Brief Note on Transfer Pricing Mechanism and Documentation in India

The Provisions of Transfer Pricing would be applicable to all transactions entered with ‘Associated Enterprises’ and such transactions are to be made at ‘Arm’s Length Price’. 

Two enterprises shall be deemed to be associated enterprises, if one enterprise or its Shareholders/Members/ their relatives are interested in other enterprise directly or indirectly, through  advancing loan, share holding, supply of technical know how, supply of raw material, influencing prices, other conditions, etc. 

Arm’s Length Price is the amount of consideration for a transaction between two unrelated parties.

Regarding Arm’s Length Price, Section 92C prescribes following Methods for determining the arm’s length price and Company has to apply most appropriate method for determination of price.

a)      Comparable Uncontrolled Price Method: Comparable Uncontrolled price is the price charged for goods sold or services rendered in respect of a comparable uncontrolled transaction. This price is adjusted to account for functional differences if any and arm’s length price is determined. This method is more reliable where an Independent enterprise provides the same service as is rendered by the associated enterprise.

b)      Resale Price Method: The price at which the goods or services obtained by the enterprise from an associated enterprise is resold to an unrelated enterprise. The said price would be reduced by expenses incurred by the enterprise in connection with purchase and normal gross profit margin. This method is more reliable where the reseller does not add substantially to value to the product.

c)      Cost Plus Method: All the Direct and Indirect Cost of production incurred by the enterprise in respect of property transferred or services rendered to the associated enterprise is determined. The normal gross profit mark-up to such costs arising in a comparable uncontrolled transaction are added to determine the arm’s length price. This method is most suitable where associated enterprises have concluded joint facility agreement or long term buy and supply arrangements.

d)      Profit Split Method: In this method the combined Net profit of the associated enterprises in respect of transaction is determined and relative contribution made by each associated enterprise in earning the combined net profit is evaluated on the basis of functions performed, assets employed etc. The combined net profit is then split amongst the enterprises on the basis of relative contributions. This method is suitable in transaction involving transfer of unique intangibles or multiple transactions among associated enterprises, which are so interrelated, that they cannot be evaluated separately for the purpose of determining the arm’s length price.

e)      Transaction Net Margin Method: The Net profit margin realized by the enterprise from a  transaction entered into with an associated enterprise is computed. Also net profit margin realized by the enterprise from an unrelated enterprise from a comparable uncontrolled transaction is computed and such profit is adjusted for functional differences. The net profit margin thus established is then taken into account to arrive at an arm’s length price.

f)       Any Other Method  is not a method but enterprises may choose other method, which is more appropriate keeping in view the nature of transactions undertaken by it. However it would be necessary to justify and document the reasons for rejections of all other five methods while selecting this method as the most appropriate method.

FACTORS TO BE CONSIDERED IN SELECTING THE MOST APPROPRIATE METHOD:

                    i. Nature and class of transaction

                  ii. Functions performed taking into account the assets employed and risk assumed by the enterprise.

                iii. The availability, coverage and reliability of data necessary for application of the method.

                iv. The degree of comparability existing between transaction with associated enterprise and uncontrolled transaction

                  v. The nature, extent and reliability of assumptions required to be made in application of a method.   

DOCUMENTATION:

As per Section 92D, an entity carrying on International Transaction should maintain all Information and documents relating to such International Transaction. Therefore full particulars relating to Method of Pricing the International Transactions needs to be maintained.

The following are the types of Information and Documents to be maintained:

        i.            Enterprise Wise Documents: Documents that describe business of the enterprise and associated enterprise, relationship with associated enterprise, etc.

      ii.            Transaction Specific Documents:

a)      Nature and Terms of International Transaction

b)      Description of functions performed

c)      Details of Services provided

d)      Risk Assumed by each party to the transaction

e)      Assets Employed

f)       Letters and other correspondence, documenting any terms negotiated between the assessee and associated enterprise.

g)      Documents normally issued in connection with transactions under the accounting practices followed.

    iii.            Computation Related Documents:

a)      Documents that describe and detail the method considered

b)      A record of the actual working carried out for determining the arm’s length price

c)      The assumptions, policies and price negotiations, if any, which have critically affected the determination of the arm’s length price

d)      Details of the adjustments, if any, made to transfer prices to align them with arm’s length prices

e)      Any other information, data or document, including information or data relating to the associated enterprise, which may be relevant for determination of the arm’s length price.