Transfer Pricing Issues CMA S VENKANNA - PowerPoint Presentation

1. Transfer Pricing IssuesCMA S VENKANNACOST ACCOUNTANT

2. Background of TPThe regulations govern the prices between inter company transactions within the multinational companies.Cross Border Transactions – between one country to another Relating to transfer of goods, intangibles and services.How much the MNCs pays tax to the country.Through manipulated prices, the MNCs pays lesser tax to the country.TP results substantial increase in tax revenue and penalties.

3. Impact of not adopting Arm’s Length PriceResults in additional income, interest and penaltiesResults in Double Taxation Problem. No refund of tax already paid in other countries.Long time litigations through tax audits by the department.If the MNCs does not apply normal transaction prices which are internationally applicable, and does not reflect arm’s length principle, it results it mis-pricing.The department may view this as tax avoidance.

4. International Transactions vis-à-vis TPAll International Transactions does not involve determination of ALPConditions1. Entities should be AEs2. Transactions between AEs3. If the Transaction Value is normal – no TPIf the Transaction Value is not normal – Then Apply TP Rules4. Determine ALP5. Apply ALP and Determine the Revised Income – Sec.92 Computation 6. Determine the Additional Tax Liability in India

5. Deemed AEs

6. Test for AEA of US holds 30% Equity Shares of B India. And B are AEs.Exceeds 26% holding with voting power.A US holds 30% Equity Shares of B India. A also holds 30% equity shares of C Japan. A B and C are AEs.Uniliver USA holds 5% Shares in Univer India. The book value of assets is Rs.150 crores. Uniliver extends loan of Rs.100 crores to Uniliver India. Both are AEs. Loan extended exceeds 51% of book value.

7. InfluenceABC India manufacture ready made garments. RMs required Rs.950 crores. The yarn of Rs.900 crores is procured from DEF USA. The price is influenced by DEF. Both ABC India and DEF USA are AEs.X India sells goods to Y USA. X India also sells goods to Z UK. The prices are influenced by Y USA for the goods supplied to Z UK.X, Y and Z are regarded as AEs.

8. ManagementMore than half of directors of the Board appointed by other company.A company appointed 1 ED of B ltd. A and B are AEs.ABC is an HUF in India. The members of HUF controls an entity outside India. ABC and Entity outside is AE.

9. International TransactionsBetween AEs.Supply or Procurement of GoodsAcquiring or selling intangibles. Ex. Technical Know, etc.Providing or Receiving Services

10. Intangibles Marketing RightsTechnologyData ProcessingEngineeringContractHumandMethods and SystemsLicence

11. ALP MethodsComparable Uncontrolled Price Method (CUP)Resale Price Method (RSM)Cost Plus Method (CPM)Profit Split Method (PSM)Transactional Net Margin Method (TNMM)Such other method – Rule 10AB Prescribed by Board (CBDT)How to Select the Method:Nature of TransactionType of AERelevant FactorsFactors and CircumstancesReliable DataComparability

12. Alp – Tolerance Notified by GovernmentIf the Variation between ALP and Actual Price exceeds the Tolerance Limit, then actual price is deemed to be ALP1% for whole sale trading3% for other casesWholesale Trading – International Transaction Purchase cost of FG is 80% or more of the total cost

13. Example – Selection of method for ALPSl.No.ParticularsCase - 1Case - 2Case - 31Transaction Price 2,3001,9002,0302ALP computed 2,0002,0002,0003Difference3001003043% of Transaction Price695760.905ObservationSl.No.3 > Sl.No.4Sl.No.3 > Sl.No.4Sl.No.3 < Sl.No.46ALP2000200020307Action of AOAddition to the extent of Rs.300If ALP applied, it reduces the profits. Hence No RecomputationNo Adjustment is required

14. Example 1 - Practical Problem on ALP - CUPM Ltd., an Indian Company supplies Computer Parts to M Inc. USA, the parent company of M Ltd., India. M Ltd., India and M Inc. USA are related partiesIn the Financial Year 2019-20, The company also supplies identical product to another company in USA, viz., N USA an unrelated Company.Transactions:The price of a product is US$ 450 (FOB) to M Ltd., USAThe price of the same product to another unrelated company is US$ 700 (CIF)Insurance and Freight cost US $ 200.

15. continueM Ltd., extends credit period of 1 month to M Inc.USAThe cost of Credit is 12% p.a.Sales to N USA is on Cash Basis M Ltd. Gives 6 months warrant to N Ltd. Cost of Warrant is US$50 per unit.How to compute ALP

16. ALPPresumptionsM Ltd. India supplies Identical Product to two companies in same countryOne is AE and the other is Unrelated.All parameters are matching Hence the transactions between M Ltd., India and N USA formsComparable Uncontrolled TransactionsApply the same Parameters to M Inc. USAComparison Statement

17. Transaction DifferencesFactorComparable Uncontrolled Transaction with N Ltd. USAInternational Transaction with M Inc. USARemarksPriceCIFFOBFreight and Insurance expenses - $200 per unitCreditNo CreditOne monthCredit Cost 12% p.a.WarrantySix MonthsNo WarrantyWarranty Cost $50 per unit

18. ALPParticularsAmount in $Price per Unit of product exported to USAAdd: Cost of Credit = 12% = 1% per monthLess: Cost of Insurance and FreightCost of WarrantALPNote: Price charged is less than ALP to M Inc.USA (450) $ 7 is added to the Income of M Ltd., India and accordingly the income will be recomputed by AO7007-200-50457

19. Example 2 - RSM P Ltd., USA supplies Product A to its wholly owned subsidiary P India Ltd., India. The product is supplied at INR 2,000 per piece. P India Ltd., incurs INR 10 for marketing per piece. And sells at INR 3,000 per piece. P India also imports from S Ltd., Singapore for INR 1,500 per piece. The marketing costs is INR 5 per piece and it is sold for INR 2,000 per piece.ALP to be computed under which method

20. ALP Method to be appliedP India purchases the product from two companiesUSA and SingaporeP India undertakes only Marketing in IndiaHence the suitable method shall be Resale Price Method (RSM)First : Determination of Margin on Uncontrolled Transaction which is Comparable:Sale Price INR 2,000Less: Purchase Price INR 1,500Gross Margin INR 500Gross Margin Percentage 25%

21. ALPThere is no other related differences between comparable and uncontrollable transaction. Hence no adjustment needed.ALPALP should not be adopted since the income of P India gets reduced.Actual transaction price is less than ALP.Sl.NoParticularsRs.1Sale Price of P Ltd., USA3,0002Apply ALP Gross Margin at 25%7503ALP of Related Party 2,2504Related Party Purchase Price 2,000

22. Example 3 - CPMBosch Ltd., India is a financial BPO arm of Bosch Inc., Germany. The BPO bills Bosch Inc., at $ 20,00,000 per month. The basis for billing is the man hours spent on each work. Bosch Ltd., India also provides the same service to SA Inc., South Africa and bills at $18,00,000 per month. The Direct Cost of services per hour for Bosch Ltd., India works out to $ 500 and Indirect Cost of services works out to $2,000 per hour.Bosch, India works in 2 shifts and number of days in month is 30Consists of 7 hours work for Bosch, Germany and 6 hours work for SA, South Africa respectively.Whether the transactions at ALP

23. Bosch Ltd., India provides services for different clients.Consumes different man-hoursDetermine the Gross Margins realized.Cost Plus Method is suitable as gross margin can be identified taking into account the man-hours spent.Particulars for Uncontrolled transaction) SA, South AfricaRs.Direct Cost of Service ($500 x 6 x 30)Indirect Cost of Service ($2000 x 6 x 30)Total CostGross Margin (Billing Price-Total Cost)(18,00,000-4,50,000)Gross Margin to Cost (13,50,000/4,50,000 x 100)90,0003,60,0004,50,00013,50,000300%

24. ALPSl.No.ParticularsRs.(1)(2)Cost of Bosch Inc., GermanyDirect Cost ($500 x 7 x 30)Indirect Cost ($2000 x 7 x 30)Total Costs1,05,0004,20,0005,25,000(3)Apply ALP Gross Margin of 300% (5,25,000 x 3)15,75,000(4)ALP of Related Party Transactions ((2) + (3)21,00,000(5)Actual Related Party Transaction Price20,00,000Price Realized from the Transaction with AE is less than the Price in Unrelated Transaction. Hence ALP should be considered. Therefore Bosch Ltd., India has to offer the difference of Rs.1,00,000 for Taxation

25. Example 4 - PSMSG Ltd., India exports semi finished goods to its parent company SG Inc., USA. Export Price $200 per unit to the US Company (Freight and Insurance $75 per unit incurred separately. The cost of the product works out to $125 per unit on import. SG Inc., USA completes the product and markets the same at $500 per unit. The finishing and marketing cost @$100 per unit.It is a single product captively consumed and ultimately sold by the AE in USA. The profit realized is only one. Hence split the margin among the related parties is suitable. Hence Profit Split Method is adopted

26. WorkingsParticularsAmount in $Amount in $Sale PriceLess: CostsManufacturing Costs of SG ImportedFinishing and Marketing CostsLess: Freight and Insurance CostsNet Profit12510050022527575200Apportionment of Profit based Direct CostsAmt in $SG India (200 x 125/225)111SG Inc., USA (200 x 100/225)89Total Profit200

27. Example 5 - TNMMM Ltd., India exports carved furniture to its Holding Company M Inc., Canada. The sale price per furniture set is Canadian $ 2,500 Million The direct and Indirect costs amount to Canadian $ 1,750. The furniture Industry in India, comparable companies earns total revenue of Canadian $ 3,750 Million. The industry average of total expenses of similar companies works out to 85%. ALP to be determined

28. AnalysisM Ltd., India exports carved furniture to its parent Company. No other comparable uncontrolled transaction available in the Company. The assessee company is in furniture industry, the industry averages shall be taken for comparison. The margin of the Company and Margin of the Industry is compared to determine ALP. The method applied is Net Margins, i.e., Transactional Net Margin Method (TNMM)

29. ComputationNet Margin of M Ltd., IndiaAmt in Canadian $ MillionSales made by M Ltd.Less: Direct and Indirect CostsNet MarginNet Margin to Cost2,5001,75075043%Net Margin of the IndustryAmt in Canadian $ MillionIndustry TurnoverLess: Total Expenses- 3,750 x 85%Net MarginNet Margin to Cost3,7503,18856218%Computation of Arm’s Length Sales RevenueAmt in Canadian $ MillionTotal Expenses incurred by M Ltd., India1,750Arm’s Length Sales Revenue Applying ALP Net Margin on Cost incurred= 1,750 x 118/100)2,065Actual Sales Revenue2,500

30. NoteAS THE SALES REVENUE REALISED FROM PARENT COMPANY, CANADA IS MORE THAN THE ARM’S LENGTH SALES REVENUE COMPUTED TAKING INTO ACCOUNT THE INDUSTRY NET MARGIN INDICATOR, THE INTERNATIONAL TRANSACTION SHALL BE REGARDED AS ADHERING WITH ARM’S LENGTH PRINCIPLE

31. TP – Issues in IndiaComparability AnalysisComparability analysis is the key to determining the arm’s length price of an international transaction. However, increased market volatility and increased complexity in international transactions have thrown open serious challenges to comparability analysis and determination of the arm’s length price. Identification of risks and of the party which bears such risks are important steps in comparability analysis

32. ALP on Intangibles Transfer pricing of intangibles has been a difficult area of work for tax administrations across the world. The situation has been same for the Indian tax administration. The pace of growth of the intangible economy has opened up new challenges to the arm’s length principle.Transactions involving intangible assets are difficult to evaluate for the following reasons:Ø intangibles are rarely traded in the external market and it is very difficult to find comparables in the public domain;Ø intangibles are often transferred bundled along with tangible assets; 

33. Serious difficulties have been encountered in determining the rate of royalty charged for the use of brands and trademarks in certain cases.Indian subsidiaries using the technical know-how of their parent company have incurred significant expenditure to customize such know-how and to enhance its value by their R&D efforts. Costs of activities, such as R&D activities which have contributed to enhancing the value of the know-how owned by the parent company, are generally considered by the Indian transfer pricing administration while determining the arm’s length price of royalties for the use of technical know-how.

34. Issues and challengesFunctional analysis – each enterprise to identifyR&DDesignEngineeringMarketing and distribution functionManagementFinancial Risks and market risksContractual termsMarket ConditionsGeographical IssuesGovernment and Regulations

35. StrategiesBusinessUse of data of different years previous year vs. current yearMNC losses Set offs within the MNC Group CompaniesUse of Customs Valuation under WTO GuidelinesBoth for imports and exports

36. Selection of TP MethodsNo one method is generally applicable to different situations.Ultimately computation of ALP is a highly complex taskRequires huge amount of efforts Co-operation from the Tax Payer and Tax Authorities regarding documentation, ground work, analysis and research.The adjustments made by the transfer pricing officers (TPOs) have been subject to judicial reviews in India and although the matter is still to be finally adjudicated by the Supreme Court and the decisions of the High Courts and Tribunals.The Indian tax administration has been applying these principles to make adjustments but it is apparent that the process is complex, fact intensive and not free from disputes. The efforts being made by the Indian tax authorities to bring uniformity in approach and the expected judicial verdict from the Indian Supreme Court are likely to bring more clarity in the process.

37. Legal IssuesA comprehensive dispute resolution mechanism is available to the taxpayers in India facing transfer pricing adjustments. As a part of the legal process in all cases, the Assessing Officer (AO) incorporates the order of the Transfer Pricing Officer (TPO) in his order and issues a draft order to the taxpayer. The taxpayer has the option to file an objection against the draft order before the Dispute Resolution Panel (DRP) which is a panel comprising three Commissioners of Income-tax. The AO issues a final order in compliance with the DRP’s directions. At present, the direction of the DRP is final for the tax administration and it cannot appeal further against the DRP’s order. The taxpayer can challenge the direction of the DRP in appellate forums.

38. Steps by Government Government of India has taken several steps to reduce litigation and the time needed to resolve tax disputes. Some of the steps taken in this direction are the following:introduction of the ‘Range’ concept in the Transfer Pricing Law along with the use of multiple-year data;Ø use of the Mutual Agreement Procedure (MAP) for speedier resolution of pending cases;Ø introduction of Advance Pricing Agreement (APA) provisions in the law; andØ introduction of Safe Harbour provisions in the transfer pricing law.

39. Thank YouBehind Every Successful Business Decision, There Is Always A CMA