
• costs of labour and capital in the markets,
• overall economic development and level of competition and
• whether the markets are wholesale or retail.
Comparable If none of the differences likely to materially affect; reasonable accurate adjustments can be made to
eliminate the effect of such differences.
Current year data to be used.
Previous 2 years’ data can also be used if reveals the facts having bearing on the determination of TP.

21. Search for comparables
21
Quantitative Search
Qualitative Search
Accept/Reject Matrix

22. Rejection by TPO/AO – 92C(3)
22
• During the course of assessment proceedings,
• On the basis of material or information or
document in possession,
• AO (or TPO) is of the opinion that -
1
The price charged or paid has not been determined in accordance
with 92C(1) and 92C(2); or
2
Any information and document have not been kept and maintained
as per 92D and 10D; or
3
The information and data used in computation of ALP is not reliable
or correct; or
4
The assessee has failed to furnish, within the specified time, any
information or document which was required by 92D(3) notice.

23. Penalties
23
Default
Penalty
Documentation not maintained
2% of value of transaction (s).
Required documents not furnished
2% of value of transaction (s).
Transaction(s) not reported in
92E/3CED Report
2% of value of transaction (s).
Incorrect documents maintained or
furnished
2% of value of transaction (s).

24. SDT- Certain cases
24
S.
no.
Transaction
Guidance
1
Remuneration to director or
key management personnel
-Look into job profile, experience and knowledge
and compare with remuneration paid to key
management personnel of comparable
companies.
- TNMM as a last resort.
2
Rent payment
-
-
Look into the size, area, location, quality of
construction, lease term and other relevant
factors and check if CUP can be used.
Independent Chartered Engineer’s certificate,
as “other method”.
3
Interest on loan, guarantee fee
- Compare with Indian bank’s rates.
4
Purchases
- CUP, RPM or TNMM
5
Royalty, FTS, Commission or
Brokerage
- CUP or TNMM

25. Uniqueness of Indian TP Regulations
25
s. no.
Unique nature
1
Arithmetic Mean
2
Single year data
3
Contemporaneous data can be refreshed during TP audit
4
TP Report (92E)

26. TP Controversies
26
1 Single year data
8
Intangibles/Advertising and
Marketing Promotion
expenses- Bright line test
15
Under valuation of
shares allotted
2 Tested Party
9
Capacity utilization adjustment
16
Loan/interest
3 Burden of proof
10
Location savings
17
Use of customs data
4 Turnover filter, Employee
cost filter, Related Party
filter
11
Entity level vs. transaction level
18
Applicability to exempt /
non-taxable income
5 Internal vs External
comparables
12
PLI selection, computation and
adjustments
19
5% tolerance limit
6 Secret Comparables
13
Selection of MAM
20
Risk adjustment
7 Management charges
14
Guarantee fee
21
Working capital
adjustment

27. Defense Strategy
27
Analysis and Benchmarking prior to transaction
Inter entity contract
Contemporaneous documentation and review on regular basis.
True-up/True-down with year end testing
Testing again while filing tax return and volunteering adjustment, if
any.
Take TP audit with all seriousness and put best foot forward at that
level itself.
Evaluate Safe Harbour option, if applicable
Evaluate APA option.

28. Safe Harbour
28
Circumstances where tax authorities shall accept the TP declared by
the assessee. Safe Harbour is an exception to ALP rule.
Eligible International Transaction and Eligible assessee defined.
Safe Harbor operating margins range – IT/ITES: 20% to 25% ; Intra
group loans: SBI rate+1.5% to 3%; Corporate guarantee fee: 1.75%;
contract R&D software 30% and pharma 29%; manufacture and
export of core auto 12%, and non-core auto 8.5%.
Operating profit margin, operating expenses, operating revenue
defined.
Insignificant risk – factors to consider

29. Safe Harbor (contd.)
29
Applicable for AY 13-14 and 4 AY thereafter. Can exit and re-enter.
No comparability adjustments
3CEB and documentation continue to be maintained.
Procedure-File tax return by due date offering safe harbour rates.
-File Form 3CEFA by due date
- wait for 60 days, if no reply treat accepted. If get a notice or
rejection, attend.
- Can go to Commissioner who to dispose of in 60 days.

30. Thank you
30
CA Vijay Goel
98101-29835
vijay@vkgc.com