LM Vispi Patel 8Sept210

8/8/2019 LM Vispi Patel 8Sept210

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Transfer Pricing Analysis and

Recent Experiences and

Judgment

BCASsp . a e


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ac groun

Case Study


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Presently five rounds of audit have been completed

TNMM is most commonly used by the taxpayers

Precedents set in earlier ears enerall followed

Emphasis has been laid on Documentation andEconomic Analysis

Legal precedents available on transfer pricing MentorGraphics, Morgan Stanley, Development Consultant

, , - , , ,Instrumentarium Corporation, Vanenburg etc.


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ase u y


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Case Study

ABC

International

Inc. China

ABC

International EndCustomer

Sale of BTS

Equipment

Outside

Purchase of

Mobile Phone

Instruments

Sale of BTS Equipment

& Providing Installation

& Commissioning

services

Installation &

Commissioning

of BTS

Equipment onMobile Towers

India

End

Customer

ABC India

Ltd.Sale of Mobile

Phone

Instruments


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Facts

ABC India Ltd. is engaged into manufacturing of BTS

Equipment, installation and commissioning of such BTS

e ui ment and tradin of Mobile Phone E ui ments

ABC India sells the BTS Equipment to end customersthrough its Associated Enterprise (AE) in various countries

of BTS Equipment and installation and commissioning of

such BTS Equipment

cost plus 10 per cent. Installation and commissioning cost is

also charged at cost plus 10 per cent


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Facts

Technical staff is deputed at the end clientsplace for installation and commissioning of

For deputation of technical staff, followingcosts are recovered at cost lus 10 er centmark-up:

Travel Cost;

Actual expenses incurred for installation andcommissioning of BTS Equipments;

a ary cos o emp oyees on as s o an- aysABC India also imports Mobile Phone

E ui ments from ABC International China


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Factso ow ng are e n erna ona ransac on

entered into by ABC India Ltd. with its AEs

Sr. No. Name of the Nature of Amount (`)

(`

in 000s)

ransac on

1 ABC

International

Sale of BTS

Equipment

104,500

2 ABC

International

GMBH

Commissioni

ng and

Installation

8,250

Charges

3 ABC

International

Purchase of

Mobile

48,580

China Ltd. Phone

Equipments


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Facts

ABC International GMBH sold the BTS Equipmentsat import cost plus 4 per cent mark-up

ABC International GMBH provided installation and

mark-up


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Consolidated P&L(` in 000s)

Opening Stock

BTS Equipment 1,250

Mobile Phones 15,250

Sales

BTS Equipment 104,500

Mobile Phones 68,250

Purchase of Mobile Phone 48,580

Installation & Comm. 8,250

,

Salary, TA, etc. 7,500

Other operating

BTS Equipment 1,000

Mobile Phones 8,200

Expense 4,950

Interest Paid 780

Interest Income 80

e ro ,

Total 190,280

Total 190,280


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11


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Economic Analysis ?

Business

Function

Intangibles/

RisksManagement

Structure/

Processes

Economic Analysis

Economic

ProfilingComparable

Strategy

Most

Appropriate

Method


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FAR Analysis Manufacturing Segment

Activities performed ABC India ABC

International

unc ons er orme

Development of global strategy / brandingfor the manufacture and sale of Groups

x

R&D activities x

Inventory Management

Selling & Distribution activities

13


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Assets ABC India ABC

ssets emp oye

Internat ona

Manufacturing Facilities x

Technical know-how x

Trademarks x

are ous ng ac t es

Human Resources

14


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Risks ABC India ABC

International

s s ssume

Market risk

Legal risk

Inventory risk

Forei n exchan e fluctuation risk x

Credit risk

ABC India can be characterised as a full fledged

15

pertaining to manufacturing of BTS Equipments


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FAR Analysis Trading Segment

Activities performed ABC India ABC

unct ons er orme

ChinaEstimation of demand x

Manufacture of goods x

Customs clearance formalities x

Marketing activities

16


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Assets employed

Assets ABC India ABCInternational

China

Fixed Assets

Human Resources

Trademarks and brand

names

x

17


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FAR Analysis Trading Segment

Risks ABC India ABC

International

s s ssume

China

Market risk

Inventory risk

Forei n exchan e fluctuation x

risk

Credit risk x

n a can e c arac er se as a u e ge ra er

not owning significant intangibles in respect of trading

of Mobile Phone Equipments

18

. .

Mentor Graphics (Noida) Pvt. Ltd. Vs DCIT (109 ITD 101)


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.

Slicing Based"

19


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Which Way forward?

anu ac ur nganu ac ur ng

Understanding the

Business Model of

the Com an

Installation

& Commissioning

TradingTrading

OperatingOperating

20

ncomencome


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Aggregation vs. Segregation

Manufacturing, Installation and Commissioning:

Installation and Commissioning of the BTS Equipment is

Trading of Mobile Phone Equipment: Trading of Mobile Phone Equipment is a separate activity

an s no nex r ca y n e o e sa e o

Equipment.

Development Consultants (P.) Ltd. vs DCIT (23 SOT 455)

Global Vantedge vs. DCIT (37 SOT 1)

n a . t . vs. p tt ng oConsolidated Accounts into Manufacturing & Trading Segments

21


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Segment Analysis

Based on the business functions of ABC India, the

business can be divided into the following segments:

Manufacturing Segment This involves manufacturing of BTS

Equipments. The international transactions in this segment

include export of BTS Equipments

Installation and commissioning of BTS Equipment

Trading Segment This involves purchase and resale of Mobile

Phone Equipment. The international transactions in this.

Benchmarking of

InternationalTransactions

Which Way

22

Forward?


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Split P&L Account

Tested Party P&L A/c Manufacturing Segment Tested Party P&L A/c Trading Segment

(` in 000s)(` in 000s)

Opening Stock 1,250

Manufacturing

Cost 94 750

Sale of BTS 104,500

Installation &

Commissionin 8 250

Opening Stock 15,250

Purchases 48,580

Sales 68,250

Closing Stock 8,200

Salary, TA, etc. 7,500

Net Profit 10,250

Closing Stock 1,000

,

Total 76,450

Operating Expense

Total 76,450

Gross Profit 12,620

Total 113,750 Total 113,750

4,950

Interest Paid 780

Interest Income 80

,

Total 12,700 Total 12,700


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Transaction Based Methods

Profit Based Methods

(CUP)

Resale Price

Cost Plus

Profit Split-Comparable

-Residual


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CUP Method

Product/Service EconomicConditions

Contractual terms

e o e compar son a mos mposs e Hence, CUP is rejected as most appropriate

method


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Resale Price Method

Determine the gross profit margin

transactions

2

Subtract the appropriate gross

margin from the applicableresa e pr ce

3The remainder will be the

arms length price with the

controlled entity


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Resale Price Method- Trading

XYZ ABC Parent

Expenses = 17

India Company

Revenue=20

Independent

rans er pr ce

using

RP Method

distributors

margin-12%

s r u orRevenue 20

Less Cost 17

Retail

Independent

DistributorMargin = 3Price

Unknown

i.e.3 divided by

20


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Cost Plus Method

Transfer Price is determined by adding appropriate

gross pro mar -up o con ro e se er s cos s o

producing the property or provision of service

Indian disclosure norms are not uniform forclassifying expenses that should come before GP

and after GP. Hence exact matching of GP with the

comparables will not be possible.

Hence, C+ is not selected as the most appropriatemethod for manufacturing and installation and

perspective


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Profit Split Method

Compares allocation of profit (loss) to allocation

Applicability

-

- Multiple interrelated International Transactions

Relies on market data

Few taxpayers qualify for this method - difficult to get

a comparable

Rejected as the Most Appropriate Method


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CostStructures

Comparability

Factors

Risks


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Determine arms length price by comparing financial

results of tested party and selected uncontrolled

parties

Apply Profit Level Indicators (PLIs)

TNMM is selected as the most appropriate method for

benchmarking the international transaction of import

o o e one qu pmen s


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Selection of Tested Party

OCED: The choice of the tested party should be consistent with thefunctional analysis of the transaction. As a general rule, the tested party is

the one to which a transfer pricing method can be applied in the most

reliable manner and for which the most reliable comparables can be found,

i.e.it will most often be the one that has the less complex functionalanalysis.

tested party

Manufacturing, Installation & Commissioning Activity:simpler entity and reliable internal comparable data available).

Trading of Mobile Phone Equipments: ABC India Ltd(assessee selected as the tested party being entity with simpler entity

and external reliable comparable data is available)

Ranbaxy Laboratories Ltd. vs. ACIT [299 ITR (AT) 175]

Development Consultants (P.) Ltd. vs DCIT (23 SOT 455)

Global Vantedge vs. DCIT (37 SOT 1)


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Selection of the Most Appropriate Method

Manufacturin Activit :

As discussed earlier, CPM is selected as themost appropriate method by benchmarking

ore gn AE

Trading Activity:

ec n ca y s app ca e;

But in view of lack of availability of data for

com utation of ross rofit mar in

TNMM is selected as the most appropriate

method.

D t i ti f A L th P i


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Determination of Arms Length Price

Manufacturing Activity AE has sold BTS System to End Customer at import cost plus 4

percent mark-up

Sale Price to End Customer

Particulars (` in 000s) (` in 000s)

Sale Price to End Customer by AE

BTS Equ pment 108,680

Installation & Commissioning 8,580 117,260

Import Price to AE

qu pment ,

Installation & Commissioning 8,250 112,750

Variation 4510

ar a on as o n erna ona ransac on

Since the variation between the international transaction and final price to end

customer is less than 5 %, international transaction of sale of BTS Equipment is at

arm s engt

ACIT vs. MSS India Pvt. Ltd (2009-TIOL-416-ITAT-PUNE)

D t i ti f A L th P i


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Determination of Arms Length Price

Trading Activity

Search for Comparable Companiesa a ase se rowess

Issues faced in case of the use of Comparable data

Comparable contemporaneous data not available

Whereas the Tax Department insists on same year data only

Limitations of databases such as inadequate information, etc.

Philips Software Pvt. Ltd. vs. ACIT (26 SOT 226) Use ofcontemporaneous data


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Search Process Trading Segment

Search criteria No. of companiespassing the criteria

Industry classification Telephones and Mobile Phones

Companies having Trading Sales / Total Sales > 90% 12

ccep compan es av ng ar e ng ver semen

Cost / Sales > 2.5%

Rejected companies making losses consistently 1

Select Companies not having significant related party

transactions

4

Arithmetic mean of Operating Profit / sales of comparable

companies is 8.59%

36

Philips Software Centre Pvt Ltd vs ACIT(26 SOT 226)


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Determination of the Arms Length Price

Selection of PLI

Operating profit margin (on sales) was considered as anappropriate PLI for comparing the operating marginearned by ABC India for Trading activities with that of

compara es n respec ve us nesses

Where, Operating Profit Margin (on sales) is computed as= Operating Profits / Operating Income

pera ng ro = pera ng ncome pera ngcost

Operating income = Total income Non operatingincomes like rofit on sale of fixed assets and

investments, income from investments, etc. Operating costs = Total costs- Non operating costs like

Preliminary expenses w/off + Loss on sale of

37

, .

Determination of the Arms Length Price


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Tested Party P&L A/c Trading Segment

Determination of the Arm s Length Price(` in 000s)

Opening Stock 15,250

Purchases 48,580

Sales 68,250

Closing Stock 8,200

Gross Profit 12,620

Total 76,450Total 76,450

Operating Expense 4,950

Interest Paid 780

Net Profit 6 970

Gross Profit 12,620

Interest Income 80

Total 12,700Total 12,700

O Profit = NP - Interest Income + Interest

Paid = 6,970 80 + 780 = 7,670Op Profit / Sales = 7670 / 68250 * 100 = 11.24%

p ro a es es e

Party) = 11.24%Op Profit / Sales

(Comparable Companies) =

8.59%

Since the Operating margin of ABC India is more than the operating margin of

comparable companies, the transaction of import of Mobile Phones is at arms length


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THANK YOU

QUESTIONS

39

Documents

LM Vispi Patel 8Sept210