Introduction
Transfer pricing refers to the pricing of goods, services, or intangible assets between related entities within a multinational enterprise group.
The objective of transfer pricing is to ensure that the prices charged for transactions between related entities are at arm's length (ALP), that is, at the same price that would have been charged between two unrelated parties.
In India, the transfer pricing regulations are governed by the Income Tax Act, 1961, and the transfer pricing rules are notified by the Central Board of Direct Taxes (CBDT).
In this article, we will discuss the different methods of transfer pricing in India.
Methods of Transfer Pricing in India
The transfer pricing regulations in India recognize five methods of transfer pricing, as follows:
1.Comparable Uncontrolled Price (CUP) Method
The CUP method is one of the most commonly used methods of transfer pricing in India. This method compares the price of a controlled transaction between related parties with the price of a similar transaction between unrelated parties. The price of the controlled transaction is considered to be at arm's length if it is the same as the price of the comparable uncontrolled transaction.
To use the CUP method, the following conditions must be met:
2. Resale Price Method (RPM)
The RPM compares the resale price of a product or service sold by a related party with the price at which the product or service is resold to an unrelated party. The resale price is reduced by a markup to arrive at the arm's length price.
To use the RPM, the following conditions must be met:
3. Cost Plus Method (CPM)
The CPM compares the cost of producing a product or service by a related party with the cost of producing a similar product or service by an unrelated party. A markup is added to the cost to arrive at the arm's length price.
To use the CPM, the following conditions must be met:
4. Profit Split Method (PSM)
The PSM is used when two or more related parties contribute to the creation of value in a transaction. The profits are split between the related parties in proportion to the contribution made by each party.
To use the PSM, the following conditions must be met:
5. Transactional Net Margin Method (TNMM)
The Transactional Net Margin Method (TNMM) is a transfer pricing method used to determine whether the transfer price between related parties is at an arm's length price. It is a profit-based method that compares the net profit margin earned by a company from a controlled transaction with the net profit margin earned by comparable companies in similar uncontrolled transactions.
The TNMM compares the net profit margin earned by the tested party (i.e., the related party that engages in the controlled transaction) with the net profit margin of comparable companies in similar uncontrolled transactions. The net profit margin is calculated as the ratio of the operating profit to the relevant base (such as sales or assets).
The TNMM requires the identification of comparable uncontrolled transactions between independent parties, which can be challenging, especially for complex or unique transactions. The method also requires a careful selection and adjustment of the financial data used for the comparability analysis.
The TNMM is one of the five transfer pricing methods recognized by the OECD Transfer Pricing Guidelines and is widely used by multinational companies for transfer pricing compliance purposes.
6. Any other method
The Indian Taxation Authorities also allow the assesses to use any other method that they deem is fit. Most prevalent method in this context is the Discounted Cash Flow (DCF method). However, the assessee needs to reject all the above methods first and then give a genuine reason for accepting this one.
These are the methods that are used in India and in case you have doubts on any of the above, you can contact me.
Thanks for reading through,
Gaurav
