The study is the certification of the Course of Independent Study undertaken on Transfer Pricing. Transfer pricing is the mechanism of valuing goods and services traded between related companies so as to cut down the revenue enhancement load for the related companies taken together. The assorted goods and services which are covered under transportation pricing have been discussed through the class of the study. All the goods and services traded are supposed to be transferred at arm ‘s length monetary value. Almost all states follow OECD norms in instance of international revenue enhancement which deals with transportation pricing. OECD norms prescribe five major methods for geting at a transportation monetary value for a peculiar good or services being traded. Transfer pricing is of importance non merely for income revenue enhancement related intents but besides from the point of position of corporate administration where a publically listed company trades with one of its related companies. The Income Tax Act, 1961 discusses transfer pricing under Section 92 to Section 92F where it has defined the construct of arm ‘s length monetary value, associate company and international dealing. It besides specifies dispute declaration methodological analysiss and punishments, in instance of default. Additionally, there is a demand for rapprochement between Income Tax Act, 1961 and Customs Act, 1962 which prescribe different methods to get at arm ‘s length monetary value for a related party dealing as it hampers trade which could be carried on smoothly alternatively.
Introduction
Transportation Pricing is the mechanism adopted by transnational endeavors for valuing the goods and services traded with their Auxiliary or Associate Companies abroad so as to take down revenue enhancements and maximise net income ( Government of India ) . As the gait of international trade has increased on history of globalisation, it has become imperative to maintain a close ticker on inter-company ( between subordinate and associate companies ) minutess. Inter-company minutess can be easy used to maximise net incomes in one state and cut down in the other by utilizing unreal monetary value for the goods and services transferred between the companies. There are a figure of states which can be considered as revenue enhancement oasiss or revenue enhancement shelters, and it would profit a company to hold maximal net incomes in those states as against the state of operations. This would set considerable strain on the national exchequer of the state with higher revenue enhancement rates as all companies will route the minutess through revenue enhancement oasiss or revenue enhancement shelters.
A simple illustration below can demo how minutess between two associate companies can blow up the net incomes in one state and cut down it in the other.
See a company A ( runing in state X ) , which has two subordinate companies B & A ; C, runing in states X and Y severally. The revenue enhancement rates in states X and Y are well different from each other. The revenue enhancement rate in state X is 35 % of the net incomes, while that in state Y is 5 % of the net incomes. Besides, there is a dividend distribution revenue enhancement of 14 % in state X and 2 % in state Y. Country X and Y have a revenue enhancement turning away understanding, such that a company can claim freedom from dual revenue enhancement. Company A earns all its grosss from the dividends that the companies B and C. There is transportation of goods from company C to company B and the same goods are sold thenceforth to the populace. Let the goods be sold to the populace in state Ten by company B at Rs. 500. Let the cost of goods in state Y for company C be Rs. 100. Now, company A would wish to gain the maximal net income from this dealing after both income and dividend distribution revenue enhancement. The figure on the following page will explicate how the entire net income for company A can be varied by altering the cost of goods that are transferred between company B and C. By changing the cost of goods and therefore, net incomes for company B and C, the net incomes earned by company A alteration well.
Company B
Gross saless: Rs 500
Cost of Goods: Rs 500
Net incomes: Rs 0
Tax @ 35 % : Rs 0
Dividend: Rs 0
Dividend revenue enhancement @ 14 % : Rs 0
Effective Dividend: Rs 0
Company C
Gross saless: Rs 500
Cost of Goods: Rs 100
Net incomes: Rs 400
Tax @ 5 % : Rs 20
Dividend: Rs 380
Dividend revenue enhancement @ 2 % : Rs 7.6
Effective Dividend: Rs 372.4
Transportation Monetary value: Roentgen 500
Company A
Entire Net incomes in Rs
372.4
260.8
Company B
Gross saless: Rs 500
Cost of Goods: Rs 200
Net incomes: Rs 300
Tax @ 35 % : Rs 105
Dividend: Rs 195
Dividend revenue enhancement @ 14 % : Rs 27.3
Effective Dividend: Rs 167.7
Company C
Gross saless: Rs 200
Cost of Goods: Rs 100
Net incomes: Rs 100
Tax @ 5 % : Rs 5
Dividend: Rs 95
Dividend revenue enhancement @ 2 % : Rs 1.9
Effective Dividend: Rs 93.1
Transportation Monetary value: Roentgen 200
Scenario 1
Scenario 2
Therefore, we see that by altering the transportation monetary value for the transportation of goods between company B and C, the net incomes for company A alteration from Rs. 260.8 to Rs. 372.4. By the economic doctrine that more is ever better than less, company A would ever prefer to hold scenario 1 over scenario 2. The monetary value of Rs. 500 for transportation of goods between company B and C is ‘arbitrary ‘ and ‘dictated ‘ as opposed to free market monetary value which would hold existed had the companies been unrelated.
To avoid this, the income revenue enhancement statute laws in assorted states specify regulations for international minutess between subordinate and associate companies. About all states which have adopted the transportation pricing regulations specify that minutess between subordinate or associate companies should take topographic point at ‘arm ‘s length monetary value ‘ . Arm ‘s length monetary value is the monetary value at which two wholly unrelated parties will transport out a dealing for transportation of goods or services. In the illustration cited antecedently, had company B and C been unrelated companies, the dealing would hold closely replicated scenario 2 and Rs. 200 could be called as the arm ‘s length monetary value. Income revenue enhancement statute laws across states will stipulate that the dealing has to travel through at Rs. 200 as opposed to Rs. 500 as Rs. 200 signifies the arm ‘s length monetary value for the dealing.
Throughout the treatment above, the focal point of transportation pricing has chiefly been on transportation of goods, but a figure of facets of concern services between subordinate companies attract reassign pricing commissariats. These facets may travel ignored by the companies and pull punishments from the income revenue enhancement governments during appraisal. They include, but non restricted to affairs related to rational belongings rights, exchequer direction, sale of bing machinery and equipment, proviso of services provided by employees of a peculiar subordinate to the parent company, stockholder services, selling related payments, etc. A elaborate treatment sing the facets mentioned above will be done in the following subdivision.
Applicability of Transfer Pricing[ 1 ]
Transportation pricing is applicable for any dealing that takes topographic point between subordinate or associate company. The definition of subordinate and associate company varies across states depending on the statute law in that peculiar state. Minutess between subordinates and associate companies can take topographic point through transportation of touchable and intangible belongings, proviso of services from one subordinate through other through human capital exchange, funding, rental and renting agreements, etc. For case, a company might have direction services through an electronic mail from an employee in the subordinate company. Ideally, a service has been performed by the subordinate company and a dealing has taken topographic point for transportation pricing intents but in the existent universe state of affairss, such services might be ignored for transportation pricing intents. As opposed, if an employee is deputed to work in an associate company, the associate company is expected to counterbalance the other company for the services provided through the employee. Again, the compensation will be determined in conformity to the principal of ‘arm ‘s length pricing ‘ . The assorted facets which might ask for transportation pricing commissariats are discussed below.
Sale of Tangible Goods
Sale or transportation of touchable goods is largely in footings of machinery, equipment or stock list. A parent company may reassign machinery and equipment to its affiliates, which it has bought from unrelated parties or is used and no longer necessary for the parent company. Tax regulations specify that the transportation of this machinery should be at arm ‘s length monetary value, which would interpret to a just market monetary value of the equipment. Sale of machinery and equipment might originate besides due to reconstituting procedure, where assets are relocated across subordinates. Aspects such as revenue enhancement deductions originating out of roll uping assets, related liabilities and good will or intangibles as against piecewise transportation of works and machinery have to be given due consideration during transportation of fixed assets. Sale of stock list would include sale of natural stuffs, work in advancement and finished goods. In these instances, arm ‘s length pricing would reflect the cost of comparable goods in free market conditions. It is easy for the company to anticipate an pertinence of transportation pricing commissariats for sale or transportation of touchable goods given the nature of goods.
Sale of Intangible Goods
In transportation pricing, transportation of services or rights from a company to its subordinate or an associate would represent as sale of intangible goods. Taking Hindustan Unilever as an illustration, it would be easy to explicate sale or transportation of intangible rights. Hindustan Unilever has to pay royalty for utilizing Unilever plc ‘s hallmark licence, engineering licence and cardinal service understanding. Unilever plc is reassigning an intangible in signifier of licences and service understandings to its subordinate company, Hindustan Unilever. Thus, the understanding is likely to pull reassign pricing commissariats, both in India every bit good as United Kingdom, where its parent company is located. Intangibles can be transferred in the undermentioned four ways from a company to its subordinate or its associate:
Outright sale
Transportation without wage ( Not considered by revenue enhancement governments as a legal dealing expect in particular fortunes )
Transportation of licence with royalty as a consideration
Royalty free transportation of licence ( Again, non considered by revenue enhancement governments )
Intangible transportation can besides be loosely classified into fabrication intangibles and selling intangibles. Patents and proficient know-how signifier the majority of fabrication intangibles that would pull reassign pricing ordinances. A company may reassign its patent to one of its subordinate or associate companies, thereby giving them the right to fabricate a peculiar good in other state. Patents form a barrier for entry for the industry of the peculiar merchandise, and therefore, more frequently than non a monopolistic state of affairs. The grade of monopoly power which is transferred to the attached company is used to find the arm ‘s length monetary value for transportation of this fabricating intangible in signifier of patents. Technical know-how, when transferred between unrelated parties attracts audience charges or royalty fees. It is hard to observe and so value transportation of proficient know-how from a company to one of its affiliates in concern operations. Unilever plc ‘s transportation of engineering licence to Hindustan Unilever would represent transportation of fabricating intangibles between subordinate & A ; associate companies.
Marketing intangibles will represent, but non restricted to permission for the usage of hallmarks and Sons, etc. As discussed antecedently in the same subdivision, Hindustan Unilever uses the same logo as Unilever plc, its parent company. Therefore, a subordinate or an affiliate company has the right to utilize the parent company ‘s logo, ensuing in a transportation of marketing intangible. Besides, the cardinal services understanding between Hindustan Unilever and Unilever constitutes a transportation of marketing intangible. It is hard to happen the arm ‘s length monetary value for marketing intangibles as a hallmark or a logo might hold no value when the merchandise is foremost introduced in a market. In add-on to reassign of hallmark and logo, being of developed gross revenues force and ability to supply service and preparation to clients would besides imply transportation of marketing intangibles between associate and subordinate companies.
Fabrication and selling intangible transportations can non into as two stray transportations between associate companies. A instance of Apple Inc, could easy explicate why the two can non be looked as stray transportations. Apple ‘s corporate repute is a consequence of the company historically bring forthing high quality merchandises such as Macintosh. Thus, corporate repute i.e. selling intangible has risen out of Apple fabrication merchandises which were “ prima border ” in the industry, which forms a portion of fabricating intangible. Another instance could be that of package developed by a parent company being used by one of its subordinates. Arm ‘s length monetary value should be paid by the subordinate to its parent company so that transportation pricing ordinances are satisfied in both the states of operation.
Therefore, we have seen that transportation of intangibles could include a broad scope of transportations like hallmark and logo to corporate repute originating out of superior merchandises. The arm ‘s length monetary value to be associated with such minutess is a comparatively slippery art. The arm ‘s length monetary value associated with such minutess is more likely to be contested by revenue enhancement governments as opposed to reassign of touchable goods.
Transportation of Servicess
A figure of services in signifier of human capital exchange are provided by related to each other. Servicess provided scope from accounting to revenue enhancement, or proficient aid on a complex operation undertaken. By and large, the parent company pools services like legal aid and exchequer for all the subordinate companies, even if they are runing in different states. The company that avails the services, the subordinate in this instance has to pay a service fee to the parent company. As the services have been transferred between related companies, it attracts transportation pricing ordinances and the service fee should closely reflect the arm ‘s length monetary value for that peculiar service. In the state where the service has been availed, the company can subtract the disbursal for revenue enhancement benefit merely if it can turn out that the service was straight good for the company. There are 5 types of services defined under PwC ‘s International transportation pricing 2012:
Everyday services such as revenue enhancement, legal and accounting assistance are included in this type of transportation of service. There is no intangible transportation in such instances. The arm ‘s length monetary value is computed by cost plus methodological analysis, the plus component changing with the type of service and the value added by the same. While some states allow the reimbursement of the ‘plus ‘ constituent, certain others do non let net incomes to be included to acquire revenue enhancement tax write-offs.
When proficient aid is provided in add-on to the transportation of an intangible between related companies, a service is said to be transferred between them. Typically, a certain sum of aid is allowed to be provided in instance of intangible transportation, but if the service is in surplus of the same, it has to be done at an excess cost in conformity to the arm ‘s length doctrine.
The transportation of proficient service, which is independent of any transportation of intangibles between related companies have to be paid for on an arm ‘s length footing.
When certain employees are deputed from the parent company to work at a new installation ( subordinate in a different state ) , the revenue enhancement governments might see it as a transportation of intangibles between the parent company and the subordinate. The revenue enhancement governments might coerce the parent company to add royalty in conformity to the arm ‘s length rule for the transportation of intangibles between the companies. The intangibles in this instance as defined by revenue enhancement governments would be knowledge and proficient know-how.
The revenue enhancement governments while measuring a parent company might coerce it to take down the net incomes of its offshore affiliates by claiming that offshore affiliates require service in signifier of expertness to pull off its personal businesss, including finding its scheme up to an certain extent.
In instance of transportation of services, it is imperative to categorise services as stewardship services or good services. As a parent company, if the company undertakes certain activities for its benefit as a stockholder of the subordinate, so no service charge can be invoked for the same. Duplicate reviews or activities already undertaken by the subordinate, general reappraisal of subordinate ‘s public presentation, study and meeting demands as bulk stockholder, cost of funding or refinancing ownership of subordinate, etc. are services which can be categorized as stewardship services and no charge can be invoked on the subordinate company by the parent company. In contrast, services like fixing operations programs, supplying legal assistance for conformity with legal and revenue enhancement norms of subordinate ‘s place state, carry oning internal audit of subordinate are good services provided to the subordinate. These good services ought to be charged in conformity to the arm ‘s length rule by the parent company.
Financing Minutess
The construct of transportation pricing arises when a peculiar company financess long or short term fund demands for any of its related companies in signifier of a loan or other support techniques. If a related company pumps in extra equity into a company, transportation pricing commissariats would non be invoked. Tax governments in different states will handle the dealing otherwise. While the revenue enhancement governments in the state of the borrower company will ground for a lower rate of involvement, the revenue enhancement governments in the company funding the debt will reason for a higher involvement rate. The factors which can be considered relevant to related party debt are:
Rate of involvement for the issued debt
The capital sum of debt
Currency in which debt is issued
The recognition worthiness of the borrower
The revenue enhancement governments would see the debt to equity ratio, involvement rate prevailing in the state due to pecuniary guidelines and if an unrelated party will be willing to fund the entity or non to repair the arm ‘s length monetary value i.e. involvement rate for the dealing. Financing minutess can be loosely categorized as shown below:
Financing of short term capital demands
Financing of long term capital demands
Mortgages: Purchase of land through payment spread over a period of clip
Lease funding: Leasing of capital goods like machinery
Capital Stock: The parent company might buy capital stock for the subordinate company
Inter-company loans
Guarantying of bank loans: The parent guarantees the bank loan undertaken by the subordinate operating in another state
Additionally, intercompany payables and receivables due for a long continuance will besides acquire categorized as loans depending on the statute law prevalent in the state. Cost sharing of R & A ; D activities undertaken by related company will besides come under the horizon of funding minutess.
The treatment above focused on the application of transportation pricing statute laws to assorted minutess that are undertaken by related companies. In all the above instances, the focal point of treatment was that the dealing should take topographic point at arm ‘s length monetary value as determined by the company and revenue enhancement governments. The Organization for Economic Co-operation and Development ( OECD ) has published guidelines with respects to geting at an arm ‘s length monetary value in related party minutess which are discussed in the following chapter.
OECD Guidelines on Arm ‘s Length Pricing
Organization for Economic Co-operation and Development was established in 1961 to set up policies within member states which would keep high and sound economic growing and contribute to universe trade through many-sided, non-discriminatory footing. OECD provides a general counsel on transportation pricing. These guidelines were first issued in 1979 and later reviewed in 1995 and 2010. The construct of arm ‘s length monetary value is explained in article 9 of OECD Model Tax Convention. The OECD Guidelines provide assorted methods which can be used to get at an arm ‘s length monetary value for a related party dealing. The methods are discussed below.
Comparable Uncontrolled Price Method
This is the most direct manner of finding the arm ‘s length monetary value. In this method the monetary value charged for goods and services in a comparable uncontrolled dealing or a few minutess identified will be used as the arm ‘s length monetary value after seting for any differences. The accommodation shall take into history any difference between the related party dealing and the comparable uncontrolled dealing or the endeavors come ining into such minutess which can impact the monetary value in the unfastened market.
The uncontrolled dealing should be a dealing between independent endeavors and should hold goods or services of a similar type, quality and measure as of the dealing between the associated endeavors. The circumstance of the sale and the footings and conditions should besides be similar.
If the differences between the minutess can be valued and has a moderately little consequence on the dealing, so the accommodations can be easy made. Adjustments can be made on differences like footings of dealing, volume of gross revenues and timing of dealing. It is hard to do accommodations if there are differences in the quality of merchandise, geographical market, degree of the market and the sum and type of intangible belongings involved in the sale.
Resale Price Method
In this method the arm ‘s length monetary value is determined by dismissing the existent resale monetary value for the activities of the reseller. The price reduction made will include the gross net income border accruing to the endeavor or to an unrelated endeavor from the purchase and resale of same or similar goods or services in a comparable uncontrolled dealing in the relevant market. This monetary value shall be reduced farther by the disbursals incurred in the purchase of goods or services. Further accommodations would be made to take into history any differences between the related party dealing and the comparable uncontrolled minutess or between the endeavors come ining into such minutess, which could impact the gross net income border in the unfastened market.
This method is normally used when there is small or no value add-on before the resale of the finished merchandises or the other goods acquired from related parties. There can be jobs in obtaining comparable informations particularly when there is a clip spread between the comparable dealing and the 1 reviewed as economic factors like involvement rates, exchange rates etc can do important deformations.
Cost Plus Method
In this method the arm ‘s length monetary value is determined by adding a suited grade up to the cost of bring forthing the goods or service. The sum of grade up is determined from similar minutess made by the endeavor or an unrelated endeavor in a comparable uncontrolled dealing. It should be ensures that the entire cost base of the comparable dealing should be similar to the cost base of the dealing to which the grade up is applied. A comparing of the accounting policies of both the endeavors should be performed to place any mismatches in expense categorization between the cost of goods sold and administrative disbursals.
While finding the grade up to be applied for a contract maker, the goods transferred under the minutess compared need non be physically similar as the contract maker is compensated for the service provided by him. But for full fledged makers the grade ups vary well from one merchandise to another.
This method is chiefly used when uncontrolled monetary value for a dealing is non available or where there are long term bargain and supply agreements. This is besides used in instance of proviso of services or contract fabrication.
Net income Split Method
In this method arm ‘s length monetary value is arrived at by dividing the combined net net incomes of the related parties originating from the dealing. This combined net net income will be allocated to each related party on the footing of returns comparable minutess by independent endeavors. As this information is seldom available, the net income split is done on the footing of their comparative part to the combined net net income. This comparative part will be evaluated on the footing of the maps performed, touchable and intangible assets employed or to be employed and hazards assumed by each endeavor.
Here it is necessary to calculate the costs and grosss of each related party in this dealing. It should besides be noted that the net income split analysis is normally performed at the operating income degree and non-operating income should be excluded from the analysis.
This method is used in minutess where both related parties make alone and valuable parts to the dealing. It is besides used in minutess where integrated services are provided by more than one endeavor and in the instance of multiple inter-related minutess which can non be evaluated individually.
Transactional Net Margin Method
In this method the net net income border of the related party dealing is calculated comparative to a base such as cost incurred or gross revenues or assets employed or to be employed by the endeavor or any other relevant base. The net net income border from a comparable uncontrolled dealing is computed to a relevant base and it is adjusted to account the differences, between the minutess or the endeavors come ining into dealing, which can impact the net income border in unfastened market. This net income markup is added to the cost of production to acquire the arm ‘s length monetary value.
This method is used in the instance of transportation of semi furnished goods or distribution of finished merchandises where resale monetary value method can non be used.
Berry ratio compared to return on gross revenues
ROS is the primary net income degree index applied to distribution operations to measure the transportation pricing mechanism. Berry ratio expressions at the gross profitableness of an activity and the operating disbursals needed to transport out the activity. It is the ratio between gross net income and operating disbursals.
When a company has done the R & A ; D and fabrication of a merchandise and a related entity is making the gross revenues. Here the grade up the distributer earns on merchandising, and general and administrative disbursals which it incurs while supplying gross revenues has to be determined. The berry ratio is used to tag up the general and administrative costs the distributer incurs in the related party dealing.
Berry ratio can be easy used as the size of the distributer used as comparable is non an issue. It is used when the distribution activity is a proviso of service to the maker and consists of a limited scope of maps and hazards. But ROS can be used to better measure distributers that operate with a higher grade of independency or that perform value add-on activities along with resale of the goods.
Tax return on Assetss
As return on equity is hard to utilize in an inter-company pricing model, return on assets is used as a replacement. ROA is normally used as a net income degree index as portion of transactional net border and cost plus method analysis. This is chiefly used in fabrication activities and when the assets used in the fabrication activity is hard to specify, return on net book value of all assets is used. Normally runing income before involvement and revenue enhancement is used as numerator and net book value of all assets on the balance sheet which are utilized in the fabrication activity, excepting fiscal and non-operating assets is used as denominator.
The age of the works and equipment should besides be considered while comparing the ROA in a related party dealing with that of an independent company dealing.
Corporate Administration
Corporate Governance is defined by OECD as “ The system by which concern corporations are directed and controlled. The corporate administration construction specifies the distribution of rights and duties among different participants in the corporation, such as the board, directors, stockholders and other stakeholders, and spells out the regulations and processs for doing determinations on corporate personal businesss ” In transportation pricing corporate administration has a important societal and economic impact in guaranting answerability in just distribution of wealth. It is implemented non merely at the corporate degree of an endeavor, but besides at the divisional degree, finding the interaction between divisions, and at the degree of single directors who are the determination shapers.
Transportation pricing will act upon the mode in which the net incomes of a transnational are distributed across the assorted states in which they are runing. Tax conformity in this respect will besides increase the stockholder value as it avoids dual revenue enhancement and punishments.
Transportation pricing can assist in alining the involvements of the assorted concern units involved every bit good as the involvements of the people who work for the units with that of the corporate ends. Divisional net incomes will be influenced by transportation pricing and this can assist in executing a better rating of the divisions involved every bit good as the public presentation rating of the troughs. If the pricing determination is moved to the corporate degree, the control of the divisional director on the divisional net income is lost and this will reflect on his public presentation step as good.
While planing the transportation pricing policy an organisation must aline the involvements of the assorted stakeholders involved like the internal stakeholders of the organisation and the external stakeholders such as stockholders and revenue enhancement governments.
Legislation in India[ 2 ]
The subdivisions 92 to 92F of the Indian Income Tax Act, 1961 provides a separate codification on transportation pricing and screens intra group cross boundary line minutess. The codification describes the assorted transportation pricing methods, enforces demands for one-year transportation pricing certification, and besides mentions the punishment for disobedience. These ordinances which are applicable from April 1st, 2001 are loosely based on the OECD guidelines. After the debut of this codification, transportation pricing has become the most of import international revenue enhancement issue impacting transnational companies runing in India.
A sum-up of these legal commissariats is given below:[ 3 ]
Section
What it provides
92A
Calculation of Income from International minutess affecting transportation pricing holding respect to ”Arm ‘s length monetary value ” A
92A
Meaning of ”Associated Enterprise ”
92B
Meaning of ”International Transaction ”
92C
Calculation of ”Arm ‘s Length Price ”
92CA
Mention to Transfer Pricing Officer
92D
Care of Documents and Information
92E
Requirement of Audit Report
92F
Important Definitions.
271 ( 1 ) ( C )
Adjustment to income on history of Transfer Pricing Provisions to be regarded as hidden Income.
271AA
Punishment for failure to maintain and keep information and paperss
271BA
Punishment for failure to supply Audit Report
271G
Punishment for failure to supply information or paperss
Rules
What it ProvidesA
10A
Meaning of look used in calculation of ”Arm ‘s Length Price ”
10B
Determination of ”Arm ‘s Length Price ‘ under subdivision 92C
10C
Most Appropriate Method
10D
Information and Documents to be kept and maintained under subdivision 92D
10E
Report from an Accountant to be furnished under subdivision 92E
Harmonizing to the Indian Transfer Pricing Code the income originating from the “ international minutess ” between “ associated endeavors ” should be computed at “ arm’s-length monetary value ” . The allowance for any disbursal or involvement arising from an international dealing will besides be determined holding respect to the arm’s-length monetary value.
Arm ‘s Length Price
Arm ‘s length monetary value is defined as a monetary value, which is applied in a dealing between individuals other than associated endeavors, in uncontrolled conditions. The arm ‘s length monetary value is determined by any of the following methods based on the nature of dealing or category of dealing or category of associated individuals or maps performed by such individuals or other relevant factors.
comparable uncontrolled monetary value method ;
resale monetary value method ;
cost plus method ;
net income split method ;
transactional net border method ;
Any other method prescribed by the Board.
Associate Enterprises
Associated EnterprisesA have been defined to cover those holding direct/indirect engagement in the direction, control or capital of one endeavor by another endeavor. Two endeavors shall be deemed to be associated endeavors if, at any clip during the old twelvemonth there is
Direct or Indirect retention of portions transporting non less than 26 % of voting power in one endeavor by the other.
Direct or Indirect retention of portions transporting non less than 26 % of voting power by one individual or endeavor in each of such endeavor.
Advancement of loan by an endeavor to the other endeavor constitutes non less than 51 % of the book value of the assets of the adoption endeavor.
Guarantee for non less than 10 % of the entire adoptions of one endeavor by the other
Appointment of more than half of the board of managers or members of the regulating board, or one or more executive managers or executive members of the regulating board of one endeavor is done by the other endeavor.
Appointment of more than half of the board of managers or members of the regulating board, or one or more executive managers or executive members of the regulating board of both the endeavors are done by the same individual.
Complete dependance on the usage of know-how, patents, right of first publications, trade-marks, licences, franchises or any other concern or commercial rights of similar nature, or any informations, certification, pulling or specification associating to any patent, innovation, theoretical account, design, secret expression or procedure of one endeavor for the industry or processing of goods or articles or concern carried out by the other endeavor.
Purchase of 90 % or more of the natural stuffs and consumables required for the industry or processing of goods or articles carried out by one endeavor, are supplied by the other endeavor, or by individuals specified by the other endeavor, and the monetary values and other conditions associating to the supply are influenced by the other endeavor.
Sale of goods or articles manufactured or processed by one endeavor to the other endeavor or to individuals specified by the other endeavor, and the monetary values and other conditions associating thereto are influenced by the other endeavor.
Control of one endeavor by an person and the other endeavor is besides controlled by such single or his comparative or jointly by such single and comparative of such single.
Control of one endeavor by a Hindu undivided household and the other endeavor is besides controlled by a member of such Hindu undivided household or by a relation of a member of such Hindu undivided household or jointly by such member and his relation.
Keeping of non less than 10 % involvement by one endeavor in the other endeavor which is a house, association of individuals or organic structure of persons.
Being of common involvement between the two endeavors.
A dealing between an endeavor and a 3rd party can besides be considered as a dealing between associated endeavors if there is a anterior understanding between the two parties or if the footings of such minutess are determined in substance between them. This clause will counter any move to avoid transportation pricing ordinance by utilizing a 3rd party during minutess between two associated endeavors.
International Minutess
International transactionA is defined to intend a dealing between two ( or more ) associated endeavors, either or both of whom are non-residents, which has a bearing on the net incomes, income, losingss or assets of such endeavors. The dealing can affect sale, purchase or rental of touchable or intangible belongings, proviso of services, imparting or borrowing money etc.
Documentation sing the international minutess between associated endeavors has to be maintained by the taxpayer on an one-year footing. The certification demands has two parts
The compulsory documents/information that a taxpayer must keep comes under the first portion. This list includes information on the ownership construction of the taxpayer, group profile, concern overview of the taxpayer and AEs, prescribed inside informations of international minutess and relevant fiscal forecasts/estimates of the taxpayer. A comprehensive transportation pricing survey including the maps performed, hazards assumed, assets employed, inside informations of relevant uncontrolled minutess, comparison analysis, benchmarking surveies, premises, policies, inside informations of accommodations and accounts as to the choice of the most appropriate transportation pricing method should besides be documented.
The 2nd portion requires the care of equal certification to confirm the information/analysis documented under the first portion of the regulation. It besides contains a list of recommended back uping paperss like authorities publications, studies, surveies, proficient publications/market research surveies undertaken by reputable establishments, monetary value publications, relevant understandings, contracts, and correspondence.
If the aggregative international dealing of a taxpayer is less than Rs.10 million, so the taxpayer is relieved from keeping the certification. But equal paperss to confirm the arm ‘s length monetary value of the international minutess have to be maintained.
Punishments
Rigorous punishments have been laid down for go againsting the transportation pricing codification.
2 % of dealing value for failure to keep the prescribed information/documentation.
2 % of dealing value for failure to supply information/documentation during the audit.
100 % to 300 % of the entire revenue enhancement on the accommodation sum for accommodation to taxpayer ‘s income.
Rs.100,000 for failure to supply an comptroller ‘s study.
Progress Pricing Agreement
With a position to cut down reassign pricing revenue enhancement differences, the authorities of India has introduced the Advance Pricing Agreement ( APA ) regulation through the Finance Act 2012. This regulation will let companies to seek counsel on the pricing of the goods and services in progress for a set of international minutess on a suited transportation pricing technique. The taxpayer can come in into an understanding for multiple old ages with the revenue enhancement authorization ( Central Board of Direct Taxes in India ) .
By come ining into an understanding the Associated endeavors can be certain about the revenue enhancement hazards and can form the hazard exposure in a better manner. Through APA, the revenue enhancement authorization agrees non to look for transportation pricing accommodations for the minutess covered under the understanding every bit long as the taxpayers abides by the footings and conditions in the APA. APAs can be one-sided, bilateral or many-sided based on the figure of taxpayers and revenue enhancement governments joined by the understanding.
APA will non be adhering on the Board or the taxpayer. If there is any alteration in the factors and premises that are critical to the APA, neither party come ining into the understanding will be bound by the understanding. Revision of the APA is possible if there is a alteration in jurisprudence or a alteration in critical premise or a petition from a competent authorization of another state in instance of bilateral and many-sided understandings. The Board can besides call off the APA if the one-year conformity study is non filed on clip or if the study filed contains material mistake.
To come in into and APA, the revenue enhancement remunerator has to pay Rs.10 hundred thousand for international minutess up to Rs.100 crore, Rs.15 hundred thousand for minutess up to Rs.200 crore and Rs.20 hundred thousand for minutess above Rs.200 crore. APA can besides supply assorted net incomes as they cut down the possibility of hazards and aids coverage of possible revenue enhancement liabilities. It can besides diminish the instances of dual revenue enhancement, the cost involved in transportation pricing certification and audit defence.
As APA is an first-class contention direction tool, many states with specific transportation pricing ordinances provide an option for APA.
Transportation pricing and Customs rating: Need for Rationalization
Any international dealing is subjected to indirect revenue enhancement through imposts, gross revenues or value added revenue enhancement to find the responsibility collectible on the goods imported. If the goods are transferred between related parties, so the transportation monetary value should be determined giving consideration to both: corporate income tax-recompressions and imposts deductions. The conflicting aims of the income revenue enhancement and imposts sections leads to the demand for rationalisation of Torahs under which arm ‘s length monetary value is arrived at for imposts and income revenue enhancement rating. To increase the grosss of their sections, usage functionaries would wish the arm ‘s length monetary value of good to be every bit high as possible while it is the frailty versa for income revenue enhancement functionaries.
Customss Evaluation
In India, imposts are governed under Customs Act, 1962. The value of a good is discussed under Section 14 of Chapter 5 ( Levy of and freedom from Custom Duties ) in Customs Act, 1962. Section 14 of Customs Act, 1962 defines the value of good to be the transactional value, such that the dealing has taken topographic point between unrelated parties i.e. arm ‘s length monetary value. The commissariats of Section 14 apply for rating and the regulations under which rating has to take topographic point are defined by The Customss Valuation ( Determination of Price of Imported Goods ) Rules, 1988. The Customss Valuation Rules are an result of the Tokyo Round, 1973-79 of GATT ( soon WTO ) treatments which developed the Agreement on Customs Valuation ( ACV ) .[ 4 ]The WTO mandates the usage of ACV for all its members and as India is a member of WTO, the rating under The Customs Valuation Rules, 1988 follow the same rule of rating as the ACV.
Income Tax Evaluation
The subdivisions 92 to 92F of the Indian Income Tax Act, 1961 provides a separate codification on transportation pricing and screens intra group cross boundary line minutess. The codification describes the assorted transportation pricing methods, enforces demands for one-year transportation pricing certification, and besides mentions the punishment for disobedience. These ordinances which are applicable from April 1st, 2001 are loosely based on the OECD guidelines. After the debut of this codification, transportation pricing has become the most of import international revenue enhancement issue impacting transnational companies runing in India.[ 5 ]
Similarities and Dissimilarities between Income Tax and Customs Valuation
The founding rule for income revenue enhancement and imposts rating in finding the transportation monetary value is the same: the monetary value established for the goods should be the same had the dealing taken topographic point between unrelated parties but there are certain differences which stand out when we compare arm ‘s length rating of the good under Income Tax Act and Customs Act. The Income Tax Act prescribes finding of the arm ‘s length monetary value by first finding the most appropriate method between the followers: comparable uncontrolled monetary value method, resale monetary value method, cost plus method, net income split method, transactional net border method or any such other method as may be prescribed by the Board. If more than one method can be considered appropriate, so the arithmetic amount of the monetary value found by each method will be chosen to be the arm ‘s length monetary value. The Customs Act contrastingly follows a consecutive procedure in finding the arm ‘s length monetary value. Under Customs Act, the arm ‘s length is determined by the method which is appropriate in the undermentioned sequence: dealing value of indistinguishable goods, dealing value of similar goods, deductive value, computed value and residuary value. So, if the arm ‘s length monetary value of goods is determined under dealing value of indistinguishable goods, it will non be subjected to deductive, computed and residuary rating. Under Income Tax Act, even if the monetary value of good is identified under comparable uncontrolled monetary value method ( which is indistinguishable to dealing value of indistinguishable goods ) , if a different rating is found under cost plus or net income split method, so the arithmetic mean of the monetary values will be determined as the dealing monetary value. Additionally, under Income Tax Act, if the arm ‘s length monetary value so determined is within 5 % of the existent international dealing monetary value, so the dealing value will be used to find the nonexempt income. There is no such proviso under Customs Act. Besides, owing to the above factors, the rating of the imported good by usage functionaries and income revenue enhancement functionaries might change significantly. To increase the grosss of their sections, while usage functionaries would wish the arm ‘s length monetary value to be every bit high as possible, income revenue enhancement functionaries would prefer it to be every bit low as possible. Besides, companies are put at a important hazard as custom rating takes topographic point when goods are imported while income revenue enhancement functionaries asses the company around 2-3 old ages after the terminal of a fiscal twelvemonth. If on history of transportation pricing accommodations, the value of the imported good is altered, so there is likely goon of proceedings from the imposts particular rating or particular probe subdivision proceedings being triggered.[ 6 ]Recently, in September 2012, the Finance Ministry notified the “ Advance Pricing Agreement ( APA ) Scheme ” under which any party could acquire into an understanding with Central Board of Direct Taxes ( CBDT ) which would repair the transportation monetary value good in progress. So, the job of imposts particular rating and particular probe subdivision proceedings being triggered may good be a thing of the yesteryear.
Furthermore, the database used for zeroing in on arm ‘s length monetary value differs for both the Boards, though they come under the same ministry. Directorate General of Valuation, under the Central Board of Excise & A ; Customs has developed its ain database: National Imports Database ( NIDB ) , Export Community Database ( ECB ) and Central Excise Database ( CEDB ) . Income revenue enhancement functionaries use ‘Prowess ‘ or ‘CapitalLine ‘ database to get at an arm ‘s length monetary value.[ 7 ]Though, basically the values obtained via both the databases should be same, more frequently than non there is a likeliness of disagreements between the two values.
Income Tax Act, 1961
Customs Act, 1962
Comparable Uncontrolled Price Method
Transaction Value of Similar / Identical Goods
Resale Price Method
Deductive Value Method
Cost Plus Method
Computed Value Method
Net income Split Method
–
Transaction Net Margin Method
–
Table: Similarity of methods for rating as prescribed under Income Tax and Customs Act
Comparable Uncontrolled Price Method
Transaction Value of Similar / Identical Goods
Similarity
This method compares the sum charged by uncontrolled minutess between unrelated companies with that of minutess within related companies
This method compares the FOB of the importer with of similar or indistinguishable goods with FOB of import by unrelated parties.
Dissimilarity
The state of beginnings need non be the same.
The state of beginning should be the same.
The accommodations to monetary value allowed are broad.
The accommodations allowed demand to be precise and accurate, clearly set uping rationality and truth of the accommodation.
Table: Comparison between CUP and TVS/TVI[ 8 ]
Resale Price Method
Deductive Value Method
Similarity
The cost incurred from import to sale is allowed to be deducted as disbursal.
Loading value is arrived at by subtracting net incomes, general disbursals, responsibilities and revenue enhancements.
The method focuses on comparison of maps involved as the accent on comparison of goods has reduced.
The accent is on the costs incurred in transporting out similar maps for goods produced by a peculiar industry sector.
Dissimilarity
Costss which are non included in operating costs are non allowed for income revenue enhancement tax write-offs.
There is no judicial admission on deducting costs which do non organize a portion of operating disbursal.
There is no stipulated comparing clip cogency for informations.
The clip for comparable informations is 90 yearss from the day of the month of import.
There is no lucidity on add-on of intangibles and is left to the discretion of the measuring officer.
There is lucidity on add-on of intangibles. If intangibles are collectible as ‘condition for sale ‘ , so it can be added as an disbursal.
Table: Comparison between RSM and DVM[ 9 ]
Cost Plus Method
Computed Value Method
Similarity
Transfer Price includes all cost of production with an add-on of gross net income.
Costss are determined on the footing of accounting patterns
Gross Profit per centum is determined utilizing comparable informations
Table: Comparison between CPM and CVM[ 10 ]
Problems Faced by Trade
Companies have internal transportation pricing policies which help in set uping arm ‘s length pricing in related party minutess. For goods that attract custom responsibilities, companies have to actively put policies which will ensue in run intoing the demands of usage governments in the state of import and make an chance for revenue enhancement and usage functionaries to accept their arm ‘s length monetary value without bias to each other. Companies besides face job due to interchange rate fluctuations while finding the arm ‘s length monetary value for usage and income revenue enhancement rating. Customs rating takes topographic point at the clip of import while for income revenue enhancement intents, the rating will take topographic point at a ulterior phase, and by and large around 2-3 old ages after the returns have been filed. A retrospective monetary value accommodation might affect re-assessment by imposts functionaries and subsequent proceedings being initiated against the company. Besides, as transportation monetary value has to be established for both, imposts and income revenue enhancement individually, a company ends up passing extra money to accomplish the same end of puting an arm ‘s length monetary value which would be acceptable. There is no lucidity with respects to the difference in certification required to set up an arm ‘s length monetary value but since the focal point of usage functionaries is per unit monetary value of imported goods, while that of income revenue enhancement section is overall nonexempt income of importer or exporter, it is bound to be different.
Government Action
The Government of India, through an order in May, 2007 implemented a recommendation of a Joint Working Group which was formed for better co-ordination between imposts and income revenue enhancement functionaries while geting at an arm ‘s length monetary value. The commission was of the sentiment that co-operation and co-ordination between the two sections on transportation pricing is highly indispensable. They proposed that there be bi-monthly meetings at regional degree in metro metropoliss between income revenue enhancement and imposts sections. In add-on, there will be a meeting every 6 months between Director General of Transfer Pricing, Director General of Valuation and the Chief Commissioners of Customs. In these meetings, the two sections will interchange of information in specific instances. In add-on, the Joint Working Committee proposed that NationalA AcademyA of Direct Taxes ( NADT ) and National Academy of Customs, Excise and Narcotics ( NACEN ) shall develop and form preparation programmes on transportation pricing. This can be considered as the first measure towards turn toing transportation pricing issues between the two sections in a harmonious mode. Even though the two sections have agreed for joint meetings and have shown purpose to get at a consensus for transportation pricing, they are no lawfully bound to co-operate with each other and repair on a peculiar arm ‘s length monetary value. Transfer pricing officers, in past have expressed a position that monetary value accepted by other officers may non be conclusive in finding the arm ‘s length monetary value for a peculiar dealing.[ 11 ]
Suggestions for Harmonization
As we have seen that imposts and income revenue enhancement officers differ on their rating guidelines for finding the arm ‘s length monetary value. In order to counter the same, Indian entities have to set about separate paperwork for imposts and income revenue enhancement to find the transportation monetary value. In instance there is difference between the same, the entity might stop up paying either extra income revenue enhancement or imposts responsibility on importing a peculiar good. The first degree of harmonization could include dissolving out the unsimilarities that exist in prescribed rating methods.
Comparable Uncontrolled Pricing Method and Transaction Value of Similar / Identical Goods
The unsimilarity can be reduced by doing demands for accommodations more rigorous under income revenue enhancement jurisprudence. While accommodations are arbitrary and liberally applied in CUP, in TVS/TVI, accommodations can merely be made on the footing of incontrovertible grounds. Besides, for imposts rating for similar or indistinguishable goods, the state of beginning of comparable goods should be same. This clause, we believe can be done off with as states are meeting towards a individual planetary monetary value of merchandises.
Resale Price Method and Deductive Value Method
Treatment to intangibles is the chief difference between rating utilizing the above two methods. Since, there is lucidity of ‘condition for sale ‘ for intangibles to be addible utilizing deductive value method ( imposts rating ) , while in resale monetary value method ( income revenue enhancement rating ) the intervention to intangibles is arbitrary, we suggest that rating utilizing resale monetary value method adopt ‘condition for sale ‘ rules to add intangibles.
Cost Plus Method and Computed Value Method
These are the easiest to harmonize as there exist really small unsimilarities between the two methods of rating to get at arm ‘s length monetary value.
Harmonisation through APAs
The freshly introduced APAs have legal proof merely for income revenue enhancement functionaries and the imposts officers may merely utilize it as a guideline to find the appropriate transportation monetary value. Since, both the organic structures study to the gross section, we propose that there be a cardinal organic structure for rating under the gross section which consists of officers from Particular Valuation Branch ( SVB ) , Customs and Directorate of Transfer Pricing ( DTP ) to set up the arm ‘s length monetary value. Alternatively of APAs with CBDT, there could be APAs with this cardinal organic structure for rating which would be lawfully adhering on the income revenue enhancement functionaries every bit good as imposts functionaries. The streamlining of procedure will be a large benefit for the companies towards a individual window to repair the transportation monetary value.
Recognition
We would wish to thank our usher, Prof. V. Gopal for assisting us through the class of our Course of Independent Study. His priceless suggestions, giving us waies at every measure were of great aid, peculiarly in the demand for rationalisation in Customs and Income Tax Acts on transportation pricing. We would besides wish to thank IIM Trichy for supplying us with resources for this survey, without which this survey would non hold been possible.
