Analyzing Indian Transfer Pricing Regulations: a Case Study

world(prenominal) investigate diary of Finance and economics ISSN 1450-2887 geld 40 (2010) Eurojournals run, Inc. 2010 http//www. eurojournals. com/finance. htm Analyzing Indian depute brand Regulations A Case account Monica Singhania Associate Professor, power of Management Studies (FMS), University of Delhi, India E-mail emailprotected du Abstract The Indian expatriation terms regulations commence been enacted with a view to offer up a statutory poser which female genitalia lead to computing of reason competent, plumb(a) and equitable win and evaluate in India so that the clams indictable to valuate in India do non get diverted elsewhere by altering the scathes charged and salaried in intra-group motions leading to erosion of Indian c t bulge out ensemble in revenue. Any income arising from an transnational action sh each(prenominal) be computed having touch on to the forts space terms (ALP).The ALP sh either be inflexible by any of the bring d knowledged mode actings, world the most portion regularity. The present antecedent illust evaluate the applicatory aspects of the law regarding head round as it exists presently in India with the dish discover of a slick study. The germane(predicate) rules envisage role of ALP by applying margins of each similar to(predicate) troupe to the allot base of the enterprise. The regulations advertize tolerate that, where more than than mavin damage is designated by the most inhibit order, the ALP shall be interpreted to be the arithmetic mingy of much(prenominal)(prenominal) sets.An alternative practicable(a) approach to arrive at much(prenominal) ALP is to compute the arithmetic close of margins of similar companies and apply the same to the susp bar base of the tried companionship to determine the ALP. The synopsis shows that the repute GP/Sales of alike(p) companies is 33. 71% while that of the PQR India (i. e. , the tested politic al troupe) is 44. 20% during the division finish March 31, 2009 indicating that the expenditures of out-of-door exertion of PQR India align to the girds continuance stock(a) overconfident infra the Indian regulations.Further, downstairs fellowship B, be recharged by PQR Group to PQR India ar accommodated. any these cost represent actual amounts paid by PQR Group to freelancer thirdly parties and ar recovered from PQR India, on a cost-to-cost basis. Applying the same with(predicate) lawless price method acting, these recharges con anatomy to the encircles aloofness standard positivistic beneath the Indian regulations. However, in that respect ar more or less practical problems arising out of the coatings of steer determine egulations, which indispensableness to be intercommunicate by the pecker administrators as premature as possible. These issues include absence of gather set agreements (APA) mechanism in India, reading limitations, extremely wide rendering of associated enterprises in India, stringent penalties, difficulties encountered while conducting stinting synopsis/benchmarking and many an(prenominal) more. Keywords change over price, value laws, foreign minutes, progresss aloofness price 1. IntroductionThe Indian graft set regulations kick in been enacted with a view to provide a regulatory manakin which is clear of computing reasonable, fair and equitable clear and tax income income income in India so that the moolah chargeable to tax in India do non get diverted elsewhere by altering the prices charged and 204 pla light upary look into diary of Finance and political economy field 40 (2010) paid in intra-group proceeding leading to erosion of Indian tax revenue.Any income arising from an supranational deed shall be computed having regard to the arms length price (ALP). The regulations on wobble price in India were intelligibly inescapable and immense overdue. The regulat ions in their present run ar a product of the findings of the quick-witted Group set up by the Government of India in n one(a)ember 1999 to study globular murder set practices and examine the affect for such(prenominal) legislation in India. The Indian agitate determine regulations applicable with do from April 1, 2001 be largely based on the OECD guidelines.By manipulating a few tidings entries in the bank notes books, transnational corporations ar able to raptus huge profits with a lot no actual change in the origin carry out. For instance, X Ltd. manufactures ipods for $ calciferol in China, but its US based hyponym buys it for $ 599, and then sells it for $ 600. By doing this, the friendships taxable profit in the US is solidly decreased. At a 30 percent tax rate, the participations tax liability in the US is solo 30 cents (i. e. , 30% of $ 1) as comp atomic number 18d to $30 (i. . , 30% of $ 100 which should wealthy person been the pillowcase). The large scale tax escape practices employ by transnational corporations came into asseverate-supported notice when the drug giant MNE, GlaxoSmithKline, hold to contribute the US brass $3. 4 billion to settle a long-running impartation determine dispute over its tax dealings mingled with the UK p arnt bon ton and its American subsidiary. This was the largest settlement of a tax dispute in the US. outside corporations pull ahead several benefits from transfer pricing.Since each bea has different tax rates, they can step-up their profits with the help of transfer pricing. By lowering prices in countries where tax rates are juicy and raising them in countries with a lower tax rate, such organizations can reduce their overall tax burden, thitherby boosting their overall profits. Indeed one often finds that corporations located in high tax countries in fact pay very superficial corporate taxes. delegate pricing features super on the schedule of Indian tax authorities .The transfer pricing discernments relating to the first dickens divisions since the foundation garment of the Transfer price regulations have seen additive tax collections arising from transfer pricing adjustments in excess of US$ 800 million. The first wheel of transfer pricing audits in India of virtually 800 taxpayers resulted in 25% facing adjustments. The additive value of those adjustments aggregated US$ cardinal hundred million. In the following course, according to estimates, tax demands in excess of US$ 500 million were imposed as a result of upward adjustments.In this connection, the Indian tax authorities had initially set a very conservative scepter for audit INR 50 million (around USD 1 million) for the first four stratums. This threshold has been compound thrice with loading from the pecuniary year 2005-06. The Indian tax authorities have as well set up a specialized group for confinement transfer pricing audits and have begun using secluded simil ar selective tuition for audit designings. examination of overall profitableness as tumesce as featal level pricing during the of course of transfer pricing audits is as well more than done. 2. Theoretical FrameworkThe role of multinational enterprises (MNEs) in world clientele has increase dramatically over the last 20 years. This reflects the increased integration of national economies and proficient progress. Intercompany proceeding across borders are ripening rapidly and are becoming much more complex. Compliance with the different requirements of quaternary overlapping tax jurisdictions is a complex and cadence-consuming task. At the same cartridge holder, tax authorities from each jurisdiction impose stricter penalties, new written documentation requirements, increased study exchange and increased audit or inspection bodily function.With a view to provide a elaborated statutory framework which can lead to computing of reasonable, fair and equitable profits and tax in India, in the case of such multinational enterprises, the Finance Act, 2001 substituted the then existing fraction 92 with contributions 92A to 92F in the Income-tax Act, 1961, relating to computation of income from an world-wide exertion having regard to the arms length price, merchandiseee of associated enterprise, meaning of selective data and documents by persons entry into external legal proceeding and definitions of certain expressions occurring in the said section (see cecal appendage I for summary of Indian Transfer determine Regulations). The essential external interrogation diary of Finance and political economy shorten 40 (2010) 205 documentation which needs to be defend for complying with these edible as also the penalties for slackness in compliance are addicted in cecal appendage I. As per the Indian Regulations, the like info to be utilizationd in analyzing the comparability of an runaway relations with an world(prenominal) proce eding should be the data relating to the financial year in which the internationalistic transaction has been entered into.However, data relating to a geological flow rate not institution more than twain years prior to such financial year whitethorn also be considered if such data reveals facts, which could have an twist on the determination of the transfer price in congener to the legal proceeding creation compared. The artillerys length principle (ALP) aims at find whether the parties to a transaction are in capable and are on an equal footing. The OECD framework as per Article 9 of the OECD exercise Tax Convention ensures that the transfer prices among companies of multinational enterprises are established on a grocery value basis, countermanding profits beingness systematically deviated to lowest tax countries. It provides the legal framework for governances to have their fair share of taxes, and for enterprises to avoid double tax revenue on their profits. The primary onus of proving the arms length character of a transaction lies with the taxpayer.If during assessment proceedings, the tax authorities, on the basis of material or information or documents in their possession, are of the effect that the arms length price was not employ, or adequate and coif documents/ information/ data were not kept up(p)/ produced, the total income whitethorn be recomputed beca ingestion subsequently large(p) the taxpayer an opportunity of being heard. 3. Literature Review There are numerous studies relating to transfer pricing in minutes taking place in developed countries1. This is primarily due to, the detailed statistical information relating to intra-firm trade make visible(prenominal) in most of the developed countries, stringent laws requiring greater transparency, and so forth In similitude, the availability of intra-firm trade data in develop countries is highly inadequate2. In addition, there is no systematic attempt in developi ng countries, to collect and analyze pertinent data in one information repository database leading to multiple uses of such organized information.This is the case even though such information may in many cases exist with different government organizations, legal and administrative authorities and on a lower floorcover championship organizations occupied in creation of such databases for commercial message reasons. This disjointed exploit to data collection leads to multiple problems in down the stairstaking quality research studies. It also highlights complete lack of coordination between policies, procedures and their practical application. Also the lack of any government sponsored studies, like those in Colombo, Greece and Sri Lanka, may be the reason why not many transfer pricing studies are low ownn in such countries.In fall in Kingdom, the transfer pricing rules were formulated as archaean as in 1915 (Payan and Wilkie (19933). However, there was little pressure on suc h rules until mid(prenominal) 1960s when the revival of international trade and investment following World contend II began. As far as get together States is concerned, even before the non-traditional methods of transfer pricing were added to section 482, Schindler and Henderson (1985)4 pointed out, Inter-corporate transfer pricing chthonic the scope of code section 482 is one of the most complex areas of international taxation. The non-traditional methods further added to complexity. The OECDs Transfer set Guidelines (1995)5, based on guidelines first issued in 1979, 1. Lall S. 1973), Transfer set by Multinational Manufacturing Firms, Oxford publicise of economic science & Statistics, Vol. 35(3), pp. 173-95. 2 Bhagwati J. N. (1974), On the under(a) Invoicing of conditional relations, Fiscal Polices of the Faking of Foreign swap Declarations of the residuum of Payments, in Bhagwati (ed. ), Illegal transactions in transnational raft, North Holland Publishing Co. 3 Paga n, Jill C. and J. Scott Wilkie, (1993) Transfer set scheme in a Global delivery, Amsterdam IBFD Publications. 4 Schindler, Geunter and David Henderson (1985), Intercorporate Transfer determine 1985 spate of Section 482 Audits, Tax Notes, Vol. 29, pp. 1171-77. 5 OECD (1995, as updated). Transfer set Guidelines (Paris OECD). 206 international query Journal of Finance and economics loss 40 (2010) largely stoop international practice with regard to transfer pricing. The Indian transfer pricing regulations, introduced in 2001, are to an goal modeled on the OECD guidelines. Li (2003)6 describes the methods of transfer pricing by way of an international comparison involving sextet countries namely, China, Hong Kong, Japan, Canada, United States and Singapore. Ring (2000)7 explains the methodology of undertaking hike Pricing mechanisms whereby both the tax payers as well as tax administrators agree in advance on the methodology to be used to determine transfer prices in order to avoid unnecessary litigation.Lall (1979)8 highlights the need of a laid back attitude towards transfer pricing in developing countries so as to remain an attractive investment speech in the form of foreign grade investment. R. Murray 19819 studied the mechanism by which international tax avoidance is wind. These mechanisms include universal manipulations as well as ad hoc manipulations to items in the profit and loss account and balance sheet. Baistrocchi (2004)10 explains the administrative inexperience of developing countries in implementing transfer pricing rules. Mo (2003)11 gives instances of manipulation of transfer prices and steps taken to combat it in China, India, Brazil and Mexico.UN Survey (1999)12 reveals that in developing countries about 61 per cent respondents felt that the domestic multinational enterprises were engaged in income shifting and 84 per cent believed that foreign enterprises were doing so. In addition, 70 per cent and 87 per cent, various(pren ominal)ly, of these countries thought the problem to be noteworthy. Newlon (2000)13 notes the tendency of MNCs to over cover up income in jurisdictions that impose heavy penalties. Mitchell (2004)14 treats astray distributed taxation as a form of tax harmonization. According to his view, tax harmonization is categorically undesirable because taxpayers are uneffective to benefit from remedy tax form _or_ system of government in new(prenominal) nations and governments are insulated from market discipline. 4. PQR India Case Study spirit and Analysis Global Tax Consultants Pvt. Ltd. ave been engaged by PQR India to review the transfer pricing arrangements for international transactions with its associated enterprises during the year ended March 31, 2009 on the terms set out in the engagement letter. The heading of this paper is to establish whether the international transactions between PQR India and its associated enterprises adhere to the arms length principle, embodied in the Indian Transfer Pricing Regulations of the Indian Income-Tax Act, 1961(see Appendix I) and in addition look to the Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations promulgated by the Organization for Economic Cooperation and developing for further guidance in applying the arms length standard. 6Li, Jinyan (2003), International tax income in the period of electronic Commerce A comparative degree Study (Toronto Canadian tax Foundation). 7 Ring, Diane M. (2000). On the Frontier of procedural Innovation kick upstairs Pricing covenants and the Struggle to exclusivelyocate Income for crossover Border Taxation, Michigan Journal of International Law, Vol. 21 (winter) pp. 143-234. 8 Lall, Sanjaya. (1979). Transfer Pricing and exploitation Countries Some Problems of Investigation, World developing, Vol. 7 figure 1 (January), pp. 59-71. 9 Murray R. editor program (1981), Multinationals Beyond the Market Intra-firm Trade and the find out of Tran sfer Pricing, capital of the United Kingdom reaper Press Brighton, pp. 119-32. 10 Baistrocchi, Eduardo. (2004). The Arms duration pattern in the twenty-first Century A Proposal for both Developed and developing Countries. Tax Notes International, Vol. 36 No. 3 (October 18), pp. 241-255. 11 Mo, Phyllis Lai Lan. (2003) Tax escape and Anti-avoidance Measures in Major Developing Economies (Westport, Conn. Praeger), pp. 207. 12 United Nations Conference on Trade and growing (1999), Transfer Pricing. (New York). 13 Newlon, T. Scott. (2000). Transfer Pricing and Income Shifting in Integrating Economies, in Sijbren Cnossen, editor, Taxing Capital Income in the European Union Issues and Options for Reform (Oxford Oxford University Press), pp. 214-42. 14 Mitchell, Daniel J. (2004). The Economics of Tax Competition Harmonization vs.Liberalization, in 2004 Index of Economic Freedom, Marc Miles, et al. , editors, (Washington heritage Foundation), Chapter 2. International interrogation J ournal of Finance and Economics Issue 40 (2010) 4. 1. Company indite 207 PQR Group, the States deals in design, manufacture and merchandise of the state of the art photocopier machines. In addition, it also offers document management solutions, one-to-one marketing expertise and efficiency management operate for versatile organizations in the United States and internationally. PQR India is a wholly- have subsidiary of PQR Group, USA. PQR India commences business of import and resale of photocopier machines merchandise from PQR Group during the financial year 200809.The organic evolution of the arms length price in this psycho synopsis recognizes that PQR India is a distributer of photocopier machines in India and is subject to ordinary find profile associated with such class of businesses. PQR India, supplements on all the semiprecious intellectual property rights (knowhow, copyrights etcetera ) and different commercial or marketing associate intangibles (brand nam es, trademarks etc. ) avouched by PQR Group. base on the functional digest, PQR India has relatively little complicated vocation operations and as such bears relatively lesser share of risks and is accordingly selected as the tested party for the purpose of leaveing out the economic analysis as part of determination of transfer price on the basis of arms length principle. 4. 2.Industry Overview As per the Indian Regulations (see Appendix 1), every person who has entered into an international transaction shall keep and maintain interalia, the information and documents giving a broad description of the constancy in which the assessee operates. The Indian Regulations also prescribe that the comparability of an international transaction with an wild transaction shall be judged with reference to the conditions common in the markets in which the respective parties to the transactions operate. Hence, for the purposes of the transfer pricing analysis a comprehensive overview of th e perseverance is essential. Industry overview fundamentally consists of industry background, evolution of industry, characteristics of marketing, emerging industry trends, key drivers, key inhibitors and future sentry for the industry. 4. 3.Functional Analysis As per the Indian Regulations, every person who has entered into an international transaction shall keep and maintain inter alia, a description of the functions performed, risks assumed and assets active or to be employ by the assessee and by the associated enterprises involved in the international transaction. A functional analysis enables mapping of the economically relevant facts and characteristics of transactions between associated enterprises with regard to their functions, assets and risks. Hence a functional analysis facilitates characterization of the associated enterprises and assists in establishing a point in time of comparability with similar transactions in errant conditions. 4. 3. 1. Functions performed b y PQR Group PQR Group, USA deals in design, manufacture and marketing of the state of the art photocopier machines.In addition, it also offers document management solutions, one-to-one marketing expertise and efficiency management services for various organizations in the United States and internationally. In addition, it has a massive research and development center. 4. 3. 2. Functions performed by PQR India PQR India is engaged in the business of import and resale of photocopier machines imported from PQR Group. To understand the functions performed by PQR India, it is cardinal to have an overview of the transactions taking place, which are depicted below legal proceeding classified ad as kinsfolk A importation of finished goods by PQR India and thereafter in large quantities distribution by PQR India 208International Research Journal of Finance and Economics Issue 40 (2010) Transactions classified as kin B Cos recharges are PQR Group from PQR India Functions performed by PQR India under course of instruction A PQR India, as a wholesale distributor performs a variety of functions including gross revenue, marketing, after sales support, etc. Category B Cost recharges Under Category B transactions, cost-to-cost recharges on account of certain expenses incurred by PQR Group on behalf of PQR India are included. Assets employed Any business requires assets (tangible or intangible) without which it cannot carry out its activities. Intangibles play a substantive role in the functioning of a business and are accordingly more important.An understanding of the assets employed and receiveed by PQR India provides an insight into the resources deployed by PQR India and their contribution to the business processes/economic activities of PQR India. Tangibles owned by PQR India It includes galvanizing installations, furniture and fixture, office equipments and computer hardware. Intangibles PQR India being a relatively new company does not own any epoch-maki ng intangibles and does not undertake any significant research and development on its own account that leads to the development of non-routine intangibles. PQR India uses the trademarks, process, know-how, technical data, software, operate(a)/quality standards etc. developed/owned by PQR Group. All companies of the group leverage from these intangibles for continued growth in revenues and profits. . 4. Overview of Inter-Company Transactions PQR India engages in the following inter-company transactions with its associated enterprises Import of finished goods, import of spare move and consumables and cost recharges. The above transactions have been grouped together in both classes namely Category A and Category B which have been separately study from a transfer pricing perspective. 4. 5. excerpt of Tested Party The tested party is the participant in the controlled transaction whose profit attributable to the controlled transaction can be verified using the most original data and requiring the fewest and most authoritative adjustments. In ost cases, the tested party is the least(prenominal) complex of the controlled taxpayers, that is, the taxpayer with the least amount of risk associated with its operations and without worthful intangibles or eccentric assets that may distinguish it from capability uncontrolled equal companies. Based on the above, PQR India is clearly the tested party for purposes of this analysis. It does not own an interest in any of the valuable know-how, patents, brand names and trademarks owned by the PQR Group. PQR Group, on the other hand, may own valuable intellectual property rights including commercial and marketing intangibles. Therefore, the comparability adjustments that would be take if independent organizations were to be selected as tested parties, would be both substantial and un true(p). 4. 6.The well-nigh seize mode The most impound method is that method which, under the facts and sight of the transaction und er review, provides the most tried measure of an arms length result. In determining the dependability of a method, the cardinal most important factors that need to be taken into setting are (i) the detail of comparability between the controlled and uncontrolled transactions and (ii) the coverage and reliability of the forthcoming data. Because the natural selection of the most grant method involves a test of relative merit, a method that may not be perfect is not rejected unless most other method can be shown to be more reliable or clearly indicating to provide a better estimate of an arms length result.International Research Journal of Finance and Economics Issue 40 (2010) 209 survival of the fittest of the around Appropriate Method Comparable loose outlay Method ( cupful) In practice, there are two types of comparable uncontrolled transactions. The first, know as an inseparable comparable, is a transaction between one of the parties to the controlled transaction and an uncor think third party. The second, known as an external comparable, is a transaction between two un colligate third parties. There are no internal cupfuls in stock(predicate) for all products imported by PQR India to benchmark its transactions under Category A. PQR India is engaged in import of finished goods and spares consumables for resale in India under Category A (all related to photocopier machines). However, PQR India does not purchase same/similar products from entities other than associated enterprises. Further, during the year, until the commencement of commercial operations by PQR India, overseas group entities sold some similar products to a third party in India. The third party was a Tier-II distributor of PQR Group whereas PQR India acts as a Tier-I distributor. In this way due to unavailability of adequate data to make equal adjustments to account for the aforesaid differences, it was considered in permit to use the third party as an internal comparable in the present case.Therefore, CUP method was not considered for the purpose of ascertaining an arms length price for the international transactions of PQR India under Category A. As for external comparables, it may be highlighted that the arms length price as far as uncontrolled enterprises are concerned, is substantially dependent upon factors such as volume, contractual terms, fixing differences, etc. It may not be possible to estimate with reasonable reliability and accuracy, the combined effect of such factors on per unit prices in case of external comparables. Further, abstract factors such as use of intangibles make the use of CUP method difficult for benchmarking purposes.In view of the above, there are no external comparables available, which may be considered sufficiently distinguish to example the use of the CUP method for Category A transactions of PQR India. However, in case of transactions in the character of cost recharges by PQR Group to PQR India, included under Ca tegory B, the third party cost reimbursed is a CUP for the reimbursement. Keeping in view the nature of transaction and the degree of comparability, CUP was considered as the most inhibit method for this class of transactions. Consequently other methods were not considered. Cost convinced(p) Method (CPM) PQR India is a distributor. It imports the finished products, spares and consumables from the Group companies (all related to photocopier machines) and resells them in the domestic market.In this way, in this case PQR India carries out the function of a pure reseller. Since RPM is most appropriate in cases involving the purchase and resale of tangible goods, this method was considered as the most appropriate method for filiation the arms length price of PQR India under Category A. The application of CPM is commonly appropriate in two situations, the provision of services to a related party and the manufacture of tangible goods that are sold to a related party. PQR India on the o ther hand, operates as a distributor under Category A. Accordingly, CPM was not considered as the most appropriate method for deriving the arms length price for Category A transactions of PQR India. proceeds Split Method (PSM) PSM is typically applied where each party to the transaction under evaluation has significant intangible assets and/or the operations of the parties to the transaction are highly integrated and cannot be evaluated on a separate basis. Also, in general, the PSM relies primarily on the internal data and assumptions pertaining to each party to the controlled transaction instead of relying on comparable uncontrolled transactions as market benchmarks, thus making the use of the PSM ordinarily less reliable than the other methods. PQR India does not own any non-routine intangibles and further the operations of PQR India can be independently evaluated.Therefore, PSM was not considered as the most appropriate method for deriving the arms length price of PQR Indias int ernational transactions under Category A. Transactional Net allowance Method (TNMM) Net profits may however, be influenced by some factors that each do not have an effect or have less substantial or direct effect on gross margins. Such factors in the case of PQR India include several 210 International Research Journal of Finance and Economics Issue 40 (2010) extraneous factors which have been in the later write up. The losses make by the Company at the operational level, in the current financial year, is a result of these factors.The reasons for loss at operating level under Category A were a) First year of operations and b) encyclopedism of mailing business. These excess expenses incurred by the company during the year adversely impacted its profitability at the operating level. However, these expenses were necessary business expenses which had to be incurred in the first year of operations. Given the aforementioned state of affairs, in order to ensure fair comparison of the operating profitability of the company with comparable companies in the industry, one would need to make suitable economic adjustments to appropriately take into account the impact of the aforesaid achievement of new business by the company.Conclusions of the Most Appropriate Method After reviewing all of the transfer pricing methods, we recommend precondition the fact and circumstances, the RPM provides the most reliable measure of an arms length result for Category A transactions of PQR India. CUP has been selected as the most appropriate method for the international transactions undertaken by PQR India under Category B. 4. 7. Search for Uncontrolled Comparables infobases The two most popular and widely recognized corporate databases (i. e. , Powers & Capitaline) to identify potential uncontrolled comparables for PQR India transactions under Category A. The primarily focus was on heroism and additional companies were considered Capitaline summing up, i. e. , companies for whi ch data was not available in the graphics database.Selection of time period As per the Indian Regulations, the data to be used in analyzing 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. However, data relating to a period not being more than two years prior to such financial year may also be considered if such data reveals facts which could have an influence on the determination of the transfer price in relation to the transactions being compared. The present analysis involves data analysis of companies from both databases only if they had relevant financial data for at least two out of the three financial years ending during the period April 1, 2006 and March 31, 2009.This has been done in order to croak, to the maximum extent possible, any divergency in results caused by short-term differences in business cycles, product life cycles o r business strategies of individual companies. Search impact Our comparable search strategy set Indian independent distributors whose functions, assets and risks were broadly comparable to those of PQR India under Category A. International Research Journal of Finance and Economics Issue 40 (2010) Search from heroism Criteria for selection Total number of companies whose information is available on Prowess as on March 31, 2009 Number of companies having positivist sales and ratio of sales trading to sales of more than 40% over the relevant time period under consideration were selected so as to capture all possible traders available in Prowess Number of companies herein sales trading as a percentage of sales was higher(prenominal) than 75% were short listed, in order to eliminate companies that were primarily not engaged in trading activity Selection of only those companies with a positive net worth Qualitative Analysis, to eliminate companies operating in industries other than e lectronics, galvanising machinery and miscellaneous distributors and to eliminate controlled/controlling companies 211 No. of Companies achieving the bar 12,994 1,050 565 496 5 Search from Capitaline Plus Criteria for selection Total number of companies whose information is available on Capitaline Plus as on March 31, 2009 Identified additional companies with positive sales over the time period under consideration were selected i. e. companies for which information was primarily not available in Prowess database Selected companies classified in the Electronics, heterogeneous Manufactured Articles, Electrical machinery other than electronics and Non-electrical machinery industries Selection of only those companies with a positive net worth Qualitative Analysis, to eliminate companies not engaged in trading activities in the same/ similar industry separate and to eliminate controlled/controlling companies. No. of companies achieving the criterion 8,160 1,650 228 86 2 Finally, at t he end of the above described search process from both the databases, we were left with 7 comparable companies for benchmarking Category A transactions of PQR India. 4. 8. select of a earn Level index finger (PLI) The application of RPM requires the selection of an appropriate Profit Level Indicator (PLI). The PLI measures the consanguinity between (i) profits and (ii) either cost incurred, revenues earned, or assets employed. A variety of PLIs can be used. Factors relevant to the selection of the appropriate profit level indicator include the reliability of the available data and the extent to which the profit level indictor takes into account be that would be considered by independent parties. plebeian Profit strand is the ratio of crude(a) Profit to Sales (GP/Sales) and was selected to reliably measure the income of PQR India that it would have earned had it dealt with uncontrolled parties at arms length under Category A. 4. 9.Determination of Arms Length Results The India n Regulations require that the Arms Length harm (ALP) in relation to an international transaction shall be determined by any of the electropositive methods (CUP, RPM, CPM, TNMM and PSM), being the most appropriate method. All methods other than CUP are methods that enable determination of ALP on the basis of respective margins earned by comparable uncontrolled companies. The relevant rules envisage determination of ALP by applying margins of each comparable company to the appropriate base of the enterprise. The regulations further provide that, where more than one price is determined by the most 212 International Research Journal of Finance and Economics Issue 40 (2010) ppropriate method, the ALP shall be taken to be the arithmetical mean of such prices. An alternative practical approach to arrive at such ALP could be to compute the arithmetic mean of margins of comparable companies and apply the same to the appropriate base of PQR India to determine the ALP. Arms Length Results S. No. 1 2 3 4. 5. 6. 7. 8. 9. 10. 11. Name of the Company X1 India Ltd. X2 India Ltd. X3 India Ltd. X4 India Ltd. X5 India Ltd. X6 India Ltd. X7 India Ltd. rigorous Median Upper Quartile Lower Quartile Data line of descent Prowess Prowess Prowess Prowess Prowess Capitaline Plus Capitaline Plus GP/Sales (%) 30. 00 40. 00 35. 00 28. 00 22. 00 45. 0 36. 00 33. 71 35 38. 00 29. 00 The above analysis shows that the mean GP/Sales of comparable companies under Category A is 33. 71%. Hence, prices of international transactions of PQR India under Category A, that achieve GP/Sales of 33. 71% or more would conform to the arms length standard prescribed under the Indian regulations. The financial results of PQR India indicate that the company has GP/Sales of 44. 20% during the year ended March 31, 2009. For Category A transactions, GP/Sales of PQR India are higher than the mean GP/Sales of comparable companies. Further, under Category B, be recharged by PQR Group to PQR India are included.A ll these costs represent actual amounts paid by PQR Group to independent third parties and are recovered from PQR India, on a cost-to-cost basis. Applying the CUP method, these recharges conform to the arms length standard prescribed under the Indian regulations. The above analysis provides evidence that both the pricing basis itself of international transactions of PQR India during the financial year 2008-09 and the outcome of the pricing i. e. , the profitability were in accordance with the Arms Length standard prescribed under the Indian Transfer Pricing Regulations. 5. Summary and Recommendations The regulations on transfer pricing in India were indeed inevitable and long overdue.The case study of PQR India clearly demonstrates the computation procedure required to be followed for scientifically determining the arms length price as per the provisions of transfer pricing in India. The analysis shows that the mean GP/Sales of comparable companies is 33. 71% while that of the PQR I ndia (i. e. , the tested party) is 44. 20% during the year ended March 31, 2009 indicating that the prices of international transaction of PQR India conform to the arms length standard prescribed under the Indian regulations. Further, under Category B, costs recharged by PQR Group to PQR India are included. All these costs represent actual amounts paid by PQR Group to independent third parties and are recovered from PQR India, on a cost-to-cost basis.Applying the comparable uncontrolled price method, these recharges conform to the arms length standard prescribed under the Indian regulations. However, there are some practical problems arising out of the applications of transfer pricing regulations, which need to be addressed by the tax administrators as early as possible. These issues include absence of advance pricing agreements (APA) mechanism in India, data limitations, extremely wide definition of associated enterprises in India, stringent penalties, difficulties encountered whil e conducting economic analysis/benchmarking and many more. International Research Journal of Finance and Economics Issue 40 (2010) 213 References 1 Baistrocchi, Eduardo. (2004). The Arms Length Standard in the 21st Century A Proposal for both Developed and Developing Countries. Tax Notes International, Vol. 36 No. 3 (October 18), pp. 241-255. Bhagwati J. N. (1974), On the Under Invoicing of Imports, Fiscal Polices of the Faking of Foreign Trade Declarations of the Balance of Payments, in Bhagwati (ed. ), Illegal Transactions in International Trade, North Holland Publishing Co. Lall S. (1973), Transfer Pricing by Multinational Manufacturing Firms, Oxford Bulletin of Economics & Statistics, Vol. 35(3) pp. 173-95. Lall, Sanjaya. (1979). Transfer Pricing and Developing Countries Some Problems of Investigation, World Development, Vol. Issue 1 (January), pp. 59-71. Li, Jinyan (2003), International Taxation in the Age of Electronic Commerce A Comparative Study, Toronto Canadian tax Found ation. Mo, Phyllis Lai Lan. (2003), Tax Avoidance and Anti-avoidance Measures in Major Developing Economies, Westport, Conn. Praeger, pp. 207. Mitchell, Daniel J. (2004), The Economics of Tax Competition Harmonization vs. Liberalization, in 2004 Index of Economic Freedom, Marc Miles, et al. , editors, Washington Heritage Foundation, Chapter 2. Murray R. Editor (1981), Multinationals Beyond the Market Intra-firm Trade and the Control of Transfer Pricing, London Harvester Press Brighton, pp. 119-32.Newlon, T. Scott. (2000), Transfer Pricing and Income Shifting in Integrating Economies, in Sijbren Cnossen, editor, Taxing Capital Income in the European Union Issues and Options for Reform (Oxford Oxford University Press), pp. 214-42. OECD (1995, as updated). Transfer Pricing Guidelines (Paris OECD). Pagan, Jill C. and J. Scott Wilkie (1993), Transfer Pricing dodging in a Global economic system, Amsterdam IBFD Publications. Ring, Diane M. (2000). On the Frontier of Procedural Innovatio n Advance Pricing Agreements and the pare to allocate Income for Cross Border Taxation, Michigan Journal of International Law, Vol. 21 (winter), pp. 143-234.Schindler, Geunter and David Henderson (1985), Inter corporate Transfer Pricing 1985 Survey of Section 482 Audits, Tax Notes, Vol. 29, pp. 1171-77. United Nations Conference on Trade and Development (1999). Transfer Pricing (New York). 2 3 4 5 6 7 8 9 10 11 12 13 14 214 International Research Journal of Finance and Economics Issue 40 (2010) Appendix I Indian Transfer Pricing Regulations Legal slip The Finance Act 2001 introduced with effect from assessment year 2002-2003, detailed Transfer Pricing regulations vide section 92 to 92F of the Income Tax Act, 1961. The primeval panel of Direct Taxes (CBDT) has come out with Transfer Pricing triumphs Rule 10A to Rule 10E.Applicability Transfer pricing provisions are applicable based on fulfillment of two conditions Firstly, there moldiness be an international transaction. Secon dly, such an international transaction must be between two or more associated enterprises, either or both of whom are non-residents. Pricing Method permitted Arms Length Price is to be determined by adopting any one of the following methods, being the most appropriate method Comparable Uncontrolled Price method, Resale Price Method, Cost Plus Method, Profit Split Method, Transaction Net Margin Method, or any other method prescribed by the Central Board of Direct Taxes (CBDT). Documentation/Return 13 different types of documents are required to be maintained.These include 1) Enterprise-wise documents-Description of the enterprise, relationship with other associated enterprises, nature of business carried out. 2) Transaction-specific documents-Information regarding each transaction, description of the functions performed, assets employed and risks assumed by each party to the transaction, Economic & Market Analysis etc. 3) Computation related documents-Describe in exposit the method considered, actual working assumptions, policies etc. , adjustment made to transfer price, any other relevant information, data, documents relied for determination of arms Length price etc. A draw from a Chartered Accountant in the prescribed form giving lucubrate of transactions is required to be submitted deep down a specific time limit.punishment Penalty for concealment of income or furnishing outside particulars thereof100% to 300% of the tax sought to be evaded. Penalty for failure to keep and maintain information and documents in respect of International transaction2% of the value of each international transaction Penalty for failure to furnish news report under section 92E- Rs. 1,00,000. OECD Guideline No reference to OECD guidelines under Indian Transfer Pricing regulations No provisions regarding Advance Pricing Agreements Advance Pricing Agreement under Indian law as of now Government web-link www. incometaxindia. gov. in Source OECD Transfer Pricing Country Profileh ttp//www. oecd. org/dataoecd/9/4/42236399. pdf