SKP Tax Alert
23 October 2015 | Volume 8 Issue 20
India moving towards global practices in transfer pricing

1. Use of multiple year data and range concept 
With the intention of aligning transfer pricing regulations in India with international practices and reducing litigations on some repetitive issues considerably, India’s Finance Minister, Arun Jaitley, in his Budget speech of July 2014, had announced the introduction of the ‘range concept’ for determining the arm's length price (ALP) and allowing the use of multiple year data for comparability analysis.

Subsequently, in May 2015, the Central Board of Direct Taxes (CBDT) released draft rules of the proposed application of range concept and use of multiple year data for computation of ALP, for public comments.

The CBDT issued the much awaited Notification on the above aspects on 19 October 2015.
The new mechanism will be applicable for the computation of ALP of international transactions and specified domestic transactions undertaken on or after 1 April 2014.
The key facets of the notified mechanism are as follows:

A. Use of multiple year and weighted average data

Eligible methods for application
Multiple year data would be used in cases where the method used for determining ALP is either the Transactional Net Margin Method (TNMM), Resale Price Method (RPM) or Cost Plus Method (CPM).

Current year is still of importance 
The draft rules proposed that if in two out of three years (current year and the preceding two consecutive years), a comparable company satisfies the comparability criteria, then weighted average data for those two years will be considered for transfer pricing analysis.
However, with a major deviation in the above approach, the notification provides that if a company is not considered to be a comparable for the current year (FY 2014-15, as easy reference), then it will not be considered as a comparable company, without looking at whether it satisfied comparability criteria for the past two years or not. If data for the current year is not available for a company, data pertaining to the immediately preceding year can be considered to determine whether it is comparable or not.  If yes, data for the third preceding year will be evaluated. Furthermore, weighted average financial details of the company for the aforesaid years would be considered in the data set.
The notified rules also provide that if during the assessment proceedings, data for the current year becomes available for that company and it is considered to be non-comparable for the current year, then that company will be removed from the comparison set, irrespective of the fact that it satisfies the comparability for the past two years. Furthermore, new comparables can be added during the assessment stage based on the comparability of current year data, even if that data was not available during the transfer pricing analysis carried out by the taxpayer. In a way, the current year still remains of paramount importance and use of past-year data is primarily for the calculation of weighted average margins of the company and not as a factor for selecting the company as a comparable.

B. Use of range mechanism 

Eligible methods for application  
The “range” concept shall be used in cases where the method used for determination of ALP is Comparable Uncontrolled Price method (CUP), TNMM, RPM or CPM.

Number of comparables to apply range mechanism 
In the draft rules, the CBDT proposed that the range concept would apply only where nine or more companies are selected as comparables, and where inadequate comparable companies exist, the arithmetic mean concept would continue to apply. However, the CBDT has relaxed this norm by reducing the minimum number of comparable companies from nine to six or more companies. This is a welcome change proposed as there are industries in India such as the manufacturing of a niche product, provision of specialised services, etc. where it would be difficult for the taxpayer to identify a large comparable set.

Range specification 
The data points lying within the 35th to 65th percentile of the data set series would constitute the arm’s length range. The CBDT has broadened the allowed range from the 40th to 60th percentile under the draft rules.

In case transfer price is out of arm’s length range                   
If the price at which the international transaction or the specified domestic transaction has been undertaken is outside the arm’s length range, then the arm’s length price shall be taken to be the median of such data set.

C. Use of arithmetic mean 
As per the notified rules, when the number of comparables is lesser than six, then instead of the range, the arithmetical mean of the values included in the data set shall be considered to arrive at the ALP along with allowable deviation not exceeding 3% (as may be notified by the CBDT) from the transfer price. 
SKP's comments
Specifying the use of multiple year data and range mechanism are welcome steps by the Indian government at a conceptual level. This is in line with the intention of the government to streamline transfer pricing matters with global practices. However, the practical application of the rules notified by the CBDT, especially the possibility of  addition or deletion of comparables based on data available after the due date of transfer pricing compliances could continue to pose challenges and result in uncertainty for taxpayers. 
2. Internal guidelines for Assessing Officers/Transfer Pricing Officers to conduct transfer pricing assessments 
The CBDT has recently published revised internal guidelines for tax officers with respect to assessing transfer pricing matters. The revised guidelines will replace the initial guidelines issued by the CBDT in 2003, soon after the introduction of transfer pricing regulations effective 1 April 2002, and further clarifications issued from time to time.  
According to the revised guidelines the selection of transfer pricing assessment cases shall be based on risk parameters. It is noteworthy that in the earlier years, volume-based criteria were used, such that if the international transactions with associated enterprises exceed a particular monetary limit (INR 50 million and then practically increased to INR 150 million), the transfer pricing matters would be mandatorily referred to the specialised transfer pricing officer for detailed scrutiny.
Furthermore, the CBDT directed that each transfer pricing officer shall not be assigned more than 50 cases to scrutinise during the audit cycle.
SKP's comments
  • This move is in line with the recommendations of the Tax Administration Reform Commission (TARC) made in May 2014. The TARC had recommended the need for broad-based selection criterion for risk assessment. The earlier mechanism of selecting cases based on threshold limits was resulting in overburdening the tax authorities with a significant amount of cases, irrespective of the level of transfer pricing risk in some of those cases. 
  • With the revised guidelines for selection of cases for transfer pricing audit based on risk parameters, India is evolving towards global practices in tax administration. The updated guidance will result in more targeted and effective use of limited tax administration resources. One can also expect the audit proceedings to be more detailed and intensive, especially given that senior officers are expected to handle a limited number of complex cases.
  • While the updated guidance does not identify the risk parameters that would be considered, taxpayers may need to keep in mind the typical factors that may suggest a transfer pricing risk in the Indian context, such as payments for intra-group services and the use of intangibles, significant transactions with related parties in low tax jurisdictions, business restructuring, loss-making operations, significant marketing spend, etc.

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