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Vispi T. Patel
October 2009
Glossary and Abbreviations
TP Transfer Pricing
Contents
DBackground of Recession
DDocumentation Requirements
DCase Study
Background of Recession
Recession!
DWhat is Recession??
D It is the economy shrinking for two consecutive quarters with a
decrease in the GDP
D It may be preceded by several quarters of slow down
D It is the situation when it is difficult to drive growth with reduced
savings, reduced domestic manufacturing capacity and reduced
consumption
5
Recession!
DThe shock of the current recession was sudden. All
thanks to abundance of cheap credit for many years
5 Country
becomes favoured 4 With feel good
destination for factor and increase
investment in demand, stock
markets rise overall
3 Increased
employment and
spending by
industry amounts 2 In response to rise
to further in demand, industry
consumption produces more,
which means
increase in
1 Consumers employment levels
feel confident in and more
the future of the consumption of
economy so resources
7 they spend
more
Downward Spiral – when
Recession! the economy has
suffered major setbacks
1 Consumers lose
confidence in the 2 In response to
future of the fall in demand,
economy so they industry lays off
spend less employees and
reduces
production
3 Now people have amounting to
less money to spend less consumption
and debts mounting of raw material
so they further
reduce spending 4 Stock markets
take a hit due to
poor earnings of
the industry
5 Country loses
creditworthiness hence
lower investments
8
A Look at the Global Financial Indicators
– Outcome of the Downward Spiral
9
Is Transfer Pricing flexible enough
to allow multinationals to adjust to
the changing winds
How should Multinationals cope
with the Transfer Pricing issues
faced by them during the
downturn
Transfer Pricing in
Recessionary Conditions
Transfer Pricing issues specific to Recession
recession
13
Transfer Pricing issues specific to Recession
14
Transfer Pricing issues specific to Recession
D Presents difficulties with profit-targeting for entities
on CPM/TNMM benchmarking policies
15
Transfer Pricing issues specific to Recession
DOperating Losses
DExcess/obsolete inventory
DCredit crunch
16
Issues specific to Recession – Captive units
DIndia, a global off-shoring centre, has been facing
tremendous pressure as the multinationals can not afford
to continue to remunerate Indian captive centers at the
same cost plus markup while the global system bleeds
Yes
Yes
20
Case Study
Case Study
D Utility Vehicles India Ltd (‘UV India’) is a well established
leading utility vehicle manufacturer in the Indian market
22
Case Study
D Due to the overall economic slowdown, the sales volumes
dropped and hence UV Korea has suffered huge losses which
could affect it’s very existence
23
Revival Plan – UV India’s Perspective
The revival plan envisioned should keep the TP Regulations
and the audit experience of the multinationals in mind. It
should involve…
Strategic plan
Identification of Determination of should dovetail into
constraints and various alternatives a ‘Benefit Test’
their effect on available under achievement from an
the profitability arm’s length scenario Arm’s Length
perspective
The resulting challenge for UV India is in trying to justify the new business
strategy. This is where the appropriate and contemporaneous Transfer Pricing
documentation comes into play which should clearly demonstrate how external
factors have affected the business – production levels, sales volume, etc.
24
Case Study
Accordingly, in the instant case, the Transfer Pricing Analysis
for the purpose of revival plan should involve:
25
Profitability Analysis
26
Profitability Analysis
D The comparable data on the public domain shows the following results:
Quarterly results show more realistic picture than the yearly results as the
yearly results include pre-recession period as well which is not comparable
This analysis also shows that it is possible for UV India to supply engines at a
lower markup. However, the same should also be corroborated by the future
benefit test
27
The Benefit Test
28
Future Projections of UV Korea Business
D In this regard, future profitability of the UV Korea under various percentage
of markups can be analysed. Various scenarios that would arise in this case
would be as follows:
Particulars / 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 Life
Year Cycle
2009-10
to 2016-17
Contribution 15,500 34,500 38,000 47,900 51,000 51000 51,000 51,000 44,500
per unit
PBIT per unit (90,000) (53,000) (14,000) 5,700 9,500 9,500 9,500 9,500 (9,600)
29
Future Projections of UV Korea Business
Scenario 2: If UV India reduces the profit markup on cost to say 2% to 4%
Projected Contribution per unit (in SKW)
2009-10 2010-11 2011-12 2012-13 2013-14 2014- 2015-16 2016-17 Life Cycle
15 2009-10 to
2016-17
30
Future Projections of UV Korea Business
D The analysis shows that if UV India continues to charge a
markup of 10% on cost, UV Korea would continue to make
losses over a life cycle i.e. 2009-10 to 2016-17
Naturally, to sustain the situation and to makeup the huge losses already
incurred, UV Korea requires support from UV India by way of
reduction in the engine costs
31
Future Projections of UV Korea Business
Break Even Point (BEP) under different situations
D Further, it has also been observed that the BEP[i.e. a
point where the total costs are equal to revenue and hence
there is no profit no loss situation] under different
markups would be as follows:
32
Sustainability of the Reduction in the Markup
DAll the above profitability and BEP analysis show that UV India may
have a good case to argue for changing the transfer pricing mechanism in
relation to the export of engines to UV Korea in view of achieving its long
term objective of doing business in Korea
33
Conclusion
DTransfer Pricing law gives due importance to the
changes in the economic conditions - OECD
34
Thank You
Questions?
Contact :
Vispi T. Patel
+91 9867635555
vispipatel5@gmail.com