Transfer Pricing
Ensuring the right cost in a multi division company
The information contained herein represents personal
views of the speaker.
The information contained herein is general in nature
and subject to change. Applicability to specific
situations is to be determined through consultation
with your tax adviser.
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Transfer Pricing – What/ Why/ How
Transfer Pricing is used to determine price of a product/ service transferred from one
subsidiary to another within a Group or one division to another within a Company
Transfer Pricing, if effectively used, helps Groups/ Companies to:
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Undertake independent performance evaluation of each company/ division
Coordinate production, sales and pricing decisions of different companies/ divisions
Allocate resources effectively
Lower overall tax incidence and reduce tax risks
Common ways to set Transfer Prices:
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Market-based Transfer Pricing
Negotiated Transfer Pricing
Cost-based Transfer Pricing
- Full Cost
- Cost-plus
- Marginal Cost
- Variable Cost plus Opportunity cost
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International Transfer Pricing
Parent Co. Country A
Sub Co. Country B
Sale price Rs.130
Cost - Rs.120
Tax Haven
35% tax on Rs. 10
Zero tax on Rs. 40
Sub Co. Country C
Sale price - Rs. 190
40% tax on Rs. 20
To prevent profit shifting by transfer price manipulation
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Domestic Transfer Pricing
Shifting of Expenses
Shifting of Expenses
Loss making
company
Profit making
company
Tax @~33%
No Tax due
to loss
Shifting of Income
Tax
@~33%
Reduced
tax due to
profit
shifting
Tax Holiday
Unit
Taxable Unit/
company
Tax @
~33%
Tax
Exemption
Shifting of Income
Loss to Indian Revenue as a result of the above
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Arm’s Length Price
Transfer
Pricing
Sec 92 of the Act
Associated
Enterprises
Sec 92A of the Act
International
transactions
Sec 92B of the Act
Specified Domestic
transactions
Sec 92BA of the Act
Arm’s Length Price
Sec 92C of the Act
Section 92(1) - Any income arising from an international transaction shall be computed
having regard to the arm's length price
Arm’s
Length
Price
Explanation - For the removal of doubts, it is hereby clarified that the allowance for any expense
or interest arising from an international transaction shall also be determined having regard
to the arm's length price
Section 92(2A) – Any allowance for an expenditure or interest or allocation of any cost or any
income in relation to the specified domestic transaction shall be computed having regards to the
arm’s length price
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Arm’s Length Price
Section 40A(2)(a) Where the assessee incurs any expenditure in respect of which payment has been or is
to be made to any person referred to in clause (b) of this sub-section, and the Assessing Officer is of
opinion that such expenditure is excessive or unreasonable having regard to the fair market value of the
goods, services or facilities for which the payment is made or the legitimate needs of the business or profession
of the assessee or the benefit derived by or accruing to him therefrom, so much of the expenditure as is so
considered by him to be excessive or unreasonable shall not be allowed as a deduction :
Provided that no disallowance, on account of any expenditure being excessive or unreasonable having
regard to the fair market value, shall be made in respect of a specified domestic transaction referred to in
section 92BA, if such transaction is at arm's length price as defined in clause (ii) of section 92F
Arm’s
Length
Price
Section 80-IA (8) Where any goods or services held for the purposes of the eligible business are
transferred to any other business carried on by the assessee, or where any goods or services held for
the purposes of any other business carried on by the assessee are transferred to the eligible business
and, in either case, the consideration, if any, for such transfer as recorded in the accounts of the eligible
business does not correspond to the market value of such goods or services as on the date of the
transfer, then, for the purposes of the deduction under this section, the profits and gains of such eligible
business shall be computed as if the transfer, in either case, had been made at the market value of
such goods or services as on that date :
Explanation - For the purposes of this sub-section, "market value", in relation to any goods or services, means (i) the price that such goods or services would ordinarily fetch in the open market; or
(ii) the arm's length price as defined in clause (ii) of section 92F, where the transfer of such goods or
services is a specified domestic transaction referred to in section 92BA
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Transfer Pricing Methods
Six Prescribed Methods
Traditional Transaction
Methods
Comparable
Uncontrolled
Price
Resale Price
Transactional Profit
Methods
Cost Plus
Profit Split
Transactional
Net Margin
Other
Method
No hierarchy or preference of methods prescribed under the Act
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Transfer Pricing Methods
CUP Method
• Price charged or paid for property transferred or services
provided in a comparable uncontrolled transaction
RPM
• Price at which property or services purchased from AE
resold to unrelated enterprise less normal gross profit
margin less other expenses incurred in connection with
purchase of property or services
CPM
• Direct and indirect costs of production incurred in
respect of property transferred or services provided to AE
plus normal gross profit mark-up on such costs
TNMM
• Net profit margin in relation to costs incurred or sales
effected or assets employed or any other relevant base
PSM
• Split of combined net profit of AEs from international
transaction in proportion to relative contribution
Other Method
• Price which has been charged or would have been
charged for same or similar uncontrolled transaction
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Some Examples –
International Transfer Pricing
 Foreign Parent has a Subsidiary in India engaged
in contract manufacturing/ service provision for/ to it
 Parent undertakes all risk bearing entrepreneurial
functions while Subsidiary operates as a risk
insulated captive, for this transaction
 Local Subsidiary also has own domestic
manufacturing and sale business
 India captive segment to be drawn using correct
cost pool and appropriate allocation keys
Parent
Parent
Outside India
India
Subsidiary
(Contract
Manufacturer)
Subsidiary
(Contract Service
Provider)
Local manufacturing
and Sale
Local manufacturing
and Sale
 Indian Parent has Foreign Subsidiary engaged in marketing and
distribution of its goods
 Parent undertakes all risk bearing entrepreneurial functions while
Subsidiary operates as a routine/ low risk bearing distributor
 If India export segment is benchmarked – appropriate cost allocation
needs to be undertaken
 If Foreign Subsidiary is benchmarked, cost details of the Foreign
Subsidiary required for India reporting and disclosure
 If Foreign Subsidiary also has own local business, correct cost
allocation to India buy-sell activity imperative
Subsidiary
Outside India
India
Parent (Full-fledged
manufacturer)
Local Sales
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Some Examples –
Domestic Transfer Pricing
Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID)
Inter unit transfer of manufactured goods for sale
Tax holiday unit
Other unit
• Cost details of the Transferor important while applying methods such as CUP, CPM or TNMM
• Cost details of the Transferee important while applying methods such as RPM or TNMM
• Cost details of both while applying methods such as PSM
Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID)
Non Tax holiday
unit (HO)
Inter unit transfer of services
Tax holiday unit
HO performs R&D, Selling & Marketing and
other leadership functions
• Appropriate allocation keys should be used to allocate common HO costs to tax holiday unit
• Revenue may challenge use of ad-hoc allocation keys
• Key to demonstrate arm’s length profits in tax holiday unit and not “More than ordinary profits”
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Conclusion
• Significant interplay between cost records/ details and Transfer Pricing
• Accurate cost details critical for both multi-unit as well as multi entity groups
• Verifiability and documentation necessary – Audits/ examination by Revenue
• Consistency between cost records/ MIS and Transfer Pricing records critical
Need for working together!
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Thank You
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