Friday, May 18, 2018

How to Make a Transfer Pricing Report?


The expression 'Transfer Pricing' denotes the methods and the rules for valuing the transactions between one economic unit and another located in different countries, and units are under common ownership and control, also referred to as associated enterprises.

Generally, these transactions include provision of any service, supply of goods, granting of finance and use of intangible assets.

The topic of Transfer Pricing is important from the perspective of the Income Tax laws to determine whether the consideration paid among associated enterprises (related parties) is at Arm's Length Price (ALP), as would be between unrelated parties, and is not aimed to distort or to shift earnings from a high tax jurisdiction country to another country with lower tax compliances.

The contents of  Transfer Pricing report should include:

A. Executive Summary 

i) Purpose and scope of the report;
ii) Structure of  report;
iii) Manner of determination of Arm's Length Price (ALP)
iv) Conclusions reached

B. Information about the Group of Associated Enterprises & Relationships Therein

i) Legal, Organizational and operational structure of the group, its subsidiaries and other associated enterprises, which includes information about its shareholders and directors;
ii) A  general description of the business and its industry of operation;
iii) Elucidation of various transactions between the associated enterprises;
iv) Advance pricing arrangements between parties, global or domestic;
v) Entitlement of intangibles (Patents, trademarks, License, Know -how);
vi) Business strategy and Key Success Factors(KSF)

C. Information about the Domestic (India-based) Associated Enterprise 

i) A complete overview of organizational , legal, operational structure of the company, including  shareholders, history and financials.
ii) Presentation about the description of business and its operating environment;
iii) A detailed elucidations of related party transactions or transactions with the parent/associated company; 
iv) The complete flow of transactions;
v) Amount of various transactions

D. Industry Analysis

i) Nature and characteristics of industry ;
ii) Evolution of industry or any significant changes in its functioning;
iii) Global trends and developments and analyzing the macro environment;
iv) Consider micro environment factors like demand and supply;
v) SWOT (Strengths, Weaknesses, Opportunities & Threats) Analysis
vi) Technological changes and foreseeable industry disruption
vii) Porter's 5 Forces Analysis of competitive environment and advantages enjoyed by the assessee
viii) Other factors influencing the Industry

E. Functional Asset & Risk (FAR) analysis:

i) Number of entities involved in the transaction;
ii) Nature and scope of functions performed by the entities, such as
- Raw material procurement
- Manufacturing of the products
- Inventory management of raw materials and finished goods
- Sales and marketing
- Logistics and Operations
- After sales support
iii) Allocations of functions with the entity;
iv) Assets utilized by the aforementioned entities in performing the functions - in this context, some of the important factors are as follows
- Whether assets are owned or leased?
- Whether activity is capital or labor intensive?
- Presence or absence of intangibles?
- Are the assets unique in nature (like an intellectual property)?
iv) Corresponding risks undertaken by entity - some of the risks which are normally found in these transactions are Financial Risks, Market Risks, Credit Risks, Foreign Exchange Risks and Product Risks.
v) Justification of risks involved;
vi) Reasons for additional risk undertaken.

F. Determining Arm's Length Price (ALP)

i) Description of the various  transfer pricing methods;
(1) Comparative Uncontrolled Price (CUP) Method,
(2) Cost Plus Method (CPM),
(3) Resale Price Method (RPM),
(4) Profit Split Method (PSM),
(5) Transactional Net Margin Method (TNMM),
(6) Other Method which takes into account (i) the price which has been charged or (ii) would have been charged for similar uncontrolled transactions between non-associated enterprises.

ii) Selection of a most appropriate method to determine ALP.

iii) Substantiation of the selection criteria - following factors should be taken into account while selecting the most appropriate method;
(1) Nature and class of the international transaction;
(2) Class or classes of Associated enterprise entering into the transaction and function performed, assets employed and risk assumed by such entities. 
(3) Availability, coverage and reliability of data  necessary for application of the method.
(4) Degree of comparability existing between the international transaction and the uncontrolled transaction between the entities;
(5) The extent to which reliable and accurate adjustments can be made on account of differences
(6) Nature, extent and reliability of assumptions required to be made in application of a method.

iv) Application of most relevant method.

G. Performing Comparative Analysis

i) Internal and/or External Comparatives;
ii) Source of Data - Industry reports, annual reports of listed entities, databases such as Capital Line, ProLine, S&P Capital IQ, etc.;
iii) Basis for selection of comparatives;
iv) Comparatives selected for ALP

H. Conclusion

i) Whether companies have a transparent and adequately designed transfer pricing system.
ii) Reasons substantiating the pricing of the tested party for each international transaction between the related parties.

I. Documentation

Section 92D of Income tax act 1961 states that a person has to keep and maintain information and documents in relation to the international transaction undertaken in the financial year. This information broadly can be classified into three types which are mentioned below:
Enterprise-wise documents
Transaction-specific documents
Computation related documents

Section 92D read with Rule 10D applies not only to the international transaction but also to specific domestic transactions covered under Section 92BA and deemed international transactions covered under Section 92B(2) of the Income tax act, 1961.

According to Section 92E of Income Tax Act, 1961, it is compulsory for all the taxpayers to obtain a report from a Chartered Accountant in Form 3CEB  in respect of all international transactions between the associated enterprises (related parties) and specific domestic transactions. 

Contributed by:

Akash Arora
Articled Assistant
Gurgaon Team

Sandeep Ahuja & Co.
Chartered Accountants