The Provisions of Transfer Pricing have been introduced to ensure that income arising from an International Transaction between Associated Enterprises shall be computed having regard to the Arm’s Length Price. Any cost or expense allocated or apportioned between two or more associated enterprises under a mutual agreement or arrangement shall also be at an Arm’s Length Price.
Examples of such transactions could be where one associated enterprise carries out centralised functions which could also benefit one or more associated enterprises, or two or more associated enterprises agree to carry out a joint activity, such as research and development, for their mutual benefit.
The arm’s length price in relation to Transfer Pricing in an international transaction shall be determined by any of the following Transfer Pricing Methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely: -
- Comparable Uncontrolled Price Method (CUP Method)
- Resale Price Method
- Cost Plus Method
- Profit Split Method
- Transactional Net Margin Method
- Such Other Method as may be prescribed by the Board
- The most appropriate method referred shall be applied for the determination of arm’s length price, in the manner as may be prescribed. Provided that where more than one price may be determined by the most appropriate method, the Arm’s Length Price shall be taken to be the arithmetic mean of such prices, or, at the option of the assessee, a price which may vary from the arithmetical mean by an amount not exceeding 5% of such arithmetical mean.
- Where during the course of any proceedings for the assessment of income, the Assessing Officer on the basis of Material of Information or Document in his possession, is of the Opinion that:-
- The price charged or paid has not been determined in accordance with the above or
- Any Information and Document relating to an International Transaction have not been kept and maintained by the Assessee in accordance with the provisions, or
- The Information or data used in Computation of the Arm’s Length Price is not reliable or correct, or
- The Assessee has failed to furnish, within the specified time, any information or document which he was required to furnish
The Assessing Officer may proceed to determine the arm’s length price in relation to the said International Transaction on the basis of such Material or Information or Document available with him.
Provided that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the Assessee to show cause on a date and time to be specified in the notice, why the arm’s length price should not be so determined on the basis of material or information or a document in the possession of the Assessing Officer.
Computation of Arm’s Length Price under CUP Method
Step 1: Determine the price charged or paid for the property transferred or services provided in a comparable uncontrolled transaction
Step 2: Such Price is then adjusted to account for the Functional Differences between the International Transaction & the Comparable Uncontrolled Transaction, which could materially affect the price in the open market.
Step 3: Such Adjusted Price is the Arm’s Length Price
Computation of Arm’s Length Price under Resale Price Method
Step 1: The Price at which the Property purchased or the Services obtained by the enterprise from an associated enterprise are sold to an unrelated enterprise is first determined.
Step 2: Such Resale Price is reduced by the Normal Gross Profit Margin accruing to the Enterprise from the purchase and resale of Similar Goods in a comparable uncontrolled transaction. If there is no comparable uncontrolled transaction, then take the Gross Profit of an unrelated person from purchase and resale of Similar Goods
Step 3: Then reduce the expenses incurred by the enterprise in connection with purchase of property.
Step 4: The price so arrived is adjusted to account for the functional differences in the International Transaction & the Comparable uncontrolled Transaction which could materially affect the Gross Profit Margin in the Open Market.
Step 5: The adjusted Price is the Arm’s Length Price
Computation of Arm’s Length Price under Cost Plus Method
Step 1: Determine the Direct and Indirect Costs of Production in respect of Property transferred or Services provided to an associated enterprise
Step 2: Determine the normal gross profit mark up to such costs which will arise from transfer of similar goods or services to an unrelated enterprise or in a comparable uncontrolled transaction
Step 3: The normal gross profit mark up should be adjusted to account for the functional differences if any between the International Transaction and comparable uncontrolled transaction which could materially affect such profit mark-up in the open market
Step 4: The cost referred in step 1 shall be increased by the adjusted profit mark up arrived
Step 5: The sum so arrived is the arm’s length price
Computation of Arm’s Length Price under Profit Split Method
This Method is applied in multiple International Transactions which are so inter-related that they cannot be evaluated separately.
Step 1:- Compute the Net Profit of the Associated Enterprise arising from the International Transaction.
Step 2:- Compute the Relative Contribution made by each of the associated enterprise to the earning of the combined Net Profit
Step 3:- Split the Combined Net Profit in proportion to their Contributions
Step 4:- The Sum so arrived at is the Arms Length Price
Computation of Arm’s Length Price under Transactional Net Margin Method
Step 1: Compute the Net Margin realised by the Enterprise from an International Transaction entered into with an associated enterprise.
Step 2: Compute the Net Profit Margin realised by the enterprise or by an unrelated enterprise from a comparable uncontrolled transaction.
Step 3: Adjust the Net Profit Margin computed in Step 2 to account for differences
Step 4: The Net Profit Margin computed in Step 1 is established to be the same as the net Profit Margin referred to in Step 3
Step 5: The net profit margin thus established is then taken into account to arrive at an arm’s length price in relation to the International Transaction
It has also been provided that no deduction u/s 10A or Sec. 10AA or Sec. 10B or under Chapter VI-A shall be allowed in respect of the amount of Income by which the Total Income of the Assessee is enhanced after computation of Income.
Moreover where the total Income of an Associated Enterprise is computed under this sub-section on the determination of arm’s length price to be paid to another associated enterprise from which tax has been deducted or was deductible, the Income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the mentioned enterprise
All the provisions of Transfer Pricing are intended to ensure that profits taxable in India are not understated (or losses overstated) by declaring lower receipts or higher outgoings than those which would have been declared by persons entering into similar transactions, with unrelated parties in the same or similar circumstances. The basic intention underlying the new transfer pricing regulations is to prevent shifting out of profits by manipulating prices charges or paid in International Transactions, thereby eroding the Country’s Tax Base. These provisions are therefore not intended to be applied in case where the adoption of Arms Length Price determined under the regulations would result in decrease in the overall tax incidence in India in respect of the parties involved in the International Transaction.