GUIDANCE NOTE ON TRANSFER PRICING

Notes on Transfer Pricing Guidance Note:

Every person who has entered into an international transaction
during a previous year shall obtain a report from an accountant
and furnish such report on or before the specified date in the
prescribed form. “Specified date” means , the 31st day of October

The object of this guidance note is to provide guidance to
accountants in discharging their responsibilities under section
92E of the Act. It intends to -

(i) assist in understanding the respective responsibilities of
the assessee enterprise and the accountant;
(ii) guide the accountant as to the nature and scope of
information to be obtained by him from the assessee
enterprise to enable him to conduct the examination;
(iii) provide guidance on the verification procedures to be
adopted by the accountant for giving the report and the
prescribed particulars in the annexure thereto; and
(iv) explain the circumstances where a disclosure or
qualification or disclaimer may be required from the
accountant while giving his report.

there must be an international
transaction. Secondly, such international transaction must be
between two or more associated enterprises either or both of
whom are non-residents.

even if a transaction entered into
between an enterprise with a person other than an associated
enterprise, it shall be deemed to be a transaction between
associated enterprises if there exists a prior agreement in relation
to the relevant transaction between such other person and the
associated enterprise or the terms of the relevant transaction are
determined in substance between such other person and the
associated enterprise.

adjustments
should be made only if it results in an increase of the income
returned by the assessee.

Assessing Officer shall not make
any adjustment to the arm’s length price determined by the
taxpayer, if such price is up to 5% less or up to 5% more than the
price determined by the Assessing Officer. In such cases, the
price declared by the taxpayer is to be accepted.

Section 92D provides that every person who has been a party to
an international transaction, during a previous year, shall keep
and maintain such information and documents, prescribed by the
Board, as will assist the Assessing Officer to compute the income
arising from that transaction, having regard to the arm’s length
price.

The requirement to keep and maintain such information and
documents with respect to an international transaction has,
however, been waived in the case of those persons who have
entered into international transactions the aggregate value of
which, as recorded in the books of account, does not exceed one
crore rupees - rule 10D(2).

Board has stipulated that the prescribed information
and documents be kept and maintained for a period of eight
years from the end of the relevant assessment year - Rule 10D
(5)

Section 92E does not stipulate that only the statutory auditor
appointed under the Companies Act or other similar statute
should perform the examination. The examination can, therefore,
be conducted either by the statutory auditor or by any other
chartered accountant in practice.

The issue of a report under section 92E, being a recurring
assignment for expressing a professional opinion, the accountant
accepting the assignment should communicate with the
accountant who had done the examination in the earlier year, as
provided in the Chartered Accountants Act.

The accountant should obtain from the assessee a letter of
appointment for conducting the examination.such an appointment letter should
be signed by the person competent to sign the return of income in
terms of the provisions of section 140

The appointment of the accountant in the case of a company
need not be made at the general meeting of the members. It can
be made by the Board of Directors or even by any officer, if so
authorised by the Board in this behalf. The appointment in the
case of a firm or a proprietary concern can be made by a partner
or the proprietor or a person authorised by the assessee. It is
possible for the assessee to appoint two or more chartered
accountants for carrying out the examination, in which case, the
report will have to be signed by all the chartered accountants. In
case of disagreement, they can give their reports separately.

The Act does not prohibit a relative or an employee of the
assessee being appointed as an accountant under section 92E. It
may, however, be noted that as per a decision of the Council
(reported in the Code of Ethics under clause (4) of Part I of
Second Schedule), a chartered accountant who is in employment
of a concern or in any other concern under the same
management cannot be appointed as an auditor of that concern.
Therefore, an employee of an assessee or an employee of a
concern under the same management cannot examine the
accounts and records of an assessee under section 92E. It may
also be noted that under the Second Schedule to the Chartered
Accountants Act, if a member gives a report under section 92E in
the case of a concern in which he and / or his relatives have
substantial interest, it will be necessary for him to disclose his
interest in the audit report.

An accountant responsible for writing or the maintenance of the
books of account of the assessee should not examine such
accounts. This principle will apply to the partner of such an
accountant as well as to the firm in which he is a partner. In view
of this, an accountant who is responsible for writing or the
maintenance of the books of account, his partner or the firm in
which he is a partner should not accept the examination
assignment under section 92E in the case of such an assessee.

Similarly, an internal auditor of the assessee cannot conduct the
examination if he is an employee of the assessee. If the internal
auditor is working in his professional capacity (as an independent
accountant not being an employee of the assessee), he can
conduct the examination. However, an accountant or a firm of
accountants appointed as tax consultants of the assessee can
conduct the examination under section 92E.

In the case of an examination, the accountant is required to
express his opinion as to whether the assessee has maintained
the proper information and documents, as prescribed, in respect
of the international transactions entered into by him. As regards
the statement of particulars to be annexed to the report, he is
required to give his opinion as to whether the particulars are true
and correct. In giving his report the accountant will have to use
his professional skill and expertise and apply such tests as the
circumstances of the case may require, considering the contents
of the report.

The report by the accountant given under Section 92E sets forth
such particulars as have been prescribed in Form 3CEB. In order
that the accountant may be in a position to explain any question
which may arise later on, it is necessary that he should keep
detailed notes about the evidence on which he has relied upon
while conducting the examination and also maintain all his
working papers. Such working papers should include his notes on
the following, amongst other matters:
(a) work done while conducting the examination and by
whom;
(b) explanations and information given to him during the
course of the examination and by whom;
(c) decision on the various points taken;
(d) the judicial pronouncements relied upon by him while
making the report;
(e) certificates issued by the client / management letters; and
(f) annexure to Form No.3CEB duly filled in and
authenticated by the client.

If the assessee is unable to obtain relevant information in respect
of the overseas branches duly certified by the overseas
Accountant, the relevant facts should be suitably disclosed and
reported upon.

Ninety per cent or more of the raw materials and consumables
required for the manufacture or processing of goods or articles
carried out by one enterprise, are supplied by the other enterprise
or by persons specified by the other enterprise, and the prices
and other conditions relating to the supply are influenced by such
other enterprise.
90% criteria should be applied
exclusively to raw materials and consumables used for
manufacturing and processing only.

A transaction is considered to be a cross-border transaction if it
originates in one courtry and get concluded in another country. A
cross-border transaction may or may not be an international
transaction within the meaning of Chapter X of the Act. Similarly,
a transaction which is not a cross-border transaction may still be
an international transaction for the purpose of the said chapter if it
falls within the ambit of the definition of “international transaction”.
For example, it may be assumed that there are two US
companies which are associated enterprises. If the Indian
subsidiary of one such US (holding) company enters into a
transaction with the Indian branch or the permanent
establishment in India of the other US company, this transaction,
even through it has originated, executed and concluded within
India, shall be an international transaction as it is between two
associated enterprises and one of the party is a non-resident.


In alternative, assume that there is an Indian company which is
the holding company of two Indian (subsidiary) companies. The
two Indian companies are associated enterprises since they are
subsidiaries of a common holding company. If one such Indian
subsidiary company enters into a transaction with the foreign
branch of the other Indian subsidiary company, such transaction
shall not be regarded as an international transaction. In this
case, even though the transaction is between two associated
enterprises, both the parties to the transaction are residents. For
a transaction to be regarded an international transaction, either or
both the parties must be non-residents.

Even where a transaction is between two non-resident associated
enterprises, the provisions of chapter X of the Act shall apply so
long as the income arising therefrom is assessable within the
perview of the Act. It is possible that an international transaction
between two associated enterprises, both of whom are nonresidents,
may not attract the provisions of chapter X of the Act if
the income from such transction is not taxable in India and falls
outside the scope of total income assessable under the Act.

The steps involved in the determination of the arm’s length price
can be summarised as follows :
(i) identification of the “international transaction”;
(ii) identification of an “uncontrolled transaction” - Rule 10A
(a);
(iii) identification and comparison of specific characteristics
embodied in international transactions and uncontrolled
transactions - Rule 10B (2);
(iv) finding out whether uncontrolled transactions and
international transactions can be compared by
reconciling/resolving differences, if any - Rule 10B (3);
(v) ascertaining the most appropriate method by applying the
tests laid down - Rule 10C;
(vi) determination of the arm’s length price by applying the
method chosen - Rule 10B (1).

Rule 10C(1) lays down the general guidelines in the selection of
the most appropriate method. The Rule states that the method to
be selected shall be the one best suited to the facts and
circumstances of each international transaction and that provides
the most reliable measure of the arm’s length price.

Further, the
selection of the most appropriate method shall be for each
particular international transaction. though the reference is to apply the
most appropriate method to each particular transaction, keeping
in view, the definition of the term ‘transaction’, the most
appropriate method may be chosen for a group of similar
transactions.

Rule 10C(2) lists the specific factors that should be taken into
account in the process of selecting the most appropriate method.
These factors are as under:
(i) nature and class of international transactions;
(ii) class or classes of associated enterprises and the
functions performed by them taking into account the
assets employed or to be employed and risks assumed
by such enterprises;
(iii) availability, coverage and reliability of data. For instance,
data relating to transactions entered into by the
enterprise itself would be more reliable than the data
relating to transactions entered into by third parties;
(iv) the degree of comparability and
(v) the extent to which reliable and accurate adjustments can
be made to account for the difference between the
transactions.

an “uncontrolled transaction” to mean “a
transaction between enterprises other than associated
enterprises, whether resident or non-resident”. In other words,
these are “transactions between enterprises that are independent
enterprises with respect to each other”. An uncontrolled
transaction can, therefore, be between:
•a resident and a non-resident; or
•a resident and a resident; or
•a non-resident and a non-resident.

When comparing international transactions and uncontrolled
transactions, Rule 10B (2), lays down the criteria for
comparability. This process is not quantitative but qualitative and
involves exercise of judgment. The criteria listed in Rule 10B are:
•distinctive nature of the property transferred or services
provided;
•functions performed taking into account the assets employed
or to be employed;
•risks assumed by the respective parties;
•contractual terms of the transaction;
•market conditions;

Distinctive nature of the property and services
•quality of product/services;
•value of the transactions;
•presence of intangibles like brand name, trade marks etc.;
•material/physical features.

Functions performed
•design and development of product
•sourcing of materials
•manufacturing
•warehousing
•sales and distribution
•technical services

Risk analysis
Transactions that are proposed to be compared should be
analysed for aggregate risk-content and risk-apportionment
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between parties. Some of the significant risks present in a
normal transaction are:
Nature of risks Particulars
1. Financial risk
a. Capital contribution
b. Method of funding
c. Funding of losses
2. Product risk
a. Design and development of
product
b. Up-gradation of product
c. After Sales Service
d. Risks associated with R & D
e. Product liability risk
f. Intellectual property risk if any
3. Market risk
a. Development of market including
advertisement and product
promotion etc.
b. Fluctuations in demand and prices.
c. Credit and collection risk
4. Entrepreneurial
risk
a. Any understanding between
associated enterprises on the
transaction flow.

Contractual terms
The important contractual terms governing the execution and
performance of the transactions should be determined to gauge
whether transactions are comparable or not.
•terms of delivery
•CIF, C&F, FOB etc
•terms of payment
•discount, if any
•credit period
•warranty period
•installation services

Market conditions
•geographical location and size
•regulatory laws and government orders
•level of competition
•nature of market whether wholesale/retail
•overall economic development

Comparability
to determine whether the
uncontrolled transactions and international transactions are
comparable at all. If there are no differences, the transactions
are comparable straightaway. If the differences can be adjusted
with reasonable accuracy, then the transactions are comparable,
subject to adjustments. If, however, the differences cannot be
adjusted with reasonable accuracy, the transactions are to be
ignored and the search for comparable transactions would need
to commence all over again.

Transactions entered into by
associated enterprises with unrelated party (called “internal
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comparables”) would provide more reliable and accurate data as
compared to transactions by and between third parties (called
“external comparables”). OECD’s Guidelines on Transfer Pricing
recognizes the fact that external comparables are difficult to
obtain and, also, it may be incomplete and difficult to interpret.
Hence for these reasons, internal comparables are preferred to
external comparables.

Rule 10B(4) provides that the data to be used in analysing the
comparability of an uncontrolled transaction with an international
transaction shall be the data relating to the financial year in which
the international transaction has been entered into. The proviso
to Rule 10B(4), further states that data relating to a period of not
more than 2 years preceding such financial year may also be
considered, if such data reveals facts which could have an
influence on the determination of the price in an international
transaction.

Power of Assessing Officer
According to section 92C (3), the Assessing Officer may himself
proceed to determine the arm’s length price if any of the following
conditions are satisfied:
(i) the price charged or paid in an international transaction
has not been determined on the basis of the most
appropriate method.
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(ii) any information and document relating to an international
transaction has not been kept and maintained as
mandated.
(iii) the information or data used in computation of the arm’s
length price is not reliable or correct.
(iv) the assessee had failed to furnish, within the specified
time, any information or document which he was required
to furnish.

METHODS OF COMPUTATION OF ARM’S LENGTH PRICE
uncontrolled transaction’ means a
transaction between enterprises other than
associated enterprises, whether resident or
non-resident;

Comparable Uncontrolled Price Method (CUP
Method)

The OECD in its Transfer Pricing Guidelines observes as under :
“This method is particularly good where an independent
enterprise sells the same product or service as is sold between
two associated enterprises”.
“The uncontrolled transactions should reflect goods of a similar
type, quality and quantity as those between the associated
enterprises, and relate to transactions taking place at a similar
time and stage in the production/distribution chain, with similar
conditions applying.”
The steps involved in the application of this method are:
(i) Identify the price charged or paid for property transferred
or services provided in comparable uncontrolled
transaction or a number of such transactions;
(ii) Adjust such price to account for the differences if any,
between the international transaction and the comparable
uncontrolled transaction or between enterprises entering
into such transaction which could materially affect the
price in the open market;
(iii) The adjusted price is taken to be the arm’s length price;
(iv) The arm’s length price is compared with the price
charged in the international transaction;
(v) If the price charged in the international transaction is
lower than the arm’s length price or the price paid in the
international transaction is higher than the arm’s length
price then an adjustment is to be made to the price
charged or paid in the international transaction by the
amount of such variance.

The following points are to be noticed:
The presence or absence of any specific
features in the uncontrolled transaction as compared to
the international transaction is to be adjusted for. These
features are to be evaluated in mathematical terms or
absolute numbers. This is a subjective process based on
objective facts.
If after the adjustment to the uncontrolled transactions, a
range of figures are available, an arithmetical average of
such range of figures will have to be arrived at and
adopted as the arm’s length price.
It may be noted that the averaging is permissible only if a
range of arm’s length prices have been arrived at under
any one particular method and not by adopting different
methods.

Resale Price Method (RPM)
Typical transactions where the resale price method may be
adopted are distribution of finished products or other goods
involving no or little value addition.
The OECD in its Transfer Pricing Guidelines has observed as
under :
“It is generally accepted amongst most tax authorities that the
Resale Price method is applicable and preferable where the entity
performs basic sales, marketing and distribution functions. (i.e.
where there is little or no value added by the reseller prior to the
resale of the goods acquired from related parties). The method is
applicable even with differences in products, as long as the
functions performed are similar. It is less useful where goods are
further processed or incorporated into other products.”

The steps involved in the application of this method are:
(i) identify the international transaction of purchase of
property or services;
(ii) identify the price at which such property or services are
resold or provided to an unrelated party;
(iii) deduct the normal gross profit margin derived by the
enterprise from the resale price of such property or
services. The normal gross profit margin is that margin
which the enterprise would earn from purchase of the
similar product from an unrelated party and the resale of
the same to another unrelated party.
(iv) deduct also expenses incurred in connection with the
purchase of goods from the price so arrived;
(v) adjust the prices so computed for the differences
between the uncontrolled transaction and the
international transaction. These differences could be
functional and other differences including differences in
accounting practices. Further these differences should
be such as would materially affect the amount of gross
profit margin in the open market;
(vi) the adjusted price arrived at is the arm’s length price for
the property purchased or service obtained;
(vii) substitute the arm’s length price for the price charged in
the international transaction and make adjustments to the
income returned accordingly.
Note : In steps (ii) and (iii) above only internal comparables are
mentioned. An enterprise can also use external comparables
and do the computation.

The following points are to be noticed:
(i) The resale price method is to be adopted only when
goods purchased from an associated enterprise are
resold to unrelated parties. For sales made to an
associated enterprise, this method would be inapplicable.
For the sales made to an associated enterprise, the
Comparable Uncontrolled Price Method or any other
appropriate method may be adopted. Thus two different
methods may be applicable for transactions that together
may constitute an integral part of a business activity;
The reference is to the gross profit margin derived from
sale of same or similar property. The reference is thus
not to the overall gross profit margin but to the gross
profit margin from individual transactions. It may be
difficult to identify and arrive at the gross profit margin
from individual transactions;

One has to arrive at the normal gross profit margin.
There may be situations where multiple normal gross
profit margins arise from comparable uncontrolled
transactions. In such case, the correct procedure would
be to apply each of such gross profit margins on the
International transaction and arrive at the arm’s length
purchase price. The arithmetical mean of the purchase
prices so arrived would be the arm’s length price.
The rule contemplates the gross profit margin of either
the transaction entered into by the enterprise or of an
unrelated enterprise in uncontrolled transactions. If there
is a variation in the gross profit margins of these
enterprise, the gross profit margin of the enterprise is to
be preferred, being an internal comparable;
The expenses incurred by the enterprise in connection
with the purchase of the property are to be further
reduced. The gross profit margin may have been arrived
at after taking into account such expenses. The purpose
of this method is to arrive at the arm’s length price of the
purchases. In this method, this purchase price is arrived
at by beginning from the resale price and reducing
therefrom the normal gross profit margin as the first step.
If the arm’s length price of the purchase is arrived at by
stopping at this step itself, the resulting figure would be
inclusive of the expenses incurred by the enterprise
which have been taken into account in arriving at the
gross profit. It is therefore necessary to arrive at the
correct arm’s length price to further reduce such
expenses.
Adjustments have to be made also for accounting
practices apart from functional and other differences.
Some of the differences in accounting practices may be
because:
(a) sales and purchases have been accounted for
inclusive of taxes or exclusive of taxes;
(b) method of pricing the goods namely, FOB or CIF;
(c) fluctuations in foreign exchange.

Cost Plus Method (CPM)
Typical transactions where the cost plus method may be adopted
are:
(a) provision of services;
(b) joint facility arrangements;
(c) transfer of semi finished goods;
(d) long term buying and selling arrangements.
The OECD in its Transfer Pricing Guidelines states as follows :
“This method is particularly useful where semi-finished goods are
sold between associates, where there are long term buy and
supply arrangements, or in the case of the provision of services
or contract manufacturing, particularly where these are of a
subsidiary or peripheral nature”.
The steps involved in the application of this method are:
(i) Determine the direct and indirect cost of production in
respect of property transferred or service provided to an
associated enterprise.
(ii) Identify a comparable uncontrolled transaction or a series
of transactions with an unrelated party for same or similar
property or service.
(iii) Determine gross profit mark-up in the comparable
uncontrolled transaction.
(iv) Adjust the gross profit mark-up to account for functional
and other differences between the international
transaction and the comparable uncontrolled transaction.
(v) The direct and indirect cost of production in the
International transaction is to be increased by such
adjusted gross profit mark-up.
(vi) The resultant figure is the arm’s length price;
(vii) The actual price charged in the international transaction
is to be compared with the arm’s length price and
adjustment made to the income accordingly.
In this method, the direct and indirect costs of production
are to be identified. The terms ‘direct’ or ‘indirect’ costs
are however not defined.
In identifying and adopting the direct and indirect cost,
the following factors would also have to be borne in mind:
(a) utilisation of the plant; for example, if the plant
has been under utilised the method of absorbing
fixed costs may have to be suitably adjusted;
(b) method of absorbing costs; absorption costing
method is normally to be preferred.
(c) in abnormal situations, marginal-costing
principles may have to be applied; for example,
substantial degree of under utilisation of plant
facilities. Thus incremental costing or marginal
costing can be used as a basis if the transactions
represent a disposal of marginal functions.
(iii) This method is to be adopted only in cases of supply of
property or services to an associated enterprise. This
method is not to be applied when the enterprise is in
receipt of property or services from an associated
enterprise.
(iv) Even under this method, the gross profit mark-up is to be
adjusted for differences in accounting norms adopted by
the enterprise.
(v) In identifying the comparables, one should depend more
upon the similarities of functions performed and less on
the product or service similarities.
Profit Split Method (PSM)
Typical transactions where the profit-split method may be used
are transactions involving:
(a) integrated services provided by more than one
enterprise;
(b) transfer of unique intangibles;
(c) multiple inter-related transactions, which cannot be
separately evaluated.
The observations of the OECD, in its Transfer Pricing Guidelines,
on this method are as follows :
“This method aims to determine what division of total profits
independent enterprise would expect in relation to the relevant
transactions. The profits should be split on an economically valid
basis that reflects the functions and risks of each of the parties. In
order to apply this method, it is necessary to identify the total
profit arising from the related party transactions and split that
profit between the parties according to their respective
contributions.”
The steps involved in the application of this method are to :
(i) determine the combined net profit of all associated
enterprises engaged in the international transactions;
(ii) evaluate relative contribution made by each of them with
regard to:
(a) functions performed;
(b) assets employed;
(c) risks assumed;(a,b,c are collectively called FAR)
(d) reliable external market data indicating how such
Contribution would be evaluated.
(iii) split the combined net profit in proportion to the relative
net contribution.
(iv) The profit so apportioned is taken to arrive at the arm’s
length price in relation to the international transaction.
Alternative approach
A two-tier allocation may also be adopted as follows :
(i) Partial allocation of the net profit to each enterprise so as
to provide it with a basic return appropriate to the type of
the international transaction entered into;
(ii) the remainder of the net profit to be allocated on the
basis of the evaluation of the relative contribution made
and
(iii) the total net profit from such a two-term allocation is
taken to arrive at the arm’s length price in relation to the
international transaction.
The following points are to be noticed:
(a) The rule itself provides an alternative method to arrive at
the arm’s length price being the two-tier profit split method
If in either of the alternatives, a range of figures is
available, the arithmetical mean of such figures may be
adopted as the arm’s length price. It may however not be
possible to adopt the arithmetical mean of the two
alternatives.
(b) Under the two-tier split-method, the basic rate of return
may have to be adopted having regard to the profits
compared to the net worth of the enterprise. Such rate of
return may not be uniform for all the associated
enterprises involved in the transaction.
(c) This is the only method for which the Rule itself has
prescribed the types of transaction to which it may be
applicable.
(d) Even though the computation proceeds with the profits
from a transaction, the purpose is only to arrive at the
arm’s length price of a transaction. It is only by
substituting the arm’s length price for the price in the
international transaction that an adjustment may be made
to the income returned.

Transactional Net Margin Method (TNMM-Most Widely Usable Method by Indian Inc. )

Typical kinds of transactions where the transactional net margin
method may be used are:
(a) provision of services;
(b) distribution of finished products where resale price
method cannot be adequately applied;
(c) transfer of semi finished goods.

The steps involved in the application of this method are:
(i) Identify the net profit margin realised by the enterprise
from an International Transaction. The net profit margin
may be computed in relation to costs incurred or sales
effected or assets employed or any other relevant base;
(ii) Identify the net profit margin from a comparable
uncontrolled transaction or a number of such transactions
having regard to the same base;
(iii) The net profit margin so identified is adjusted to take into
account the differences if any between the international
transaction and the comparable uncontrolled transaction.
The differences should be those that could materially
affect the net profit margin in the open market;
(iv) The adjusted net profit margin is taken into account to
arrive at the arm’s length price in relation to the
international transaction.

The following points are to be noticed in the application of the
transactional net margin method:
(a) Different bases of arriving at the net profit are
recognised. The same basis of arriving at the net profit
margin is to be adopted year after year, unless
circumstances justify an alternate base being adopted.
This would ensure consistency and hence comparability
would become meaningful;
(b) Whichever base is selected in determining the net profit
margin in an international transaction, the same basis is
to be adopted for arriving at the net profit margin in the
comparable uncontrolled transaction;
(c) The net profit is not a derivative of the product / service
alone, but a derivative of various processes, namely,
nature of market, cost practices, the price of intangibles
etc. Hence, it would be very essential that appropriate
comparables are identified for this method.
(d) Net profit, for example, can be influenced by a number of
factors a few of which could be:
(i) threat of new entrants
(ii) management efficiency
(iii) individual strategies
(iv) cost of capital
(v) business experience
(vi) obsolescence due to change in demand /
technology
(vii) method of depreciation
(e) The selection of the comparable transaction therefore
becomes very crucial, and consistency is critical;
(f) The accounting treatment of expenses and depreciation
is also a critical factor in finding a comparable. Unlike the
preceding method, the rule does not explicitly provide for
adjustment on account of differing accounting practices.
Nevertheless, such differing practices would have to be
factored in;
(g) Some of the ratios that can be used for determining the
arm’s length price under the method are:
(i) ratio of net profit before tax to sales
(ii) ratio of net profit before interest & tax to sales
(iii) ratio of cash profit to sales
(iv) ratio of net profit before tax to shareholders’
funds
(v) ratio of net profit before interest & tax to assets.
(vi) Berry ratio - ratio of operating cost to operating
revenue.

Most appropriate method
(1) For the purposes of sub-section (1) of section
92C, the most appropriate method shall be
the method which is best suited to the facts
and circumstances of each particular
international transaction, and which provides
the most reliable measure of an arm’s length
price in relation to the international
transaction.
(2) In selecting the most appropriate method as
specified in sub-rule (1), the following factors
shall be taken into account, namely:-
(a) the nature and class of the
international transaction;
(b) the class or classes of associated
enterprises entering into the
transaction and the functions
performed by them taking into
account assets employed or to be
employed and risks assumed by such
enterprises;
(c) the availability, coverage and
reliability of data necessary for
application of the method;
(d) the degree of comparability existing
between the international transaction
and the uncontrolled transaction and
between the enterprises entering into
such transactions;
(e) the extent to which reliable and
accurate adjustments can be made to
account for differences, if any,
between the international transaction
and the comparable uncontrolled
transaction or between the
enterprises entering into such
transactions;
(f) the nature, extent and reliability of
assumptions required to be made in
application of a method. [Rule 10C]

No particular method is suitable in every possible situation. It is
not possible to provide specific rules that will cover every case.
While selecting the most appropriate method, the factors
prescribed in Section 92C of Income tax Act 1961 and Rule
10C(2) should be considered.

Although it is difficult to prescribe general principles for choice of
most appropriate method, the following broad categorisation may
be considered as already indicated under each of the respective
methods :
(i) Comparable uncontrolled price method may be used in
case of loans, royalties, service fee, transfer of tangibles,
etc.
(ii) Resale price method is most useful in case of marketing
operations of finished products, especially in case of
distributors not performing significant value addition to
the product.
(iii) Cost plus method is normally used where raw materials
or semi-finished goods are sold; where joint facility
agreements or long-term buy-and-supply arrangements,
or the provision of services are involved;
(iv) Profit split method is normally used in cases where the
transactions involve provision of integrated services by
more than one enterprise; and
(v) Transactional net margin method could be used in
majority of the cases including transfer of semi-finished
goods; distribution of finished products where
applicability of resale price method appears to be
inappropriate and transaction involving provision of
services.


DOCUMENTATION AND VERIFICATION
Type of information and documents
Rule 10D(1) lays down 13 different types of information and
documents that a person has to keep and maintain. Broadly,
these information and documents may be classified into three
types:
(i) enterprise-wise documents – These are documents that
describe the enterprise, the relationships with other
associated enterprise, the nature of business carried out,
etc. This information is, largely, descriptive [clauses (a)
to (c)]
(ii) transaction-specific documents – These are documents
that explain the international transaction in greater detail.
It includes information with regard to each transaction
(nature and terms of the contract, etc.), description of the
functions performed, assets employed and risks assumed
by each party to the transaction, economic and market
analyses, etc. This information is both descriptive and
quantitative in nature [clauses (d) to (h)].
(iii) Computation related documents – These are documents
which describe and detail the methods considered, actual
working assumptions, policies etc., adjustments made to
transfer prices and any other relevant information, data,
document relied for determination of arm’s length price
[clause (i) to (m)].

Ownership, profile and business
A description of the ownership structure of the assessee
enterprise with details of shares or other ownership interest
held therein by other enterprises [clause (a), Rule 10D(1)]

Where the person is a firm or an association of persons, the
names of the partners of the firm or members of the association
of persons and their profit sharing ratios have to be stated.
Similar details, to the extent applicable, need to be furnished
when the person is a body of individuals, trust, Hindu undivided
family, etc. The description of the ownership structure should be
stated as at the day on which one person became an associated
enterprise of another and as at every other day on which there
was change in the ownership interest of that other enterprise.

The regulations require the assessee to maintain information
regarding the shareholding pattern.

The accountant shall verify that the assessee maintains
information regarding enterprises having direct or indirect
ownership interests, through intermediaries, in the assessee
enterprise. The accountant may rely on representation from the
management with regard to the veracity of the same.

A profile of the multinational group of which the assessee
enterprise is a part along with the name, address, legal
status and country of tax residence of each of the
enterprises comprised in the group with whom international
transactions have been entered into by the assessee, and
ownership linkages among them [clause (b), Rule 10D(1)]

it may be advisable to maintain, amongst other things, corporate brochures,
catalogues and other similar printed and / or electronic material
that describe:
•The principal line(s) of business in which the group is
engaged, such as manufacturing of electronic goods, trading
in chemicals, wholesale trade in food grains,
pharmaceuticals, etc.;
•Geographical areas in which the group 1 operates;
•Summarised global financials and other details such as
capital invested, assets employed, turnovers achieved,
incomes earned, profits made / losses incurred, etc.

With respect to each of the associated enterprises in the group
with whom the assessee has entered into international
transaction have been conducted, the following specific details
must be maintained:
•Name;
•Address;
•Legal status (company, limited liability partnership, firm, etc.);
•Country of tax residence;
•Ownership linkages between the assessee and the
associated enterprise.
Sometimes, the establishment of ownership linkages between the
assessee and other associated enterprises is a problem for the
reason that sufficient reportable information is not available. In
such cases, the assessee will have to provide only the
information that is available with him.

The remarks of the OECD in their Transfer Pricing Guidelines on
this issue merits reference:
“Tax administrators further should not require
taxpayers to produce documents that are not in
the actual possession or control of the taxpayer
or otherwise reasonably available, e.g.,
information that cannot be legally obtained, or
that is not actually available to the taxpayer
because it is confidential to the taxpayer’s
competitor or because it is unpublished and
cannot be obtained by normal enquiry or market
data.”

The assessee is required to maintain a document that describes
the profile of the multinational group. The member may exercise
his professional judgment to determine whether the profile
prepared by the assessee provides sufficient information
regarding the group, pertinent to transfer pricing. Some of the
information that may be contained in the profile are as follows :
•the name and place of incorporation of the immediate parent
company.
•the name and place of incorporation of the ultimate parent
company.
•the major product lines, services offered by the group.
•a brief description of the technology, brands or other
intangibles owned by the group.
•names of major competitors.
Any other information regarding the group that may be pertinent
to the transfer pricing analysis.

The assessee is also required to provide a list of associated
`enterprises from within the group, with whom the assessee has
entered into international transactions( Except one which have been covered above which are part of multinational group). The following details are
required to be maintained by the assessee :
•name of the group entity (associated enterprise)
•address of the group entity
•legal status
•country of tax residence.

The assessee is not required to maintain this information in
respect of other associated enterprises i.e. enterprises that are
not its group entities but are deemed to be associated enterprises
by virtue of provisions of clauses (c) to (m) of section 92A(2).

The accountant should obtain written representation from
management providing him with name, address, legal status and
country of tax residence of each of the enterprises comprised in
the group with whom international transactions have been
entered into by the assessee, and ownership linkages among
them.

The accountant should check the register of
members maintained by the assessee under section 150 of the
Companies Act, 1956 and the voting rights corresponding to the
shares of the associated company.

A broad description of the business of the assessee and the
industry in which the assessee operates, and of the business
of the associated enterprises with whom the assessee has
transacted [clause (c), Rule 10D (1)]

This explanation could typically cover areas such as:
•the business model used;
•technologies employed;
•products manufactured, traded;
•markets addressed and competition faced;
•geographic dispersion of manufacturing facilities; etc.

The broad description of the industry in which the assessee
operates will include reports about the industry, which are
available in the public domain. This could be material published
in business newspapers, trade journals and magazines, etc. all of
which provide a macro-economic perspective to the industry.

The assessee has to determine whether by virtue of clauses (c)
to (m) of Section 92A(2) certain enterprises shall be deemed as
associated enterprises. The accountant shall conduct the
following checks to verify if the assessee has conducted due
diligence in determining whether an entity is an associated enterprise or not.
Clause (c): The accountant should check the register of loans
and investments maintained by the assessee under section 372A
of the Companies Act, 1956
Clause (d): The accountant shall obtain details of all the
guarantees pertaining to the borrowing from the management
and representation for its completeness thereof.
Clause (e): The accountant shall obtain a representation from
management detailing composition and appointment of the
members of board of directors or governing board, Executive
Directors and Executive Member of the governing board. Further
the member shall check the Register of Directors maintained by
the company under section 303 of the Companies Act, 1956.
Clause (f): The accountant shall obtain a representation from the
management detailing composition and appointment of the
members of board of directors or governing board, Executive
Directors and Executive Member of the governing board. Further
the member shall check the Register of Directors maintained by
the both companies under section 303 of the Companies Act,
1956.
Clause (g): The accountant shall obtain a representation from the
management to the fact that enterprise is wholly dependent upon
the intangible assets such as know-how, patents, copyrights,
trademarks, licenses, franchises, or other commercial rights of
similar nature, or any data, documentation, drawing or
specification relating to any patent, invention, model, design,
secret formula or process, of which the other enterprise is the
owner or has exclusive right.
Clause (h): The accountant shall obtain the details of all the
purchases of raw material and consumable requirement made by
the assessee and compute the party wise share of business i.e.
party-wise purchases. He shall obtain representation from the
management to the fact that the information provided is correct
and complete.
Clause (i): The accountant shall obtain a representation from the
management to the fact that enterprise sold the goods or articles
manufactured or processed by it, are sold to the other enterprise
or to persons specified by the other enterprise, and the prices
and other conditions relating thereto are influenced by such other
enterprise
Clause (j): The accountant shall obtain a representation from
management providing details of controlling interests in all the
affiliated parties so as to determine the common controlling
interest in two companies.
Clause (k): The accountant shall obtain a representation from
management providing details of controlling interests in all the
affiliated parties so as to determine the common controlling
interest in two companies.
Clause (l): The accountant shall obtain the partnership of AOP
agreement in order to determine whether the any enterprise holds
not less than ten per cent interest in other firm, association of
persons or body of individuals.
Clause (m): The accountant shall obtain a representation from
management to the effect that there exists or does not exist
between the two enterprises, any relationship of mutual interest in
case any such relationship is prescribed by CBDT. The
accountant shall exercise his professional judgement and due
diligence to verify that the same is prima facie correct. Page 90