PROJECT REPORT

ON

TRANSFER PRICING
Submitted for partial fulfillment of award of MASTER`S DEGREE IN BUSINESS ADMINISTRATION

BY DEBASHISH ROY MBA l Year, 3rd trimesters 2/5/2011 To 31/7/2011

DAYANANDA SAGAR BUSINESS SCHOOL

Shavige Malleshwara Hills, kumaraswamy layout Bangalore-560078

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ACKNOWLEDGEMENT
I take this as an opportunity to thank with bottom of my hear all those without whom the journey of doing my project would not have been as pleasant as it has been to me. Working on my project was a constant learning experience with all sweat and tear which was its due but not without being richly stimulating experience of life time. I am very thankful to Dr. PARUL TANDON for giving me their valuable advice and guidance towards fulfillment of the project Finally I would like to convey my heartiest thanks to all my well wishers for their blessing and co-operation throughout my study. They boosted me up every day to work with a new and high spirit.

Debashish Roy

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DECLARATION
I hereby declare that this Research Project entitled, A Study on TRANSFER PRICING written and submitted by me, under the guidance of Mr. MANISH KUMAR KOTHARI is my original work and that has not been submitted to any other University / Institute previously.

DEBASHISH ROY PGDM-3RD TRIMESTER

DAYANANDA SAGAR BUSINESS SCHOOL

CERTIFICATE

This is to certify that the Research Project Report entitled, TRANSFER PRICING for the award of POST GRADUATES DIPLOMA IN MANAGEMENT from DAYANANDA SAGAR BUSINESS SCHOOL, BANGALORE, has been carried out by DEBASHISH ROY. The Report embodies result of original work and studies carried out by the student himself and the contents of the Report do not form the basis for award of any other Degree to the candidate or to anybody else.

Dr. PARUL TANDON DEPT. PGDM (AICTE)

DAYANANDA SAGAR BUSINESS SCHOOL DATE:PLACE:-

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CONTENT
CHAPTER-I
,,

i) ii) iii) iv) v)

CHAPTER-2

Introduction Objectives of the study Scope of the study Importance of study Research Methodology

vi) vii) viii) ix) x) xi)

CHAPTER-3

Theoretical perspective Objectives of transfer pricing Methods to calculate transfer pricing Checking transfer pricing manipulation Penalties Changes in transfer pricing

xii) xiii) xiv) xv) xvi) xvii)

Data Problem solved Recommendation Conclusion Limitation of the study Bibliography

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CHAPTER I

i) INTRODUCTION ii) OBJECTIVE OF THE STUDY iii) SCOPE OF THE STUDY

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INTRODUCTION
Over the course of past few years. Transfer pricing become an increasingly important- and often complex issue facing by chief financial officer (CFO) of the companies in India which provide service to their parent or affiliated organization overseas. This is not just because of the increase in such transaction as a result of the hectic pace of globalization, but also importantly, due of the lack of the clarity in the minds of both tax payer as well as revenue official on what the effective and optimal pricing mechanism should be, the area of transfer pricing is still a relatively new field and both corporation and tax authorities are on a learning curve. Further, what is the right margin for a business at a point of time is somewhat is subjective issue open to different interpretation and hence disputes. The price of a service, and therefore the margin of that business, is that function of the type of activity that the service provider is engaged in. Ideally the margin charged by the provider should be directly proportionate to the value addition undertaken software design and architecture (higher value adding activities), or just code-writing (lower value addition). Similarly, in the of a transaction involving manufacture of a component, margins would be lower if design and tools were provided by the buyer and the provider undertook only conversion or assembling Equally, the risk borne by the taxpayer is an important determinant of the margin-again both are directly proportionate; the greater the risk, the higher the margin. Risks, often considered for the purpose of determination of margin, include market risk; human capital risk; credit risk; foreign exchange fluctuation risk; product/service price risk and product development risk. Captive units generally bear lower risks than other types of Associated Enterprises (AE), For example, parent organization can afford higher bench strength than an independent service provider. They will also carry lower product development risk because they have much greater access to the company information. However, they do carry foreign exchange fluctuation risk as much as any export organization. Since they carry lower risk, they can, theoretically, operate at lower margins. Whether this logic is accepted by transfer pricing auditors however, is a separate issue.

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What is transfer pricing and its method?

Transfer pricing is simply the act of pricing of goods and services or intangibles when the same is given for use or consumption to a related party (e.g. Subsidiary). There can be either Market-based, i.e. equivalent to what is being charged in the outside market for similar goods, or it can be non-market based. Importantly, two-thirds of the managers say their transfer pricing is non-market based. There can be internal and external reasons for transfer pricing. Internal include motivating managers and monitoring performance, e.g. by putting a cost to imported inputs. External would be taxes and tariffs. Different method to calculate transfer pricing 1. Best rule method of transfer pricing 2. Multiple method if transfer pricing 3. Comparable uncontrolled price method 4. Resale price method of transfer pricing 5. Cost plus method of transfer pricing 6. Profit split method of transfer pricing 7. Transactional net margin method (TNNM) of transfer pricing

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OBJECTIVE OF THE STUDY 1. To study about transfer pricing 2. To evaluate the various application of transfer pricing 3. To analyze the various method of transfer pricing

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Scope of study
The scope of this study is to identify the methods of the Client of M.K.kothari & Associates. This study is based on secondary data only because of the rules of Indian government that a CHARTERED ACCOUNTANT cannot publish their clients accounting details. Due to time constraint only limited number of Clients was contacted. This study only focuses on the clients of M.K. Kothari & Associates because the study conducted with the clients of M.K. Kothari The study does not say anything about the other firms which are not the clients of M.K.kothari & Associates. The scope of study is limited for clients of M.K.kothari & Associates in Kolkata. It provides help to further study for transfer pricing in corporate sector.

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Research Methodology
Research Methodology is a set of various methods to be followed to find out various informations regarding transfer pricing of different company.

Research Methodology is required in every industry for acquiring knowledge of their method of calculating transfer pricing. Area of study: The study is exclusively done in the area of finance. It is a process requiring care, sophistication, experience, judgment, and knowledge for which there can be no mechanical substitutes. Information Collection: Information is collected from various clients through personal interaction. Information is collected with mere interaction and formal discussion with different clients. Some other relevant information collected through secondary data Tools of Analysis : The survey about the techniques of marketing and nature of expenditure is carried out by personally interacting with the potential clients in Kolkata.

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Theoretical Perspective
Transfer price refers to the amount used in accounting for transfer of goods or services from one responsibility centre to another or from one company to another which belongs to the same group. Transfer pricing is a mechanism for distributing revenue between different divisions which jointly develop, manufacture and market products and services. Transfer pricing systems are designed to accomplish the following objectives: to provide each division with relevant information required to make optimal decisions for the organization as a whole; to promote goal congruence that is, actions by divisional managers to optimize divisional performance should automatically optimize the firm's performance; and to facilitate measuring divisional performances. The fundamental principle is that the transfer price should be similar to the price that would be charged if the product were sold to outside customers or purchased from outside vendors. Market-based transfer pricing system provides optimal results when the market for the intermediate product is perfectly competitive and the selling division can sell its output either to insiders or outsiders and as long as the buying division can obtain all its requirements from either outsiders or insiders. In such a situation the company as a whole has no additional cost of providing autonomy to divisions. For example, if division A decides to sell its product at the market price of Rs. 100 per unit and division B decides to buy the same product from market at the market price, net cash flow to the firm will be zero If the market for the intermediate product is imperfect, this system may lead to sub-optimal utilization of production capacity by the buying division. The transfer price will form an element of the total marginal cost and the buying division will restrict its output at the level where marginal cost = marginal revenue. Thus the firm as a whole will lose an opportunity to improve its profit because actual marginal cost is lower than the transfer price. For instance, the intermediate product that the sub-unit A of the firm uses is produced by the sub-unit B of the firm and another firm. The market price of the product is Rs 100 per unit, while the variable cost of production in division B is Rs 40 per unit. If, the transfer price is fixed at Rs 100 per unit (the market price) the sub-unit A will consider Rs 100 per unit as a part of its marginal cost. It will restrict the output at the level where marginal cost = marginal revenue. If the
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sub-unit B has excess capacity, the decision of the sub-unit A is sub-optimal for the firm as a whole. Even in a situation where the sub-unit B has no excess capacity, that is, it can sell its total output to outsiders at Rs 100 per unit, the decision of the sub-unit A to restrict its output at a level lower than its achievable capacity might be sub-optimal for the firm as a whole. Assume that the firm earns a contribution of Rs 100 per unit on the final product, the output of the sub-unit A. The contribution is higher than the contribution of Rs 60 per unit on the intermediate product. The firm loses the opportunity to earn higher profit by using the intermediate product internally in the sub-unit A instead of selling the same to outsiders. If competitive prices are not available or it is too costly to obtain market prices, transfer prices may be determined based on the cost plus a profit. Cost-based transfer prices should be used only as a second option to market-based transfer prices because it involves complex calculations and results are less than satisfactory Companies use variations of market-based and cost-based transfer pricing mechanisms to achieve the objective of goal congruence. Transfer-pricing system must have in-built mechanisms for smooth negotiation and conflict resolution. Although there is sound economic theory behind the selection of transfer pricing methods, companies use transfer price methods to achieve certain other objectives even at the cost of goal congruence. Often in family run businesses, decisions are taken at the group level. Therefore, decisions aim to optimize group performance. When group companies produce products that are used within the group, transfer price is established with an aim to optimize the group performance, although it may hurt the selling or the buying company within the group. An issue that is often ignored is that whether this practice undermines the interest of minority shareholders. If there is no minority shareholder in the company that is hurt, the ethical/corporate governance issue does not arise. Otherwise, this is an important issue and need to be addressed by the board of directors of individual companies. For multinational corporations, it may be advantageous to arbitrarily select prices such that most of the profit is made in a country with low taxes, thus shifting the profits to reduce overall taxes paid by a multinational group.

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However, most countries enforce tax laws based on the arm's length principle as defined in the OECD (Organization for Economic Co-operation and Development) Transfer Pricing Guidelines for Multinational Enterprises and Tax Administrations, limiting how transfer prices can be set and ensuring that that country gets to tax its "fair" share. In India, the OECD principle was adopted in 2001. Applying transfer pricing rules based on the arm's length principle is not easy, even with the help of the OECD's guidelines. It is not always possible and certainly takes valuable time to find comparable market transactions to set an acceptable transfer price. The revenue authority and the MNCs should work together in good faith to implement regulations effectively. The question of ethics cannot be ignored even in tax planning.

Objective of transfer pricing

The main objective is to take advantage of different tax rates between countries. Transfer pricing also is used to evaluate performance of divisions within a company.

Tax Savings

Imagine a company with two branches, where one makes semi-finished goods in a low-tax country and exports them to a branch in a high-tax country, where they are finished and sold. By increasing the transfer price and declaring more of its profits in the low-tax country, the company can reduce its global tax bill.

Boost Profits

By undercharging for goods crossing national borders, a company can save money on customs duties paid by the branch in the importing country. Conversely, by overcharging, a company can extract more money from a country with tighter currency outflow restrictions.

Measure Performance

Companies need to know how their individual divisions are performing. A way of measuring that is through transfer pricing. By setting a price for goods in each stage of the production process, a company can measure the profitability of each division and decide where to make organizational adjustments.

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Arm's Length Standard

The basic principle of this standard used by most developed countries is that for transactions between branches a company should use market prices. However, enforcement of this rule is complicated, especially when a company has branches in numerous countries.

Method to calculate transfer pricing Best rule method of transfer pricing

The best method rule is intended to avoid the rigidity of the priority of methods that formerly had been required. The rule guides taxpayers and the IRS (internal revenue service) as to which method is most appropriate in a particular case. The temporary regulations no longer provided for an ordering rule to select the method that provides for an arms-length result. Rather, in choosing a method, the arms-length result must be determined under the method which provides the most accurate measure of an arms-length result. The best method rule appears to be somewhat subjective and, because of its technical nature, may require special expertise. Certainly, the rule does not appear to eliminate the potential for controversy between the IRS and taxpayers. The rule will likely require taxpayers to expend more energy developing intercompany transfer prices and reviewing data. The best method rule had three limitations: 1. Tangible property rules normally do not adequately consider the effect of no routine intangibles in determining which method is the best method. In these cases, adjustments may be required under the intangible property rules. 2. Tangible property comparable methods may be superseded, especially as they effect significant no routine intangibles that are not defined. 3. A taxpayer can request an advance pricing agreement to determine its best method.

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Multiple Methods of Transfer Pricing The temporary regulations encouraged the taxpayer to use more than one transfer pricing method. When two or more methods produce inconsistent results, the best method rule should be applied to determine which method produces the most accurate measure. Presumably, if the results are consistent, it may not be necessary to invoke the best method rule. If the best method rule does not clearly indicate the most accurate method, consistency between results should be considered as an additional factor. Using this approach, the taxpayer should ascertain whether any of the methods, or separate applications of a method, yields a result consistent with any other method. Comparable Uncontrolled Price Method The CUP method provides the best evidence of an arm's length price. A CUP may arise where:

the taxpayer or another member of the group sells the particular product, in similar quantities and under similar terms to arm's length parties in similar markets (an internal comparable); an arm's length party sells the particular product, in similar quantities and under similar terms to another arm's length party in similar markets (an external comparable); the taxpayer or another member of the group buys the particular product, in similar quantities and under similar terms from arm's length parties in similar markets (an internal comparable); or an arm's length party buys the particular product, in similar quantities and under similar terms from another arm's length party in similar markets (an external comparable).

Incidental sales of a product by a taxpayer to arm's length parties may not be indicative of an arm's length price for the same product transferred between non-arm's length parties, unless the non-arm's length sales are also incidental.

Transactions may serve as comparables despite the existence of differences between those transactions and non-arm's length transactions, if:

the differences can be measured on a reasonable basis; and Appropriate adjustments can be made to eliminate the effects of those differences.

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Where differences exist between controlled and uncontrolled transactions, it may be difficult to determine the adjustments necessary to eliminate the effect on transfer prices. However, the difficulties that arise in making adjustments should not routinely preclude the potential application of the CUP method. Therefore, taxpayers should make reasonable efforts to adjust for differences. The use of the CUP method precludes an additional allocation of related product development costs or overhead unless such charges are also made to arm's length parties. This prevents the double deduction of those costs-once as an element of the transfer price and once as an allocation. Resale price method of Transfer Pricing The resale price method begins with the resale price to arm's length parties (of a product purchased from an non-arm's length enterprise), reduced by a comparable gross margin. This comparable gross margin is determined by reference to either:

the resale price margin earned by a member of the group in comparable uncontrolled transactions (internal comparable); or The resale price margin earned by an arm's length enterprise in comparable uncontrolled transactions (external comparable).

Under this method, the arm's length price of goods acquired by a taxpayer in a non-arm's length transaction is determined by reducing the price realized on the resale of the goods by the taxpayer to an arm's length party, by an appropriate gross margin. This gross margin, the resale margin, should allow the seller to:

recover its operating costs; and Earn an arm's length profit based on the functions performed, assets used, and the risks assumed.

Where the transactions are not comparable in all ways and the differences have a material effect on price, the taxpayer must make adjustments to eliminate the effect of those differences. The more comparable the functions, risks and assets, the more likely that the resale price method will produce an appropriate estimate of an arm's length result. An exclusive right to resell goods will usually be reflected in the resale margin. The resale price method is most appropriate in a situation where the seller adds relatively little value to the goods. The greater the value-added to the goods by the functions performed by the seller, the more difficult it will be to determine an appropriate resale margin. This is especially true in a situation where the
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seller contributes to the creation or maintenance of an intangible property, such as a marketing intangible, in its activities Cost plus method of Transfer Pricing The cost plus method begins with the costs incurred by a supplier of a product or service provided to an non-arm's length enterprise, and a comparable gross mark-up is then added to those costs. This comparable gross mark-up is determined in two ways, by reference to:

the cost plus mark-up earned by a member of the group in comparable uncontrolled transactions (internal comparable); or The cost plus mark-up earned by an arm's length enterprise in comparable uncontrolled transactions (external comparable).

In either case, the returns used to determine an arm's length mark-up must be those earned by persons performing similar functions and preferably selling similar goods to arm's length parties. Where the transactions are not comparable in all ways and the differences have a material effect on price, taxpayers must make adjustments to eliminate the effect of those differences, such as differences in:

the relative efficiency of the supplier; and Any advantage that the activity creates for the group.

The more comparable the functions, risks and assets, the more likely it is that the cost plus method will produce an appropriate estimate of an arm's length result. In general, for purposes of applying a cost-based method, costs are divided into three categories: (1) Direct costs such as raw materials; (2) Indirect costs such as repair and maintenance which may be allocated among several products; and (3) Operating expenses such as selling, general, and administrative expenses. The cost plus method uses margins calculated after direct and indirect costs of production. In comparison, net margin methods-such as the transactional net margin method (TNMM) discussed in Section B of this Part-use margins calculated after direct, indirect, and operating expenses. For purposes of

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calculating the cost base for the net margin methods, operating expenses usually exclude interest expense and taxes. Properly determining cost under the cost plus method is important. Cost is usually calculated in accordance with accounting principles that are generally accepted for that particular industry in the country where the goods are produced. However, it is most important that the cost base of the transaction of the tested party to which a mark-up is to be applied be calculated in the same manner asand reflects similar functions, risks, and assets as-the cost base of the comparable transactions. Where cost is not accurately determined in the same manner, both the mark-up (which is a percentage of cost) and the transfer price (which is the total of the cost and the mark-up) will be misstated. Transactional Profit Methods of Transfer Pricing Traditional transaction methods are the most reliable means of establishing arm's length prices or allocations. However, the complexity of modern business situations may make it difficult to apply these methods. Where the information available on comparable transactions is not detailed enough to allow for adjustments necessary to achieve comparability in the application of a traditional transaction method, taxpayers may have to consider transactional profit methods. However, the transactional profit methods should not be applied simply because of the difficulties in obtaining or adjusting information on comparable transactions, for purposes of applying the traditional transaction methods. The same factors that led to the conclusion that it is not possible to apply a traditional transaction method must be considered when evaluating the reliability of a transactional profit method. The OECD Guidelines endorse the use of two transactional profit methods:

the profit split method; and Transactional net margin method (TNMM).

The key difference between the profit split method and the TNMM is that the profit split method is applied to all members involved in the controlled transaction, whereas the TNMM is applied to only one member. The more uncertainty associated with the comparability analysis, the more likely it is that a one-sided analysis, such as the TNMM, will produce an inappropriate result. As with the cost plus and resale price methods, the TNMM
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is less likely to produce reliable results where the tested party contributes to valuable or unique intangible assets. Where uncertainty exists with comparability, it may be appropriate to use a profit split method to confirm the results obtained. Profit split method of Transfer Pricing Under the profit split method:

The first step is to determine the total profit earned by the parties from a controlled transaction. The profit split method allocates the total integrated profits related to a controlled transaction, not the total profits of the group as a whole. The profit to be split is generally the operating profit, before the deduction of interest and taxes. In some cases, it may be appropriate to split the gross profit. The second step is to split the profit between the parties based on the relative value of their contributions to the non-arm's length transactions, considering the functions performed, the assets used, and the risks assumed by each non-arm's length party, in relation to what arm's length parties would have received.

The profit split method may be applied where:

the operations of two or more non-arm's length parties are highly integrated, making it difficult to evaluate their transactions on an individual basis; and the existence of valuable and unique intangibles makes it impossible to establish the proper level of comparability with uncontrolled transactions to apply a one-sided method.

Due to the complexity of multinational operations, one member of the multinational group is seldom entitled to the total return attributable to the valuable or unique assets, such as intangibles. Also, arm's length parties would not usually incur additional costs and risks to obtain the rights to use intangible properties unless they expected to share in the potential profits. When intangibles are present and no quality comparable data are available to apply the one-sided methods (i.e., cost plus method, resale price method, the TNMM), taxpayers should consider the use of a profit split method. The second step of the profit split method can be applied in numerous ways, including:

splitting profits based on a residual analysis; and

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relying entirely on a contribution analysis.

Following the determination of the total profit to be split in the first step of the profit split, a residual profit split is performed in two stages. The stages can be applied in numerous ways, for example:

Stage 1: The allocation of a return to each party for the readily identifiable functions (e.g., manufacturing or distribution) is based on routine returns established from comparable data. The returns to these functions will, generally, not account for the return attributable to valuable or unique intangible property used or developed by the parties. The calculation of these routine returns is usually calculated by applying the traditional transaction methods, although it may also involve the application of the TNMM. Stage 2: The return attributable to the intangible property is established by allocating the residual profit (or loss) between the parties based on the relative contributions of the parties, giving consideration to any information available that indicates how arm's length parties would divide the profit or loss in similar circumstances.

Transactional net margin method (TNMM) of Transfer Pricing The TNMM:

compares the net profit margin of a taxpayer arising from a non-arm's length transaction with the net profit margins realized by arm's length parties from similar transactions; and Examines the net profit margin relative to an appropriate base such as costs, sales or assets.

This differs from the cost plus and resale price methods that compare gross profit margins. However, the TNMM requires a level of comparability similar to that required for the application of the cost plus and resale price methods. Where the relevant information exists at the gross margin level, taxpayers should apply the cost plus or resale price method. Because the TNMM is a one-sided method, it is usually applied to the least complex party that does not contribute to valuable or unique intangible assets. Since TNMM measures the relationship between net profit and an appropriate base such as sales, costs, or assets employed, it is important to choose the appropriate base taking into account the nature of the business activity. The appropriate base that profits should be measured against will depend on the facts and circumstances of each case

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CHECKING TRANSFER PRICING MANIPULATION Having understood the implications and growing importance of Transfer Pricing, more Precisely Transfer Pricing Manipulation, we look at what regulations have been enacted to counter this by India. The Finance Act 2001 introduced detailed Transfer Pricing regulations w.e.f. 1st April, 2001. The basic idea behind regulations is determining whether International Transactions between associated parties are conducted at arms length prices Arms Length Price (ALP) This is the price that would be charged in uncontrollable transactions, i.e. when parties are unrelated. Two most common methods of doing this are 1. Checking the price in a similar transaction between two totally different parties and A B vs. C D 2. Checking the price in a similar transaction between one of the involved party and one Unrelated party . A B vs. A C The various methods prescribed by Indian regulations to find out the arms length price. There is generally more than one Transfer Price which is defendable in any transaction and hence most countries talk of a transfer pricing band rather than a singular transfer price. There are clearly some roadblocks in implementation of ALP, like: - Specialized nature of goods/ services and uniqueness of intangibles - Independent entities might not undertake similar transactions, because of Copyright issues. For e.g. Coke would only share its formula with a related party where it has some stakes. - There is a huge administrative burden on part of tax authorities in determining the true transfer price and this exercise might sometime take years, by when the Situation changes dramatically - Confidentiality issue may restrict availability of comparable information. Associated Parties Those having 26% or more Equity holding, having loans or Guarantees over a certain value, having power to appoint Board Members or Managers or when there is dependence for license, copyrights or raw materials for that matter. International Transactions International transaction has been defined as a transaction between two or more associated enterprises, either or both of whom are non-residents. The transactions intended to be covered are purchase, sale or lease of tangible or intangible property, provision of services, lending and borrowing of money cost sharing and any other transaction which have a

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bearing on the profits, income, losses or assets of an enterprise. As such, virtually every conceivable transaction is proposed to be roped in for scrutiny. The regulations apart from filing of proper tax returns require maintenance of a host of documentary and other evidence to substantiate transfer prices adopted by MNEs and penalties have gotten stricter. An organization can be fined up to 2% of the transaction value for not just evasion of tax but also for non-compliance with procedural requirements.

PENALTIES

Penalties have been provided as a disincentive for non-compliance with procedural requirements is as follows. (a) Penalty for Concealment of Income - 100 to 300 percent on tax evaded (b) Failure to Maintain/Furnish Prescribed Documentation - 2 percent of the value of the international transaction (c) Penalty for non-furnishing of accountants report - INR 100,000 (fixed) The above penalties can be avoided if the taxpayer proves that there was reasonable cause for such failures.

Changes in transfer pricing

India has a relatively short history of transfer pricing (TP) legislation compared to some countries where this law is well developed. The detailed TP regulation in the country was introduced in the Finance Act, 2001, with a view to check erosion of tax base in the country. The domestic TP regulation is designed for an international transaction, which has been defined to mean a transaction between associated enterprises, either or both of whom are non-residents. As per the domestic TP regulation, an international transaction between associated enterprises is required to adhere to arm's-length standard. In order to ensure that the international transaction between associated enterprises is at

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arm's length, there are reporting and detailed documentation requirements that a taxpayer must maintain to avoid stringent penalties. A domestic transaction a transaction between two tax residents of India may not be governed specifically by the domestic TP regulation. Generally speaking, one may assume that the overall tax base of a country is unaffected by manipulation in the prices of domestic transactions between related parties, since it will have nullifying effect as far as overall taxability of the transaction is concerned. However, there may be situations where pricing of a domestic transaction could be manipulated for tax arbitrage opportunities. For instance, price manipulation could result in shifting of profits between a loss-making entity and a profit-making entity to achieve an overall reduced tax rate. Similarly, profit shifting to an entity enjoying tax concessions under an incentive scheme could also be achieved through pricing of transactions of such entity with another related company. The Income-Tax Act has provisions (sections 40 A (2) and 80IA10) that empower the assessing officer to get into the aspect of pricing of the transaction between a taxpayer and a related person, and adjust the expense or income as per the market value of such transaction. However, a taxpayer is not required to maintain specific and detailed documentation to support the pricing of such transactions. Also, there is no guidance in the Act or rules governing such provisions pertaining to determination of fair market value of the transaction. This often results in the tax officer exercising his best judgment in estimating the market value of the transaction and disregarding the excessive expenditure and income reported by the taxpayer. In an interesting development, the Supreme Court in the recent case of Commissioner of Income Tax IV, Delhi, vs. GlaxoSmithKline Asia (P) Ltd (SLP (Civil) no 18121/2007) discussed the above-mentioned limitations in the current provisions governing pricing of domestic transaction between related parties. In this case, the court, on the facts of the case, declined to interfere and dismissed the special leave petition filed by the tax department. However, since the issue involved concerned section 40A (2) of the Act, the court took up a larger issue of the scope of domestic TP regulation being limited to cross-border transactions. The apex court observed that in the case of a domestic transaction, under invoicing of sales and over invoicing of expenses would ordinarily be tax neutral.

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However, there could be situations where a tax arbitrage could be created. The court expressed the view that certain provisions of the Act, such as sections 40(A)(2) and 80IA(10), need to be amended to empower the tax officer to make adjustments to income having regard to the fair value of the transactions between related parties. Identifying the shortcomings of current provisions and with a view to reduce litigation, the court has suggested that the ministry of finance should consider whether the law ought to be amended to provide for extensive documentation to be maintained by the taxpayer even for domestic transactions with related parties. This would align the provisions governing domestic transactions between related parties with the provisions of the domestic TP regulation. The amendment of law to introduce documentation requirements even for domestic transactions between related parties would not be unique to India. There are many countries that mandate compliance requirements for domestic transactions within their transfer-pricing regimes. The UK, for instance, is a jurisdiction where TP provisions governing domestic transactions are fairly developed. The issue is whether the objective of reduced litigation would be achieved? Considering that litigation surrounding TP issues has increased significantly, the change might not result in the desired outcome. However, it would rule out absolute discretion and bring out some objectivity in the application of the provisions. So, are we ready for domestic transfer-pricing legislation? Or, more importantly, whether the increased burden on the taxpayer as well as the tax officers is worth the effort? The answer may not be a simple 'aye' or 'nay'. However, as the Supreme Court has suggested, this is a change that merits consideration by lawmakers.

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In the books of nilimara jute mills Trading & Profit and loss account for the year ending 31st of March 2009 PARTICULAR
Opening stock Purchase Wages Expenses Impartment Interest Depreciation Net profit (b/f)

AMOUNT
231000 718800 744900 73900 37100 228100 37100 658200 2729100 Sales

PARTICULAR

AMOUNT
2500000 266200

Closing stock

2729100

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Balance sheet as at 31st march 2009 PARTICULAR AMOUNT PARTICULAR

SHARE CAPITAL
AUTHORISED CAPITAL@2
ISSUED AND SUBSCRIBED

AMOUNT

Fixed assets
7500
Goodwill Land & building 1215000 1753900 1245800 5375000 5306000 749000 599000 332000

2 2963478@2 RESERVES & SURPLUS

45926956

Tea Estate Roads & culverts

General reserves

1073500 Plant/ machinery Drawing design &trading 406000 Vehicles Computers software Investment Equity 294500 Tide wale oil 1851300 228390@10 1410700 New beblwon coal ltd 1035355@12.27 15000 Others Gloster jute mills 125700 208@10 500000 Exide industry 461000 212714@1 256000 212714 2080 12703805

Tea board subsidy as capital res 114000 Housing subsides Preference shares Loans Secured loans W.B.govt sales tax loan Others Bonds 9% secured redeemable non-

convertible 12yrs bond Scheduled banks State banks of India Bank of Baroda Allahabad banks United banks of India

Contd...

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Particular

Amount

Particular

Amount

Sundry creditor& liabilities

544300 Advances and Deposits received from
Customers and others Micro Small and Medium Enterprises Unclaimed Redeemed Preference Shares

Unquoted The statesman 9966@10 ABC tea worker service

640
99660

121660

750@10 Debentures

7500

260

Interest accrued but not due on loans

Bond (FULLY PAID) 305@10000 SUNDRY DEBTOR Unsecured debt Other debt Cash Closing stock
509614 229418 . 1291833 3166 3050000

80000
and deposits

36096190

36096190

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Problems Solved
Assumption completive and perfectly competitive and the manager are motivated to maximize short-run profit. The production capacity of department A is 1000 denotes the quantity transferred by X. Maximize = ( )(1000-x)+( )X

= (200-120)-(1000-X) + (300+150+120) = 8000 -50X Two decentralized decision makers each maximizing her division profits:Profit A = (200-120) (1000-X) + (TP-120) x = 8000 + (TP-200) x Profit B = (300-150-TP) x = (150-TP) x (1) What is the minimum transfer pricing according to the course text? ANSWERS Variable cost + Opportunity =120+80 =200

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(2) What are the transfer price according to the variable cost and full cost? ANSWER VARIABLE COST: 120 FULL COST: 120+31000/1000=151

From the above calculation we can understand that how to calculate the transfer pricing of a firm. The above calculation is one of the methods of calculating transfer pricing. It is merely the amount of price of the product or service which should be charged by the firm on the parent company. The problem was very simple and it has been drawn on certain assumption. And through this we can understand the concept of transfer pricing.

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RECOMMENDATION
The calculation of the transfer pricing is very complex for the normal person and so he has to take help of the expert There are many method for calculating transfer pricing so the normal people are not able to get which methods will project the best and fair value for their business line The calculation for the multinational companies are very difficult because of the international transaction and the complexity of international taxes rates and rules and regulation The day to day changes in the taxes rates by the government makes it too complex for the Officer to calculate the correct figure for the transfer pricing.

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CONCLUSION
Transfer pricing is inherent in the way the global economy is structured with sourcing and consuming destinations being different, with numerous organizations operating in multiple countries and most importantly due to varying tax and other laws in different nations. Also nations have to achieve a fine balance between loss of revenues in the form of outflow of tax and making their country an attractive investment destination by giving flexibility in Transfer Pricing. One can choose to go to extremes like Singapore would be doing especially when it is the low tax country. Given that countries are not integrated into a global system, each of them want increase in total inflow through tax or FDI and something like VAT is not expected to remove this non-competitive method of attracting investment, countries will need to enact legislations on their own. Thus, achieving the mentioned balance, suiting their conditions and pattern of international transactions, according to the stage of economic development they are in, are some of the challenges companies are facing as they become a global economic community.

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Limitation of the study

Certain limitations do creep in a research study due to constraints of the time, money and human efforts, the present study is also not free from certain limitation, which were unavoidable. Although all effort were taken to make the result of the work as accurate as possible as study but the study have following constraints a. Some clients were calculating there transfer pricing from their own methods of calculation, which were not applicable according to Indian government rules & regulation. b. Due to large number of clients only few clients books were studied c. Due to time constraint and other imperative work load during the period it could not be made possible to explore more area of concern pertaining to study. d. Also impossible for company to provide their confidential details for the study e. As per the rules of a chartered accountant they cannot disclose or publish their client details in any place.

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Bibliography
Prasan chandra 2009 TATA McGraw-Hill

Taxation of international business transaction http://en.wikipedia.org/wiki/Transfer_pricing

http://www.business-standard.com/india/news/transfer-pricing-explained/327373/ Books provided by the chartered account

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