Transfer Pricing –International Transaction and Methods of Arm’s Length Price
Introduction: In current scenario it is possible that entity is operating not only in multiple state but also in multiple country; for said purpose it is important to understand whether entity is required to comply any additional law; how income tax will be levied if one of the branches of entitywhich is operating in tax free zone makes transfer of goods or service to another branch who is operating in taxable zone or vice-versa. In this article we will cover all compliance and related interpretation of transfer pricing.
One of the other conditions in chart for applicability of transfer pricing was, transaction must be International transaction and it has been defined that International transaction means a
(i) transaction between two or more associated enterprises, either or both of whom are non-residents; and
(ii) transaction in the nature of:
(a) sale/ purchase/ lease of tangible property; or (b)sale/ purchase/ lease of intangible property; or
(c) provision of services; or (d)lending/ borrowing money; or (e)any other transaction having a bearing on profits, income, losses or assets of such enterprises.
To cover more transactions here also provision has been inserted for treating transaction as deemed to be international transaction.
Deemed International Transaction: Where, in respect of a transaction entered into by an enterprise with a person other than an associated enterprise;
(i) There exists a prior agreement in relation to the relevant transaction between the other person and the associated enterprise or,
(ii) where the terms of the relevant transaction are determined in substance between such other person and the associated enterprise; and
(iii)either the enterprise or the associated enterprise or both of them are non-residents,
then such transaction entered into between the enterprise and the other person shall be deemed to be an international transaction entered into between two associated enterprises, whether or not such other person is a non-resident.
Illustration: Mr. R wants to supply raw material to its associate enterprise situated in Canada. He decided to supply such material directly but due to applicability of transfer pricing provision Mr. R decided to route the transaction he entered in to agreement with one the dealer, dealer is resident and ordinary resident in India. Mr. R has also made him agreed that he will supply such material only to his associate enterprise in Canada at specified price with specified terms and conditions. Whether for transaction entered by Mr. R and dealer transfer pricing provisions are applicable?
It shall be noted that were transaction is been entered between two parties with intention of providing benefit to associate enterprise; i.e., by fulfilling above three transaction than the said transaction will be treated as International Transaction. In the given case Mr. R is supplying material to dealer with the intention that dealer will supply such material to associate enterprise at specified price with specified conditions, therefore transaction entered between Mr. R and dealer will deemed to be treated as international transaction.
So far, we have understood what do we mean by Associate Enterprise and what do the term International Transaction means, one the condition specified in chart was that, the transaction entered must be entered at arm’s length price. To understand this, we need to look at the definition given for it and methods for calculating it.
Arm’s Length price means price which is applied or proposed to be applied in a transaction between persons other than associated enterprises in uncontrolled conditions. It simply means, price that can quoted to non-associate entity in uncontrolled transaction.
There are several methods which has been prescribed for calculation of Arm’s Length Price
It shall be clarified that from the above five methods most appropriate method is to be used for determining arm’s length price.
Comparable uncontrolled price method: Under this method, if open market price of product or service which has been supplied to associate enterprise is available, (i.e., entity has also provided such service or supplied such goods to any other enterprise in an uncontrolled transaction and such entity been non-associate enterprise) than in such case the said price can be taken to determine Arm’s length price for International transaction undertaken with associate enterprise.
Illustration: D & Co. has associate enterprise in Australia, he has supplied them with raw material at the rate of Rs. 15 per kg. where it has not incurred any transportation cost and has not been provided with replacement warranty. The same material has been supplied to local supplier at the rate of Rs. 20 per kg. in said transaction it has incurred transportation cost of Rs. 1 per kg. also, it has been provided with replacement warranty which will cost additional Rs. 2 per kg. cost to D & Co. What can be taken as arm’s length price if entity wants to determine such price according to Comparable uncontrolled price method?
In the given case as entity has also supplied such goods to any other enterprise in an uncontrolled transaction and such entity been non-associate enterprise, arm’s length price can be determined through Comparable uncontrolled price method.
The Arm’s length price as per Comparable uncontrolled price method will be Rs. 17 per kg. as Rs 20 being the price quoted to local supplier from which additional cost incurred is required to be removed i.e., cost which has not been incurred while transacting with associate enterprise, such cost amounts to Rs. 3 per kg.
What if in the given case additional cost incurred while supplying goods to local supplier comes to Rs. 6 per kg.
In said case if transfer pricing provisions are implemented than it will result in reduction of income recognise by the assessee as in said case price will fall to Rs. 14 per kg. and therefore, transfer pricing provisions will not be applied but instead of it, price at which transaction is entered will be deemed to be treated as arm’s length price.
The comparable price method is simplest and widely used method, in other next part we will cover explanation and illustrations relating to other methods and what is Advance Pricing Agreement.