Short Communication with the readers:
On this new day, with new idea and new enthusiasm I have again come up with an Article on somewhat a new topic called as Transfer Pricing. The Article has been written in a style which in my opinion will suit to the new learners and beginners like me. I have tried my best to make the things as simple as it could be, but still if you face any single doubt you can always share that with me. Happy reading!
Introduction to Transfer Pricing:
a. Transfer pricing relates to the pricing (valuation) of international transactions that take place between two associated enterprises.
b. Due to globalization, there are increasing no. of multinational enterprises which has given rise to new and complex issues arising from transactions entered into between two or more enterprises belonging to the same multi-national group. For Example- Nokia Ltd. is a group whose origin country is Finland, but it has many subsidiaries & sister concerns across the world. In India, its subsidiary/sister concern is Nokia (India) Ltd.
Need of Transfer Pricing:
a. For Example Nokia India buy handsets manufactured by Nokia Finland. Here assume that Nokia Finland is a tax heaven (tax free) country and India is as usual progressive taxing country.
b. So, here the tax planners of Nokia India will ask Nokia Finland to charge them as much as they can for the handsets, because due to purchase at higher price the taxable profit of Nokia India will go down and that of Nokia Finland will go up, but Nokia Finland is anyway a tax heaven so no need to pay any taxes on any profits. In this way the group Nokia as a whole will earn profits but will save/avoid tax in countries like India etc.
c. Thus in order to curb/restrict such practices of multinational groups the provisions of Transfer Pricing has been introduced by Ministry of Finance, GOI in year 2001.
d. So, under transfer pricing (TP) provisions the value of international transactions b/w associated enterprises will be the Arm’s Length Price (ALP) of the transaction.
e. ALP is the price that would be charged for the transaction if it had been entered into by unrelated /not associated parties in similar conditions. So in our aforesaid example the Transfer price (ALP) of the transaction b/w Nokia India and Nokia Finland is the price at which Nokia Finland is selling the same under same T&C to any other company (say Karbonn Mobiles). Therefore, if Nokia India has paid extra price for purchasing handsets from Nokia Finland then such extra price may be disallowed by Assessing Officer under TP regulations.
Computation of income from international transaction (Sec 92)
(1) Any income (also includes expense or interest) arising from an international transaction shall be computed having regard to the arm’s length price. The example of Nokia group discussed above is an example of international transaction, so there transaction has to be valued as per ALP.
Meaning of an International Transaction-(Sec 92B)
“International transaction” means a transaction between two or more *associated enterprises(explained later in the article), either or both of whom are non-residents, in the nature of :
(i) purchase, sale or lease of tangible or intangible property, or
(ii) provision of services, or
(iii) lending or borrowing money, or
(iv) any other transaction having a bearing on the profits, income, losses or assets of such enterprises,
International Transaction shall include (Inclusive clause of definition)-
a. arrangement between two or more associated enterprises for any contribution to, any cost or expense incurred in connection with a benefit, service or facility provided to any one or more of such enterprises.
b. For Example- A Ltd., B Ltd., C Ltd. And D ltd. are four associated enterprises, these four companies entered into an agreement that they will pay annual charges for a secret manufacturing formula to be shared by A Ltd with B,C and D Ltd. Thus transactions b/w A&B, A&C, A&D are international transactions, by virtue of inclusive clause. Thus, such transactions will be also be governed by TP regulations.
Further International Transaction shall also include:
a. A transaction entered into by an enterprise with a person other than an associated enterprise shall be deemed to be a international transaction as entered into between two 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.
b. For Example: Where Nokia Finland instead of directly selling the handsets to Nokia India Ltd., enters into an arrangement with a Finss Mobiles Ltd (local company of Finland) to sale handsets to Nokia India at a higher price than that of prevailing market price .And further Nokia Finland may ask Finss Mobiles Ltd to return half of profits earned by it on selling to Nokia India. Thus, Nokia Group as a whole can avoid tax by making some arrangements with the third party.
c. Therefore, such inclusive clause take care of such practice,. So here for TP regulations Finss Mobiles Ltd and Nokia India even if not actually associated will be deemed to have associate enterprise of Nokia India and the transaction b/w them is international transaction as per Sec 92B.
Two Enterprises will be termed as Associated Enterprises as per following [Sec 92A(2)]
1. One enterprise holds, directly or indirectly, shares carrying minimum 26% of the voting power in the other enterprise;
Direct holding to samajh me aata hain ye indirect holding kya hain?
Let us understand it with an example:
There are three enterprises A &co.(a proprietary concern whose proprietor is Mr. A), Sun Ltd. and Moon Ltd.
Sun Ltd. and A&Co are AE because Mr. A(A&Co) hold 33% of share capital of Sun Ltd. Here if Sun Ltd. hold 25% share cap of Moon Ltd. then it is known as Indirect holding of Mr. A(A&Co.) in Moon Ltd.. In short, holding of an associate (intermediary )in any third enterprise(Moon Ltd. in above case) is known as Indirect holding of the other enterprise(here A&Co. in the example above)
But still A&Co. and Moon Ltd. will not be termed as associated because the indirect holding of A&Co. in Moon Ltd. is less than 26%.
2. Any enterprise holds, directly or indirectly, shares carrying minimum 26% of the voting power in each of such enterprises:
For Instance: If Sun Ltd hold 30% share cap in Moon Ltd. and hold 45% in Star Ltd. , in such a case
(i) Sun and Moon are AEs.
(ii) Sun and Star are also AEs
Therefore by virtue of clause 2 above, Moon and Star also becomes associated
3. A loan advanced by one enterprise to the other enterprise constitutes not less than (i.e. minimum) 51% of the book value of the total assets of the other enterprise:
For Instance: PQR Ltd. of USA has advanced loan of USD 5 million (Rs. 20crores) to XYZ Ltd. of Bangalore. The total book value of the assets of XYZ Ltd. (Factory building and other assets) is Rs.35 crores. Here PQR and XYZ are associated enterprise because loan advanced by PQR to XYZ constitute 57.14% of book value of the total assets of XYZ.
4. One enterprise guarantees not less than (minimum) 10 % of the total borrowings of the other enterprise:
For Instance: PQR Ltd. has given guarantees to a bank in USA for loan of Rs.1.7 crores taken by XYZ Ltd.
The total borrowings of XYZ from various source is Rs. 20 crores. Here, PQR and XYZ are not associated because the loan amount guaranteed by PQR in respect of loan taken by XYZ is less than 10% of XYZ total borrowings.
5. The manufacture or processing of goods or rendering of services or any business activity carried on by one enterprise is fully dependent on the use of know-how, patents, copyrights, trade-marks, licenses, franchises, brand name, secret formula or any other such rights, and such rights have exclusively owned by the other enterprise. In such a case such right holder and right user are become associated enterprises(AE)
For Instance: A Ltd enters into agreement with Sky Inc.(most of the foreign co use Inc in place of Ltd.) of USA to use the brand name of Sky Inc. viz "skype". A Ltd will affix the brand "skype" and sell the goods in India. During this period of the agreement, A Ltd is prohibited from using any other brand for the leather shoes.
Here the business of A Ltd is exclusively dependent on the brand of Sky Inc. Hence A Ltd and Sky Inc. will be considered as associated enterprises and hence the transaction b/w them would be subject to TP provisions of Section 92.
6. 90% 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 (ii) by persons specified by the other enterprise where the prices and other conditions relating to the supply are influenced by such other enterprise.
For Instance: (i) AB Limited is engaged in the manufacture of Steel. AB Limited proposes to enter into agreement with XYZ Inc. of USA to supply steel to XYZ Inc. XYZ Inc will use the steel in manufacture of various machines and equipments. . The records of XYZ Inc show that 95% of steel used by it is purchased from AB Ltd. So here AB Ltd. and XYZ Inc. would become AEs as more than 90% of raw material used by XYZ Inc. is supplied by AB Ltd. Hence the transaction b/w them would be subject to TP provisions of Section 92.
(ii) In the above case AB Ltd instead of supplying itself to XYZ Inc, arrange the supply through another company CD Ltd. and the arrangement b/w AB ltd and CD Ltd. empower AB Ltd. to influence the prices to be charged to XYZ Inc. So, here also AB Ltd and XYZ Inc. will become associated enterprise.
7. The goods or articles manufactured or processed by one enterprise, 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.
It is to be noted that there is a small difference b/w point 6&7. Because point 6 speaks of supply of raw materials for use in manufactures while point 7 speaks that whether the articles or goods supplied by an enterprise is used in manufacture or not, the associate enterprise relation will crop up if there is any direct or indirect influence on the prices. Further, as contrary to 6 no % limit has been prescribed.
Therefore, even a single piece is sold by an enterprise to the other and other enterprise can influence the price then AE relation will come into the picture.
8. Where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual.
9. Where one enterprise is controlled by a Hindu undivided family, the other enterprise is controlled by a member of such Hindu undivided family or by a relative of a member of such Hindu undivided family or jointly by such member and his relative. In such a case HUF and that other enterprise will become AEs.
10. Where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than 10 % interest in such firm, association of persons or body of individuals. In such a case that Firm/AOP/BOI and other enterprise (holding 10% interest in Firm/AOP/BOI) becomes AEs.
11. More than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, is appointed by the other enterprise. For Example: If more than 50% directors of A and B Ltd. are same then A& B Ltd. will become AEs.
12. More than half of the directors or members of the governing board, or one or more of the executive directors or members of the governing board, of each of the two enterprises are appointed by the same person or persons.
For Instance : Mr. Raghav is an executive director of A, B and C Ltd. then also A, B and C will become AEs [Executive director means a director who regularly manage the business of the company].
Thus for the purpose of 11 & 12, Thus, even if ‘one’ Executive Director of a company is appointed by the other, the two shall be deemed to be associated enterprise.
Some Interesting Facts about TP Provisions:
1. India has been very late in introducing TP provisions as compared to other countries like US , UK etc.
The TP provisions were introduced by the then Honorable Finance Minister Mr. Yashwant Sinha in Finance Budget , 2001.
2. People call these TP provisions as world class tax provisions but it is equally true that the same has been poorly managed by I.T Department. The reason may be absence of proper training to AO/TPO (Transfer pricing Officer).
3. The TP Provisions are not only one of the most disputed but also one of the most complicated to be complied with by especially by asssessees.
4. And Last but not least if I am not wrong(as per discussion with my friends who have prepared Direct taxes)that whether it is CA or CMA(cost) Final students they are very scared of these provisions and almost leave the same.
With this I am finishing my Article and discuss the remaining aspects in the next article soon.
Any sort of queries, comments and suggestions are heartily welcomed.
Thanks for reading.
Saurabh Maheshwari
CRO0310510, Ahmedabad
Email: saurabhchokhra92@gmail.com
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