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1 TRANSFER PRICING Navigating the Indian & Singapore waters! Narayan Mehta Partner, Sudit K. Parekh & Co. 25th May 2005.

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Presentation on theme: "1 TRANSFER PRICING Navigating the Indian & Singapore waters! Narayan Mehta Partner, Sudit K. Parekh & Co. 25th May 2005."— Presentation transcript:

1 1 TRANSFER PRICING Navigating the Indian & Singapore waters! Narayan Mehta Partner, Sudit K. Parekh & Co. 25th May 2005

2 An Overview of Indian Transfer Pricing Regulations

3 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 4 An Illustration- Outsourcing Singapore Parent Singapore Parent Indian Subsidiary Indian Subsidiary Singapore Client Singapore Client Contract for software development Offshore software development 100% Equity S $ 35 per hour Indian tax rate -Nil Singapore tax rate= 20% Need for balancing the Indian and Singapore TP/ Tax regulations!! Outsourcing Arrangement Consideration?? Transfer pricing issues

5 5 Importance of Compliance Any related party transaction undertaken from 1 st April 2001 onwards covered Currently 60% of worlds 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 IRSs 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 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 7 Addition to Income Failure to maintain documentation Failure to furnish documentation Failure to furnish Accountants Report 100% to 300% of tax on addition 2% of value of transaction Rs. 100,000 Penalties are high ! Penalties are not tax deductible! Importance of Compliance

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

9 9 Transfer Pricing- The Indian Perspective Income arising to Associated Enterprises fromInternational Transactions shall be computed having regard to the Arms Length Price Indian regulations largely modeled on OECD guidelines

10 10 International transaction Associated Enterprise Legislative Framework Income needs to be computed on an arms length basis

11 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 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 13 Associated Enterprise Term of wide import - following parties also covered: VC investors with 26% stake FIs advancing loans exceeding 51% stake of assets of borrowing enterprise Franchisers, licensees, technical collaborators, etc. Term of wide import- is your company covered?

14 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 15 Arms 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 16 Computing Arms Length Price Arms 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 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 18 Comparable Uncontrolled Price Method or CUP AE-India AE - Singapore 3P - Singapore 3P-India TP $ 60 (internal comparable) $ 60 (internal comparable) 3P - Singapore $ 60 (external comparable) 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 19 Resale Price Method (RPM) Reduce arms length Gross Profit Margin and procurement expenses from resale price of goods / services resold to an unrelated party Certain adjustments permissible

20 20 Resale Price Method AE-India AE - Singapore 3P - Singapore $ 100 – 20% $ 100 3P-India3P- 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 21 Cost Plus Method Add an arms length gross profit margin to the production cost of supplier providing goods / services to related purchaser Certain adjustments permissible

22 22 Cost Plus Method AE-IndiaAE - Singapore 3P - Singapore $ 100 – 15% 3P-India3P - Singapore 15% GP Margin on sales Production Costs of AE-India = % = Gross Profit Margin on production costs earned by 3P-India on comparable sales made by other Indian software manufacturers

23 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 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 25 How methods are chosen in practice? Most Appropriate Method ? ? ? ?? ? ? TNMM Cost Plus Profit Split Resale Price Method Comparable uncontrolled price Other Yet to be prescribed

26 26 Computing Arms 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 27 Powers of Indian Tax Authorities Powers to: Call for information Determine Arms Length Price Determine total income having regard to Arms 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 28 Taxpayer given an opportunity to respond to TPOs position Transfer Pricing Assessment TPO will review compliance by the tax payer with the arms length principle Does the TPO agree with the views of the tax payer Has the taxpayer responded with sufficiently detailed facts & arguments to enable a re- evaluation of TPO position TPO re-evaluates his position Does the TPO now agree with the taxpayers position TPO would pass a favourable order in relation to the international transaction examined TPO will make further enquiries TPO will make further enquiries TP Adjustment TP Adjustment ? ? Yes No ? ? ? ? Yes No

29 29 Documentation- why necessary? To be better prepared for transfer pricing audit To support your arms 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! The tax authorities will never understand your business as well as you, therefore… Effective communication of your TP policy is critical!

30 30 Documentation- fixing the jigsaw puzzle! Documentation Benchmarking Accountants Report Functional Analysis Industry Analysis Agreements

31 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 arms length price Details of comparable data used in applying most appropriate method

32 32 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 Secondary Documentation required under Indian Regulations Relevant agreements and contracts entered into with associated enterprises or with unrelated enterprises Letters and correspondence documenting terms negotiated with the associated enterprise

33 33 Indian Documentation No need for fresh documentation every year Requirement for filing of CAs report 31st Oct/31st July

34 34 Summing Up Indian Income-tax Act, 1961 Transfer Pricing Regulations Arms length price Arms length price Documentation Accountants Report Accountants Report

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

36 36 Contact Narayan Mehta Tel: Fax: Mobile: Queries ? Thank You


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