1. Navigating the Indian & Singapore waters!
TRANSFER PRICING
Navigating the Indian & Singapore waters!
Opening thoughts
Narayan Mehta
Partner, Sudit K. Parekh & Co th May 2005

2. An Overview of Indian Transfer Pricing Regulations

3. Transfer Pricing- an Introduction
Denotes price charged by one related party to another for goods, services, etc.
Objective: To check the erosion of tax base and plug the leakage of revenue

4. An Illustration- Outsourcing
Contract for software development
Singapore
Parent
Singapore
Client
Singapore tax
rate= 20%
S $ 35 per hour
100% Equity
Outsourcing
Arrangement
Consideration??
Transfer pricing issues
Indian
Subsidiary
Indian tax rate
-Nil
Offshore software
development
Need for balancing
the Indian and Singapore TP/ Tax regulations!!

5. Importance of Compliance
Any related party transaction undertaken from 1st April 2001 onwards covered
Currently 60% of world’s cross-border trade is between related parties- Indian tax authority is also going to be vigilant!
UK – for every £1 spent investigating transfer pricing cases, £120 was recovered in extra taxes
Japan –transfer pricing has been a major revenue churner- individual cases exceeds $100 m!
US – transfer pricing remains the topmost priority of IRS’s agenda on international tax
India - FY assessments complete - Press has reported incremental tax revenues in excess of INR 50 million based on the first year of TP audit adjustments

6. Importance of Compliance
No exemption from compliance
Transactions exceeding INR 50 million to attract compulsory transfer pricing audit
Onus of proof- tax payer primarily liable
S.10A / 10B units- thin margin for error
No deduction under section 10A / 10B on enhanced income!
More than ordinary profits taxable & not tax exempt!
Adverse tax incidence for the Singapore parent outsourcing BPO operations to Indian entity
Double taxation for the Group in respect of enhanced income

7. Penalties are not tax deductible!
Importance of Compliance
Penalties are high !
Addition to Income
Failure to maintain documentation
Failure to furnish documentation
Failure to furnish Accountant’s Report
100% to 300% of tax on addition
2% of value of transaction
Rs. 100,000
Penalties are not tax deductible!

8. Importance of Compliance
An effective tax planning tool to establish the appropriateness of transfer prices

9. Transfer Pricing- The Indian Perspective
Income arising to “Associated Enterprises” from “International Transactions” shall be computed having regard to the “Arm’s Length Price”
Indian regulations largely modeled on OECD guidelines

10. Legislative Framework
International
transaction
Associated
Enterprise
Legislative Framework
Income needs
to be computed on an arm’s length basis

11. Associated Enterprise
Means direct or indirect participation in management, control or capital
by one enterprise into another enterprise; or
by the same person in both the enterprises
Either or both of Associated Enterprises
should be non-residents

12. Associated Enterprise
“Deemed Associated Enterprises” include:
Holding of 26% of voting power
by one enterprise into another enterprise; or
by the same person in both the enterprises
Dependence on intangible assets
Sale of goods
influence on price and conditions of supply by buyer
Control by individual or his relative
Loan transaction
51% or more of book value of total assets of the borrowing enterprise

13. Associated Enterprise
Term of wide import - following parties also covered:
VC investors with 26% stake
FI’s advancing loans exceeding 51% stake of assets of borrowing enterprise
Franchisers, licensees, technical collaborators, etc.
Term of wide import- is your company covered?

14. International Transaction
Means “transaction” between 2 or more Associated Enterprises:
For sale of products / other properties OR
Affecting profits, losses, income, assets or liability of the enterprise

15. Arm’s Length Price
Denotes price which is applied or proposed to be applied in a
comparable transaction between
unrelated independent parties in
uncontrolled conditions
Corresponds to the open market price

16. Computing Arm’s Length Price
Arm’s Length Price to be computed as per “Most Appropriate Method”, to be selected out of:
Price based method
Comparable Uncontrolled Price Method (CUP)
Margin based method
Resale Price Method (RPM)
Cost Plus Method (CPM)
Profit Split Method
Transactional Net Margin Method (TNMM)

17. Comparable Uncontrolled Price Method or CUP
Compare price charged in a controlled transaction with uncontrolled transaction
Adjustment for differences materially affecting the price is permissible

18. Comparable Uncontrolled Price Method or CUP
3P-India
AE - Singapore
$ 60 (internal comparable) TP
$ 60
(external
comparable)
AE-India
$ 60 (internal
comparable)
3P - Singapore
3P - Singapore
Price charged by AE–India to AE–Singapore should be as per open market price
$ 60 represents the open market price - Internal comparable preferable to external comparable

19. Resale Price Method (RPM)
Reduce arm’s length Gross Profit Margin and procurement expenses from resale price of goods / services resold to an unrelated party
Certain adjustments permissible

20. Resale Price Method $ 100 $ 100 – 20% AE-India AE - Singapore
3P - Singapore
3P-India
3P-Singapore
3P-Singapore
20% GP
Margin on sales
$ 100 = The price at which sales made by AE-Singapore to 3P- Singapore
20% = Gross Profit Margin identified from gross profit margin earned by Italian distributors on similar / comparable uncontrolled transactions

21. Cost Plus Method
Add an arm’s length gross profit margin to the production cost of supplier providing goods / services to related purchaser
Certain adjustments permissible

22. Cost Plus Method $ 100 – 15% AE-India AE - Singapore 3P - Singapore
3P-India
3P - Singapore
3P - Singapore
15% GP
Margin on sales
Production Costs of AE-India = 100
15% = Gross Profit Margin on production costs earned by 3P-India on comparable sales made by other Indian software manufacturers

23. Profit Split Method
Splitting the combined net profit of associated enterprises arising from international transaction between respective entities based on their relative contribution to the net profits
Rarely used in practice

24. Transactional Net Margin Method (TNMM)
Comparing net profit margin of Associated Enterprise arising from international transaction with adjusted net profit margin for similar transaction with unrelated parties in comparable circumstances
Similar to RPM / CPM

25. How methods are chosen in practice?
Most Appropriate
Method ???
??? ?
Cost Plus
Profit Split
TNMM
Resale Price
Method
Comparable
uncontrolled price
Other
Yet to be prescribed

26. Computing Arm’s Length Price- summary
Selection of the most appropriate method – relevant factors:
Business model and organizational structure
Functional and risk profiling of related parties
Contractual terms
Nature of products and services

27. Powers of Indian Tax Authorities
Powers to:
Call for information
Determine Arm’s Length Price
Determine total income having regard to Arm’s Length Price
5% difference allowed
No deduction under section 10A / 10B / 80HHC on enhanced income!
Corresponding adjustments not permitted !
Permitted under certain Indian Treaties!
No adjustment to withholding tax!
Compulsory scrutiny for transactions exceeding INR 50 million

28. Transfer Pricing Assessment
TPO will make
further enquiries
TPO will review compliance by the tax payer with the arm’s length principle ? ?
Does the TPO agree with the views of the tax payer No
Yes
Taxpayer given an opportunity to respond to TPO’s position TP
Adjustment
TPO would pass a favourable order in relation to the international transaction examined
Has the taxpayer responded with sufficiently detailed facts & arguments to enable a re-evaluation of TPO position ?
This is very much a simplified process
It is the application where the hurt starts and continues:
- loss of control of agenda - incredible diversion for management - defensive / reactionary behaviour - costly in professional advice - likely to revisit in penalties and interest
Will almost always exceed cost of doing a proper study and/or having a good process of contemporaneity
This is the very serious end of the journey - to be avoided at all cost.
ATO re-evaluates its position: Your response may just correct ATO mistakes & disclose your basic defence if litigation was pursued
Is ATO view materially diff from taxpayers: Generally set out in a “Position Paper”
Taxpayer invited to respond to ATO position: Silence may be acquiescence
Has taxpayer responded with detailed facts: If “No” or poor response, assessment will issue ? No
Yes
TPO re-evaluates his position
Does the TPO now agree with the taxpayer’s position ? No
Yes ? 18

29. Documentation- why necessary?
To be better prepared for transfer pricing audit
To support your arm’s length price in future
Especially important in loss situations
The tax authorities will never understand your business as well as you, therefore…
Effective communication of your TP policy is critical!

30. Documentation- fixing the jigsaw puzzle!
Accountant’s
Report
Documentation
Agreements
Functional
Analysis
Benchmarking
Industry
Analysis

31. Primary Documentation required under Indian Regulations
Associated Enterprise related documents
Transaction related documents
Description of functions performed, risks assumed and assets utilised
ALP computation related documents
Record of transactions considered for determining price of international transactions
Analysis performed to evaluate comparability
Description of all methods considered and reasons for selection of the most appropriate method
Record of actual working for determining arm’s length price
Details of comparable data used in applying most appropriate method

32. Secondary Documentation required under Indian Regulations
Government publications, reports, studies, databases
Market research studies and technical publications of recognized national or international institutions
Price publications including stock exchange and commodity market quotations
Relevant agreements and contracts entered into with associated enterprises or with unrelated enterprises
Letters and correspondence documenting terms negotiated with the associated enterprise

33. Indian Documentation No need for fresh documentation every year
Requirement for filing of CA’s report
31st Oct/31st July

34. Transfer Pricing Regulations
Summing Up
Indian Income-tax Act, 1961
Transfer Pricing Regulations
Arm’s
length price
Documentation
Accountant’s
Report

35. Compliance and Certification Timeline
April 1st ’05
March 31st ’06
Oct 31st ’06
Oct 31st ’07
March 31st ’09
March 31st ’15
Beginning of tax year
End of tax year
Deadline for maintaining documentation
Filing tax return
Filing Accountant’s Report
Limitation for initiation of assessment
Limitation for completion of assessment
Date till which docn. is required to be maintained

36. ? Thank You Queries Contact Narayan Mehta Tel: +91 22 22821141
Fax:
Mobile: ?
Queries