CONTENTS
I
MOST APPROPRIATE METHOD
II
COMPARABLE UNCONTROLLED PRICE METHOD
III
RESALE PRICE METHOD
TRANSFER PRICING METHODS
 These methods are used to establish whether the conditions imposed in the
commercial or financial relations between AEs are consistent with Arm’s
Length Principle.
 The Traditional transaction method is preferable to the transactional profit
method [Serdia Pharmaceuticals (India) (P.) Ltd 2011]
MOST APPROPRIATE METHOD







When the CUP method and another TP method can be applied in an equally
reliable manner, the CUP method is to be preferred
Mandatory to follow one of the prescribed methods [Dy. CIT v. Starlite 2010]
Choice of method is subject of certain procedures i.e. not an unfettered choice of the
tax payer [Cherokee India P. Ltd v. ITO 2011]
Onus on justifying MAM is on assessee. It is a significant component of the TP process
[Serdia Pharmaceuticals 2011]
Onus on TPO to establish how the method selected by him is superior to the method
selected by assessee [Dishman Pharmaceuticals 2011]
Internal Comparables preferred over External Comparables [Genisys Integrating System
2013 and several more]
Where transaction to transaction or item to item comparision is possible, that should
be preferred if proper adjustment can be carried out to account for the differences that
could materially affect the prices in the open market [Delphi TVS Diesel Systems v.
Assst CIT 2012]
COMPARABLE UNCONTROLLED
PRICE (CUP) METHOD
COMPARABLE UNCONTROLLED PRICE (CUP)
A CUP is the price which is, in all material aspects, equal to the prices
agreed upon by unrelated parties as well as AE’s for the transfer of
goods and services
AE 1
Transaction at
Price X
Transaction at
Price X
AE 2
Unrelated
Party A
CUP METHOD
‘’The CUP method compares the price charged for property or services transferred in a
controlled transaction to the price charged for property or services transferred in a
comparable uncontrolled transaction in comparable circumstances.’’
‘’An uncontrolled transaction is comparable to a controlled transaction (i.e. comparable
uncontrolled transaction) for purpose of CUP method if one of two conditions is met:
(a) none of the differences (if any) between the transactions being compared or
between the enterprises undertaking those transactions could materially affect the
price in the open market;
or
(b) reasonable accurate adjustments can be made to eliminate the material effects of
such differences. ‘’
‘’As for any method, the relative reliability of the CUP method is affected by the degree
of accuracy with which adjustments can be made to achieve comparability’’
CUP METHOD
AE 1
Transaction at
Price X
AE 2
Situations where transaction price
is not the same:
1. Minor differences (Adjustable)
2. More than minor differences
(Reliability of CUP is reduced
after adjustments)
Transaction at
Price X
Unrelated
Party A
3. Material product differences
(Adjustments cannot be made)
CUP METHOD
When --- No Difference / Minor Difference – CUP Method preferred with reasonable adjustments
Comparable Sales of same product:
Example: Manufacturer sells product to AE & TP with only difference being the cost of travel and
Insurance being excluded in one sale and included in another. Thus minor difference and CUP
applicable
Effect of a Valuable Trademark :
Example: If the manufacturer charges separate prices where AE is charges higher for IP and TP not
charged for IP. IP cannot be reasonably estimated and thus CUP reliability is not there. Therefore CUP
rejected.
Minor Product Differences:
Effect of Geographic Differences:
Example: If except the geographic differences, the product and other circumstances for the sale are
the same., then:
Does this have a material effect on price ?
If yes, then whether the differences have definite and reasonably ascertainable effects and whether
the adjustments could be made ?
More than Minor Difference – CUP method reliability reduces:
If adjustments cannot be made to such geographical differences, then reliability of CUP method
reduces
Major Difference- Cannot use CUP
Example: U.S. company manufactures machines and modifies business machines in some situations
but not in others. If such difference has a material difference on the price, the same cannot be
compared under CUP.
CUP METHOD – INTERNAL & EXTERNAL
CUP can be bifurcated into:
Internal CUP – A situation wherein a
comparable transaction is carried out
with an unrelated party for same or
similar goods or services
AE 1
AE 2
Transaction 1
(Internal)
External CUP – A situation wherein two
independent
enterprises
transact
for
comparable goods or services under
comparable conditions
Transaction 2
(Internal)
Case Laws:
Unrelated
Party A
- [UCB India (P.) Ltd v. Asst CIT 2009]
- Internal CUP - Independent party mandatory
[Skoda Auto India (P.) Ltd. 2009]. & [Tech
Mahindra 2011]
- No distinction b/w Internal & External CUP
[Gharda Chemicals Ltd 2010]
(External)
Unrelated
Party B
Transaction 3
(External)
Unrelated
Party C
CUP TRANSACTIONS & PRODUCTS…
TRANSACTIONS..
 The interest rate charged on a loan
 Royalty payments
 Industries where CUPs are more prevalent; e.g. standard software
development where products are often licensed to third parties
 The price charged for the transfer of a homogeneous item, such as
traded commodity
 Transactions that depend on publicly available market quotations
PRODUCTS…
 Extracted Raw Materials (Gold / Silver / Copper/ Crude Oil / Heating Oil / Fuel
Oil / Gasoline etc)
 Harvested Crops (Wheat / Corn/ soybeans/ soybean oil/ castor oil/
cottonseed/ cotton meal/ cotton oil/ sugar and so on
 Animal products ( cattle / offal / pork bellies/ hides/ tallow etc)
 Other fungible goods without brand name ( pens/ pencils / paper clips/
computer disks )
 Other fungible goods with brand name ( soft contact lenses)
CUP METHOD -- FACTORS
-
Same product
-
Similar quality
-
Similar quantity
-
Same time / date
-
Same stage in product / distribution chain
-
Level of market (wholesale / retail / distributor etc)
-
Contract terms (warranty, billing period & credit terms)
-
Alternatives realistically available to buyer and seller
-
IP associated with sale
-
Transportation costs
-
Market conditions / Economic conditions
-
Risks borne
Discussed in:- [UCB India (P.) Ltd v. Asst CIT 2009]
[Asstt. CIT v. Dufon Laboratories 2010]
CUP – STRENGTHS & WEAKNESSES
Strengths:
 Two-sided analysis as price reflects the agreed price between two unrelated
parties
 Avoids the issue of the tested party
 Direct transactional comparison
 Readily useable in several instances
Weaknesses:
 Difficulty in finding comparable uncontrolled transactions
CUP METHOD – ADJUSTMENTS
Adjustments warranted for:
 Geographic differences – whether command a premium or discount (climatic
conditions / labor)
 Volume – 100 tons vs. 1000 tons – research market
 Delivery Terms - sales @ F.O.B vs. Sales @ delivered need to account for
insurance and transportation
 Product characteristics – customized / standard
 Contractual Terms – credit period
 Risk incurred – inventory risk etc.
Adjustments may not be possible for:
 Unique and valuable trademarks
 Fundamental differences in the products
If reasonable accurate adjustments cannot be performed, the reliability of the CUP
Method is decreased and one must move to the next MAM.
CUP METHOD - ILLUSTRATION 1
AE1 sells product X to AE2 located in
South Africa
AE1 also sells product X to Unrelated
Party A, located in Egypt
AE 1
The only material difference that could be
identified between the controlled and
uncontrolled transactions concerns the
location.
Sale
Transaction
To perform adjustments to account for
this difference one might have to
consider:
-
differences in inflation rates between
South Africa and Egypt,
-
competitiveness of the product market
in the two countries; and
-
differences in government regulations
if relevant.
South
Africa
AE 2
Egypt
Unrelated
Party A
CUP – CASE STUDY
FACT :
AE1 sells 1,000 tons of a product for
Rs.800 per ton to AE2 (associated
enterprise) in its MNE group
At the same time sells 500 tons of the
same product for Rs.1000 per ton to an
Unrelated Party A
AE 1,
China
Sale
Transaction
1000 tons of
X for
Rs.800/ton
AE 2,
India
OPTIONS:
A. Internal CUP
adjustments
B. External
CUP
adjustments
C.
applicable
applies
w/o
w/o
CUP applicable with potential
adjustment depending on market
research to determine typical volume
discounts.
500 tons of X
for
Rs.1000/ton
Unrelated
Party A,
India
CUP METHOD – ILLUSTRATION 2
Assesse is a manufacturer of compact Discs (CD) writers and its
customers, inter alia, include Foreign Co. and third-party M. Co.
Factor
Intl Trn
(For.Co)
M.Co (Third Details
Party)
Price
FOB
CIF
F&I INR 550
Quantity Yes
Discount
No
1 CD of INR 10 each for every CD
writer plus INR 20 per CD writer
Credit
Cash and
carry
Cost of credit 1.25% per month
Warranty No
6 Months
Cost of Warranty is INR 250 per unit
Qty
10000
100
INR SP
2000/p.u
3000/p.u
1 month
CUP METHOD - ILLUSTRATION 2 CTD
Particulars
M.Co
For. Co
Actual SP
3000
2000
Adjustments:
Less: Insurance & Freight
-550
Less: Qty Discount INR 10+20
-30
Less: Warranty cost
-250
Add: Cost of credit
+37.5
NET PRICE
2,207.5
2,000
CUP METHOD - CASE STUDY 2 & PUBLIC DATA
FACT:
Unbranded Colombian coffee beans V. Unbranded Brazilian coffee beans:
- material effect on price ? –
- whether it commands a premium or requires a discount (Source: Commodity markets)
-
If such adjustments cannot be made then reliability of CUP reduces moving to next MAM
Data from Public Exchanges and Quotation media
Data from Public Exchanges and Quotation media is used to ascertain the CUP but this is
usually termed as an indirect evidence.
Requirements for Dissemination of data:
-
If the data is widely and routinely used,
-
used in the ordinary course of business within the specified industry
-
to negotiate prices for uncontrolled sales, the same can be acceptable.
Requirements apply to use of data already obtained:
- Data is used to set prices in controlled transaction,
- Data is used in same way by uncontrolled taxpayers in the industry.
ILLUSTRATION 3
A U.S. company and its foreign subsidiary agreed that the parent would purchase crude
oil from the subsidiary based on local published prices, the average price published in a
quotation medium
The price was computed for a five-day interval, based on the date set for delivery
The parent and its foreign subsidiary agreed to adjust the price for the particular
circumstances of their transactions, including the following:





Quantity of the crude oil being sold
Contractual terms
Transportation costs
Risks borne by the parties
Other factors that would affect price
ILLUSTRATION 4
The quotation medium used by the parties is “widely and routinely used in the
ordinary course of business in the industry” to establish prices for uncontrolled
sales
The data is used to set prices between the related parties, and appropriate
adjustments are made to account for the differences. Accordingly, the price
derived from the quotation medium “will be considered evidence” of a CUP
Extraordinary Market Conditions
The facts are the same as above Example 1, except that before the U.S.
company and foreign subsidiary enter into their contract, a war breaks out
between major oil-producing countries. The foreign subsidiary is located in a
different country, and this country is not a participant in the war
The war causes significant instability in world petroleum markets. As a result,
prices listed on the quotation medium may not reflect a reliable measure of an
arm’s-length result.
CUP METHOD – QUICK SUMMARY

Starting point is the price
transaction.

All adjustments to be made to the price charged in uncontrolled transaction.

What is adjusted ? The presence or absence of any specific feature in the
uncontrolled transaction as compared to the international transaction is to be
adjusted for.

Features to be evaluated in monetary forms

Which differences to be accounted for ?
charged in case of the comparable uncontrolled
Only differences that would materially affect the price in the open market are
required to be adjusted.
- Materiality needs to be judged in light of circumstances. Individually not material
but collectively material needs to be accounted for.
Open market means a transaction between a knowledgeable and a willing
purchaser and a knowledgeable and willing seller where neither of them is influenced
or compelled to act in a particular manner.
RESALE PRICE METHOD
(RPM)
RESALE PRICE METHOD (RPM)
 PURCHASE FROM AE & SALE TO THIRD PARTY
 Determines Profitability of a Distributor
RPM begins with the price at which a product that has been purchased from an associated
enterprise is resold to an independent enterprise.
Re-sale price
1000
(-) Gross profit margin*
100
(-) Expenses**
150
(-) Adjustment for other costs***
Arm’s length purchase price
50
700
* Compensation in return for the initial investment and assumption of risk. Gross Profit is
defined as Sales – COGS.
** associated with purchase of product (e.g. custom duties) or obtaining of services
*** Adjustments to account for functional and other differences (accounting etc)
Discussed in:[Aztec Software & Technology Services Ltd. v. Asstt. CIT [2007]]
RPM - APPLICABILITY
 Typically used for distributor of goods involving little or no value addition [Star
Diamond Group v. Dy. DIT 2011]
 Most useful where applied to marketing operations. [ITO v. L’Oreal India 2012]
 Where reseller not adding substantial value to the tangible product by physically
altering the goods before resale. Packaging, repackaging, labeling, or minor assembly
does not ordinarily constitute physical alteration.
 More accurate when short time lapse between purchase and resale (absence of
factors like change in market rate, exchange rate, costs etc)
 Can be used in purchase and sale of any tangible property.
Hence, Cannot use RPM when controlled taxpayer / distributor uses its intangible property
to add substantial value to the tangible goods.
RPM – COMPARABILITY FACTORS
FIVE MAIN FACTORS:
 Functional comparability including Contractual Terms
 Risks assumed (ownership / warranty/ financing stocks/ other connected services)
 Physical similarity is less important
 Accounting Consistency - Differences having material effect on the attribute being used
to measure AL conditions – adjustments warranted
 Commission and buy-sell transactions are treated as being equivalent
OTHERS:
 Management Efficiency
 Inventory Maintenance
 Level of activities performed by the reseller (advertising / marketing/ distributing)
 Low margin for plain transfer of goods
 High margin for expertise in marketing / creation of intangible etc
 Exclusive right to resell the product (monopoly / greater efforts)
 Financial data comparability
RPM – INTERNAL & EXTERNAL
AE1
TP1
Assesse
TP2
INTERNAL
TP3
TP4
COMPARABLE
TP8
AE2
TP6
Assesse
TP7
TP9
EXTERNAL
TP10
TP11
COMPARABLE
CONDITIONS :
 None of the Differences (if any) between the transactions being compared or
between the enterprises undertaking those transactions could materially affect
the resale price margin in the open market. OR
 Reasonable accurate adjustments can be made to eliminate the material effects
of such differences
RPM V. CUP
 Fewer adjustments to account for product differences vis-à-vis CUP method.(reason:
minor product differences are less likely to have as material an effect on profit margins
as they do on price)
 Where uncontrolled and controlled transactions are comparable in all characteristics
other than the product itself, RPM might produce a more reliable measure of arm’s
length conditions than CUP method, unless reasonable accurate adjustments could be
made to account for differences in products transferred. (valid for cost plus method as
well)
 Less dependent on close physical similarity than under CUP method
RPM: ADJUSTMENTS
-
Only if material differences between controlled and uncontrolled transactions
-
Based on commercial practices, economic principles or statistical analyses
-
Adjustment made to GPM of uncontrolled
transaction
-
-
Inventory
Consider operating expenses
as FAR reflects in OE
Affect GPM
Gross Profit may be affected by:
Cost structures for example – age of
plant and equipment
Business experience, such as
whether business is in a start-up
phase or is mature
Management Efficiency – sales /
overtime
compensation
to
employees etc
Contractual
Terms (warranty/
credit/
transport)
Level of the
Market
TYPES
Sales,
Marketing,
Advertising
Programs, and
Services.
Foreign Currency
Risks
RPM - MORE
 Commission and Buy-Sell Arrangements – treated at par and thus
comparable.
 Accounting consistency includes consistency in financial reporting of COGS
and OE for items like:
-
packaging,
-
Insurance,
-
Transportation costs,
-
Rebates,
-
Discounts,
-
Returns, and
-
Allowances
EVIDENCE (Part of DOCUMENTATION):
 Activities performed by reseller (reseller/ commercial activity / distribution
chain)
 Risks assumed
 Justification for reasonably high marketing expenditures
RPM - ILLUSTRATIONS
1.
Brokerage business – brokerage fee - % of SP- Agent or Principal ?
2. Toaster v. Blender – not substitutes therefore price not similar. However, both
functions of distributors are same and thus comparable under RPM as both
distributors would be expected to earn same level of profit.
3. Assume two distributors - selling same product - same market - under same brand
name. Distributor A offers warranty and Distributor B does not. A does not include
warranty in pricing strategy and thus sells at a higher price resulting in higher GPM
(if costs of servicing the warranty are not taken into account) than distributor B
which sells at a lower price. Two margins are not comparable until a reasonable
accurate adjustment is made to account for such difference.
4. Assume that warranty is offered with respect to all products so downstream price is
uniform. Distributor C performs warranty function but is in fact compensated by a
supplier through a lower price. Distributor D does not perform warranty function
which is performed by the supplier (products send back to factory) for this the
supplier charges D a higher price than distributor C. If C accounts for costs of
warranty in COGS, then adjustment in GPM is automatic. However, if it accounts
as operating expenses, there is a distortion in margins which must be corrected
and thus warrants an adjustment.
RPM - ILLUSTRATIONS
5. A sells a product through independent distributors in five countries in which it has no
subsidiaries. The distributors simply market the product and no additional work. In
one country, the Company has set up the subsidiary. Because this market is of
strategic importance, the Company requires its subsidiary to sell only its product and
to perform technical applications for the customers. Even if all other factors and
circumstances are similar, if the margins are derived from independent enterprises
that do not have exclusive sales arrangements or perform technical applications like
those undertaken by the subsidiary, it is necessary to consider whether any
adjustments must be made to achieve comparability.
6. Microwave ovens, refrigerators, radios, televisions, computers, fax machines would
fall under one umbrella i.e. consumer electronics and thus grouped together for
comparision purpose as against CUP
RPM – CASE STUDY 1
FP B.V.
TP.
GmbH
$ 600
Ind. Co.
$1000
Third
Parties
$ 200
FACTS:
-
Ind. Co is the exclusive distributor for FP B.V. (foreign parent).
-
Ind. Co reports a GPM of 20% being $1000-$ 600-$200 = $200/$1000 = 20%
-
Revenue rejects above and determines GPM @ 25%
ADJUSTMENT:
What is the final value after such adjustment ?
A. $ 500
B. $ 550
C. $ 650
RPM – CASE STUDY 2
Manuf.
$ 600
Ind. Co.
$ 700
Bharat
Co.
$850
Third
Parties
Domestic AEs
FACTS:
-
Manuf. is the exclusive manufacturer for its AEs namely Ind. Co. and Bharat
Co.
-
Ind. Co is a distributor who buys the products from Manuf. and re-sells to
Bharat Co.
-
Bharat Co. also acts as a distributor and re-sells the same to Third Parties
-
What is the starting point to determine GPM ?
SOLUTION:
A. Segmental FAR analysis b/w Ind.Co. and Bharat Co.
B. $ 850
C. $ 700
RPM – CASE STUDY 3
A Ltd Manuf
& IP owner,
China
branded
Product
Ind. Co.,
distributor,
India
Third
Parties
FACTS:
-
A Ltd is the exclusive manufacturer and IP owner for its AEs namely B Ltd and C Ltd
-
Ind. Co is a distributor who buys the products from A Ltd and re-sells to Third Parties in
India
-
While searching for external comparable, assuming all other comparability factors
matching, Ind. Co finds 5 comparables namely QLtd, R Ltd, S Ltd , U Ltd and V Ltd.
Q/R/S sell unbranded products while U/V sell branded products but do not own IP
-
Which of the above external comparables may be considered for our analysis ?
SOLUTION:
A. RPM not applicable
B. All comparables
C. Q/R/S Ltd
D. U/V Ltd
RPM – CASE STUDY 4
 When data available is insufficient, does the method become:
A. Inapplicable
B. Less reliable
 IP & RPM– Presence or Absence of IP in and of itself, does not preclude the
use of RPM. Significant differences in value of distributed goods-due, for
example, to the value of the trademark-may also affect the reliability of the
comparision
QUESTIONS & ANSWERS
&
THANK YOU
THANK YOU