Effective Transfer Pricing Methods"

Transfer pricing is a reference to ways of determining the cost of transactions between companies that are associated, which can be conducted under circumstances that differ from the ones that are in place among independent companies.

It is a reference to the cost that is attached to transfers of products, services, and technologies between businesses. A transfer pricing arrangement generally involves two related businesses including holding companies as well as subsidiary firms. The agreement stipulates the cost of transfer purchases or sales of products between subsidiary and holding firms.




The provisions for Transfer Pricing rules in India were enacted to guarantee that any income earned from the proceeds of an International Transaction or specified domestic transactions among Associated Enterprises shall be computed on Arm's Length Prices. Costs or expenses that are that is shared to two or more related businesses under a common arrangement or agreement must be computed at an Arm's Length price.

Price of Arm's Length

The Arm's Length Cost (ALP) in a deal between two companies is the cost to be paid if the transaction took place with two similar independent non-related entities, if the only consideration offered is commercial.

The computation of Arm's length price

The following procedures were prescribed by Section 92C, of the Act to establish the price of an arm's length:

* Comparable uncontrolled price (CUP) method

* Resale price method (RPM)

* Cost plus method (CPM)

* Profit Split Method (PSM)

* Method of transactional net margin (TNMM)

* Other Methods

1. Comparable Uncontrolled Price ('CUP') method

CUP is the most common and most commonly used method of to determine ALP in cases where comparable data are accessible in databases of commercial companies. The price is the amount of goods or services, and the circumstances of a controlled transaction in comparison to the uncontrolled transactions. CUP Method is a method of determining the price for goods or services. CUP Method can also be utilized to identify the arm's length fee for the usage of any intangible asset. CUPs could be determined based on or "internal" similar transactions or on "external" similar transactions.

In determining the comparative value of the controlled and uncontrolled trades, each factor of importance must to be taken into account. Therefore, this technique should not be used in the event that the products or services can be compared.

Guidelines of the OECD Guidelines recommend the use CUP CUP in the following situations:

Where an AE sells the same product or services as is sold to independent third parties; None of the differences between the International Transaction/Specified Domestic Transaction and the comparable uncontrolled transaction, if any, could materially affect the pricing mechanism; and In case pricing mechanism is affected on account of differences in the nature of transactions as discussed above, reasonably accurate adjustments can be made to eliminate such differences.

2. Resale Price Method or Resale Minus Method ('RPM')

The method considers the cost for a particular item or service is purchased to individuals who were not related to it and originally purchased or acquired through AEs. The price is called to as the'resale' price. To apply RPM selling a the product or service must occur without providing any substantial commercial worth to this particular. That means it's ideal in situations when only fundamental selling, marketing and distribution operations take place.

To determine the applicability of RPM in the context of RPM, the resale value of the item is decreased through the gross margin that can be determined by comparing gross profit margins of an uncontrolled similar transaction. Additionally, the costs related to the purchase of these products, like customs duty are subtracted.

Example: Given price = $500

Resale price margin (20%) = $100

Price for arm's length = $400

3. Cost Plus Method ('CPM')

Cost Plus Method ('CPM') Cost Plus Method ('CPM') calculates the arm's-length cost through the addition of a reasonable Gross Profit Margin to the associated entity's cost in the production of goods or providing services. First, it is to find out the cost that the provider incurs in the course of a transaction controlled for goods given to an associate buyer. Additionally, a reasonable mark-up must to be included to the price, to make an appropriate profit in relation to the tasks that are performed. When you add the (market-based) mark-up to the costs involved, a cost can be viewed as an arm's length.

Example:Cost of associated enterprise 1 equals $500

Gross profit mark-up (50 percent) equals $250

The price for an arm's length is $750

4. Profit Split Method ('PSM ')

The PSM is a transactional profit-splitting method which focuses on showing how profits (and in fact losses) might have been distributed among independent businesses in similar transactions. The process begins by calculating the gains from controlled transactions to be divided. Profits are split across the related enterprises in accordance to the way they might have been split by independent businesses during a similar uncontrolled transaction. This process will result in a fair arm's-length price for controlled transactions.

There are two primary approaches to be used to split profits. There are two main options:

  1. Analysis of Contribution The profits are split on the basis on the value relative to the tasks that are performed by the parties involved in the control transaction (considering the assets utilized and the risks taken on) or an uncontrolled tax payer's share of the operating profit or loss. This is employed to determine the proportion of operating profits or losses of the business that is involved.
  2. Analysis of residuals The profit is divided into two steps:
    1. Contribute the income to the regular contribution
    2. Reserve residual profits

5. Transnational Net Margin Method ('TNMM ')

The TNMM is among two techniques for calculating transactional profits that are that are outlined by the OECD in order to establish the transfer price. The methods are used to evaluate the profit from specific restricted transactions. The TNMM is a method of evaluating net profits on a "appropriate base" like the sale or asset that comes from controlled transactions. The OECD declares that for the calculation to be precise tax payers should apply the same indicators for net profits as they do to similar uncontrolled transactions. Taxpayers can utilize comparable information to discover the net margin achieved by companies that were independent when they conducted similar transactions. Additionally, the taxpayer has to conduct a practical study of these transactions to determine their compatibility.

In the event that an adjustment is necessary to allow a markup of gross profits to be similar, but the data on the costs involved are not readily available, taxpayers may apply the net profit method and indicator to examine the transactions. This method can be used in cases where the duties carried out by the comparable organizations are slightly distinct.

6. Alternative Method

CBDT has set out"other method" retroactively beginning on April 1, 2012, under Rule 10AB. Rule 10AB will apply to Assessment Year 2012-13 (i.e. FY 2011-12) as well as the following years. The rule that was introduced to this regard focuses on the comparison of actual prices for an transactions that are not controlled, and appears to appear similar to CUP Method. CUP Method. This rule introduces the notion of third-party transactions that are hypothetical. It suggests the use of prices that could be charged or paid for an uncontrolled exchange, like quotes, price publication etc. As per the OECD Guidelines, another approach allows for relaxation on choosing between five standard methods to establish ALP.

The method that is most suitable to for calculation of the price at arm's length and in the way that is required. In the event that multiple prices can be determined with the best method the price of Arm's Length shall be considered to represent the average of these prices or depending on the preference of the assessor, the price can differ from the arithmetical


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