Transfer Pricing Ensuring the right cost in a multi division company

1. Transfer Pricing Ensuring the right cost in a multi division company

2. 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.

3. 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: • 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: • Market-based Transfer Pricing • Negotiated Transfer Pricing • Cost-based Transfer Pricing • - Full Cost • - Cost-plus • - Marginal Cost • - Variable Cost plus Opportunity cost

4. Parent Co. Country A Cost - Rs.120 Sub Co. Country B Tax Haven Sale price Rs.130 35% tax on Rs. 10 Zero tax on Rs. 40 No direct transaction Sale price Rs.170 Sub Co. Country C Sale price - Rs. 190 40% tax on Rs. 20 International Transfer Pricing To prevent profit shifting by transfer price manipulation

5. Domestic Transfer Pricing Shifting of Expenses Shifting of Expenses Loss making company Profit making company Tax Holiday Unit Taxable Unit/ company Tax @~33% Reduced tax due to profit shifting Tax @~33% No Tax due to loss Tax @ ~33% Tax Exemption Shifting of Income Shifting of Income Loss to Indian Revenue as a result of the above

6. 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 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 Arm’s Length Price

7. Arm’s Length Price 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 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

8. Transfer Pricing Methods Six Prescribed Methods Traditional Transaction Methods Transactional Profit Methods Transactional Net Margin Other Method Comparable Uncontrolled Price Profit Split Cost Plus Resale Price No hierarchy or preference of methods prescribed under the Act

9. Transfer Pricing Methods

10. 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 Subsidiary Parent Parent Outside India Outside India India India Subsidiary(Contract Manufacturer) Parent (Full-fledged manufacturer) Subsidiary(Contract Service Provider) Local Sales 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

11. Some Examples – Domestic Transfer Pricing Sub-section (8) of section 80-IA (and similar such provisions in 10AA, 80IA, 80IB, 80IC, 80ID) Other unit Tax holiday unit Inter unit transfer of manufactured goods for sale • 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) Tax holiday unit Non Tax holiday unit (HO) Inter unit transfer of services 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”

12. 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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