TAXATION OF INTERNATIONAL TRANSACTIONS
1. What is arm's length price? What are the prescribed methods for its computation?
What are the methods under which the arm's length price, relating to an international transaction, is
determined u/s.92C?
Answer: It means a price which is applied or proposed to be applied in a transaction -
(a) Between persons other than associated enterprises,
(b) In uncontrolled conditions.
Methods of Computation [Section 92C]; The arm's length price in relation to an international
transaction shall be determined by any of the following methods -
(a) Comparable Uncontrolled Price Method,
(b) Resale Price Method,
(c) Cost plus Method,
(d) Profit
(e) Transactional Net Margin Method,
(f) Such other method as may be prescribed by the Board.
2. Explain the computation of ALP using Comparable Uncontrolled Price method.
Answer:
Step I: Identify the price charged/ paid for property transferred or services provided in a comparable
uncontrolled transaction(s).
Step II: Adjust the price derived in Step I above for differences, if any, which could materially affect the
price in the open market.
(a) between the international transaction and the comparable uncontrolled transactions, or
(b) between the enterprises entering into such transactions.
Step III: Arm’s Length Price = Step I Add/Less: Step II
Illustration :
Phones and sells them to
2,50,000 Cellular Phones to Jackle Korea at a price of Rs.3,000 per unit and 35,000 units to Fox at a price of
Rs.5,800 per unit. The transactions of CD Ltd with Jackle and Fox are comparable subject to the following
considerations -
(a) Sales to Jackle are on FOB basis, sales to Fox are CIF basis. The freight and insurance paid by Jackle
for each unit is Rs.700.
(b) Sales to Fox are under a free warranty for Two Years whereas sales to Jackle are without any such
warranty. The estimated cost of executing such warranty is Rs.500.
(c) Since Jackle's order was huge in volume, quantity discount of Rs,200 per unit was offered to it.
Compute the Arm's Length Price and the amount of increase in the Total Income of AB Ltd, if any, due to
such Arm's Length Price.
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1. Computation of Arm's Length Price of Products sold to Jackle
Particulars Rs. Rs.
Price per Unit in a Comparable Uncontrolled Transaction 5,800
Less: Adjustment for Differences -
(a) Freight and Insurance Charges 700
(b) Estimated Warranty Costs 500
(c) Discount for Voluminous Purchase 200 (1,400)
Arms's Length Price for Cellular Phone sold to Jackle
2. Computation of Increase in Total Income of CD Ltd
Particulars Rs.
Arm's Length Price per Unit
Less: Price at which actually sold to Jackle
4,400
(3,000)
Increase in Price per Unit 1,400
No. of Units sold to Jackle
Therefore, increase in Total Income of CD Ltd (2,50,000 x Rs.1,400) Rs.35 Crores.
3. Resale price method.
Step I : Identify the price at which property purchased or services obtained by the enterprise from an
associated enterprise is resold or are provided to an unrelated enterprise.
Step II: Reduce the normal GP margin accruing to the enterprise or to an unrelated enterprise from the
purchase and resale of the same or similar property or from II) obtaining and providing the same or similar
services, in a comparable uncontrolled transaction (s).
Step III: Reduce expenses incurred by the enterprise in connection with the purchase of property
or obtaining of services.
Step IV: Adjust for functional and other differences, including differences in accounting practices, if any,
between the international transaction and the comparable uncontrolled transactions, or between the enterprises
entering into such transactions, which could materially affect the amount of gross profit margin in the open
market.
Step V: Arm's Length Price = Step I
Less Step II & III
Add / Less Step IV.
Illustration: Swinhoe LLP of France and Rani Ltd of
compressors for Air Conditioners from Swinhoe at Rs.7,500 per unit and these are sold to Paharpur Cooling
Solutions Ltd at a price of Rs.11,000 per unit. Rani had also imported similar products from Cold Ltd and
sold outside at a Gross Profit of 20% on Sales.
Swinhoe offered a quantity discount of Rs.1,500 per unit. Cold could offer only Rs.500 per unit as Quantity
Discount. The freight and customs duty paid for imports from
respect of purchase from Cold Ltd, Rani had to pay Rs.200 only as freight charges.
Determine the Arm's Length Price and the amount of increase in Total Income of Rani Ltd.
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1. Computation of Arm's Length Price of Products bought from
Resale Price of Goods Purchased from Swinhoe
Less: Adjustment for Differences –
(a) Normal Gross Profit Margin at 20% of
(b) Incremental Quantity Discount by Swinhoe[RS.1,500 -Rs.500]
(c) Difference in Purchase related Expenses[Rs. 1,200 -Rs.200]
11,000
2,200
1,000
1,000
Arms Length Price
6,800
2. Computation of Increase in Total Income of Rani Ltd
Particulars . Rs.
Less :
Price at which actually bought from Swinhoe LLP of France
Arms Length Price per unit under Resale Price Method
7,500
(6,800)
Decrease in Purchase Price per Unit 700
No. of Units purchased from Swinhoe 1,000
Therefore, increase in Total Income of Rani Ltd [3,000 Units x Rs.700] Rs. 21,00,000
4. Explain Cost plus Method in determining ALP.
Step I: Determine the direct and indirect costs of production incurred by the enterprise in respect of
property transferred or services provided to an associated enterprise.
Step II: Determine the normal GP mark-up to such costs (computed under same accounting
norms) arising from the transfer or provision of the same or similar property or services by the
enterprise, or by an unrelated enterprise, in a comparable uncontrolled transaction(s).
Step III: Adjust the normal gross profit mark-up referred to in Step II to take into account the
functional and other differences, if any, between the international transaction and the comparable
uncontrolled transactions, or between the enterprises entering into such transactions, which could
materially affect such profit mark-up in the open market.
Step IV: Arm's Length Price = Step I
Add Step III
Illustration: Branco Inc., a French Company, holds 45% of Equity in the Indian Company Chirag Technologies
Ltd (CTL). CTL is engaged in development of software and maintenance of the same for customers across the
globe. Its clientele includes Branco Inc.
During the year, CTL had spent 2,400 Man Hours for developing and maintaining software for Branco Inc, with
each hour being billed at Rs.1,300. Costs incurred by CTL for executing work for Branco Inc. amount to Rs.
20,00,000.
CTL had also undertaken developing software for Harsha Industries Ltd for which CTL had billed at
Rs.2,700 per Man Hour. The persons working for Harsha Industries Ltd and Branco were part of the
same team and were of matching credentials and caliber. CTL had made a Gross Profit of 60% on the
Harsha Industries work.
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CTL's transactions with Branco Inc. are comparable to the transactions with Harsha Industries,
subject to the following differences:
(a) Branco gives technical know how support to CTL which can be valued at 8% of the
Gross Profit. Harsha Industries does not provide any such support.
(b) Since the work for Branco involved huge number of man hours, a quantity discount of 14% of
Normal Gross Profits was given.
(c) CTL had offered 90 Days credit to Branco the cost of which is measured at 2% of the
Billing Rate, No such discount was offered to Harsha Industries Ltd.
Compute ALP and the amount of increase in Total Income of Chirag Technologies Ltd.
Computation of Arms Length Gross Profit Mark Up
Particulars % %
Normal GP Mark Up 60
Less: Adjustment for Differences
(a) Technical Support from Branco 8% of
(b) Quantity Discount 14% of
46.8
Add: Cost of Credit to Branco 2% of
Arms Length Gross Profit Mark-up 48
2. Computation of Increase in Total Income of Branco Ltd
Particulars Rs.
Cost of Services Provided to CTL 20,00,000
Less:
Arms Length Billed Value
Actual Billing to Boulevard
[Cost / (100 - Arms' Length Mark up)]
[=Rs. 20,00,000 / (100% - 48%)]
[2,400 Hours x Rs.1,300]
38,46,154
(31,20,000)
Therefore, increase in Total Income of Branco 7,26,154
5. Explain Profit
This method is mainly applicable in international transactions involving transfer of unique intangibles
or in multiple international transactions which are so inter-related that they cannot be evaluated
separately for the purpose of determining the Arm's Length Price of any one transaction.
Step I: Determine the combined net profit of the associated enterprises arising from the international
transaction in which they are engaged.
Step II: Determine the relative contribution made by each of the associated enterprises to the earning of
such combined net profit. This is determined on the basis of the functions performed, assets employed and
risks assumed by each enterprise and on the basis of reliable external market data which indicates how
such contribution would be determined by unrelated enterprises performing comparable functions in similar
circumstances.
Step III:
and in proportion to their relative contributions, as determined in Step II. (See note below)
Step IV: Arm's Length Price - Profit apportioned to the assessee under Step III.
NOTE: Combined Net Profit shall be split as under:
III.A. First Split = Reasonable Return: Allocate an amount to each enterprise so as to provide it with a
basic return appropriate for the type of international transaction with reference to market returns achieved in
similar types of transactions by independent enterprises.
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III.B. Second Split = Contribution Ratio: Allocate the residual net profit amongst the enterprises in
proportion to their relative contribution.
III.C. Total Profit: Share of profit of each enterprise = Step III.A + III.B
Illustration: NBR Medical Equipments Inc. (NBR) of
based Hospital for development of a hi-tech medical equipment which will integrate the best of software
and latest medical examination tool to meet varied requirements. The order was for 3,00,000 Euros. To
execute the order, NBR joined hands with its subsidiary Precision Components Inc. (PCI) of
Bioinformatics India Ltd (BIL), an Indian Company. PCI holds 30% of BIL. NBR paid to PCI and BIL Euro
90,000 and Euro 1,00,000 respectively and kept the balance for itself. In the entire transaction, a profit of
Euro 1,00,000 is earned. Bioinformatics India Ltd incurred a Total Cost of Euro 80,000 in execution of its
work in the above contract. The relative contribution of NBR, PCI and BIL may be taken at 30%, 30% and
40% respectively. Compute the Arm's Length Price and the incremental Total Income of Bioinformatics
India Ltd, if any due to adopting Arms Length Price determined here under.
Particulars Euros
3,00,000
A.
Share of each of the Associates in the Value of the Order
Value of the Order
Share of BIL [Given]
Share of PCI [Given]
Share of NBR [Amount Retained = 3,00,000 – 1,00,000 - 90,000]
1,00,000
90,000
1,10,000
B. Share of each of the Associates in the Profit of the Order
Combined Total Profits
Share of BIL [Contribution of 40% x Total Profit € 1,00,000]
Share of PCI [Contribution of 30% x Total Profit € 1,00,000]
Share of NBR [Contribution of 30% x Total Profit € 1,00,000]
1,00,000
40,000
30,000
30,000
80,000
40,000
1,20,000
(1,00,000)
C. Computation of Incremental Total Income of BIL
Total Cost to Bioinformatics India Ltd
Add: Share in the Profit to BIL (from B above)
Revenue of BIL on the basis of Arm's Length Price
Less: Revenue Actually received by BIL
Increase in Total Income of BIL
20,000
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6. Transaction Net Margin Method.
Step I: Compute the net profit margin realised by the enterprise from an international transaction
entered into with an associated enterprise, in relation to costs incurred or sales effected or assets
employed by enterprise or having regard to any other relevant base.
Step II: Compute the net profit margin realised by the enterprise or by an unrelated enterprise from
a comparable uncontrolled transaction (s), having regard to the same base as in Step I.
Step III: Adjust the net profit margin as per Step II for differences, if any, which could materially
affect amount of net profit margin in the open market:
(a) between the international transaction and the comparable uncontrolled transactions, or
(b) between the enterprises entering into such transactions.
Step IV: Net Profit Margin for uncontrolled transactions = Step II Add/Less Step III.
Step V: Arm's Length Price = Transaction Value x Net Profit Margin as per Step IV above.
Meaning of certain terms: For the computation of Arm's Length Price -
1. "Transaction" includes a number of closely linked transactions.
2. "Uncontrolled Transaction" means a transaction between unrelated enterprises, whether
resident or non-resident.
3. "Unrelated Enterprises": Enterprises are said to be unrelated, if they are not associated or
deemed to be associated u/s 92A.
4. "Uncontrolled conditions": Conditions which are not controlled or suppressed or
moulded for achievement of pre-determined results are said to be uncontrolled conditions.
5. "Property" includes goods, articles or things, and intangible property.
6. "Services" include financial services.
Illustration: Fox Solutions Inc. a US Company, sells Laser Printer Cartridge Drums to its Indian
Subsidiary Quality Printing Ltd at S 20 per drum. Doc Solutions Inc. has other takers in
Cartridge Drums, for whom the price is $ 30 per drum. During the year, Fox Solutions had supplied
12,000 Cartridge Drums to Quality Printing Ltd.
Determine the Arm's Length Price and taxable income of Quality Printing Ltd if its income after
considering the above is Rs.45,00,000. Compliance with TDS provisions may be assumed and Rate per
USD is Rs.45. Also determine income of Doc Solutions Inc.
1. Computation of Total Income of Quality Printing Ltd
Particulars Rs. Rs.
Total Income before adjusting for differences due to Arm's Length Price
Add: Difference on Account of Adopting Arm's Length Price
Amount actually paid to Doc Solutions [12,000 x $ 20 x Rs.45]
Less: Amount under Arms Length Price [12,000 x $ 30 x Rs.45]
Incremental Cost on adopting ALP
U/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore,
difference on account of ALP is ignored.
1,08,00,000
(1,62,00,000)
54,00,000
45,00,000
Total Income of Quality Printing Ltd 45,00,000
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2. Computation of Total Income of Fox Solutions Inc.
The provisions relating to taxing income of Fox Solutions Inc., on applying Arm's Length Price for
transactions entered into by a Foreign Company is given in Circular 23 dated 23.7.1969, which is as
follows:
a. Transactions Not Taxable in
transactions are on principal-to-principal basis and are entered into at ALP, and the subsidiary also
carries on business on its own.
b. Transactions Taxable in
own. The following are the other considerations in this regard -
(i) Adopting ALP does not affect the computation of taxable income of Fox Solutions Inc. if tax
has been deducted at source or if tax is deductible.
(ii) Where ALP is adopted for taxing income of the Parent Company, income of the recipient
Company (i.e. Quality Printing Ltd) will not be recomputed.
Illustration: Khazana Ltd is an Indian Company engaged in the business of developing and manufacturing Industrial
components. Its Canadian Subsidiary Techpro Inc. supplies technical information and offers technical support to
Khazana for manufacturing goods, for a consideration of Euro 1,00,000 per year.
Income of Khazana Ltd is Rs.90 Lakhs. Determine the Taxable Income of Khazana Ltd if Techpro charges
Euro 1,30,000 per year to other entities in
other entitles. (Rate per Euro may be taken at Rs.50.)
Computation of Total Income of Khazana Ltd
Particulars Rs.(Lakhs) Rs.(Lakhs)
When Price Charged for Comparable Uncontrolled Transaction is € 1,00,000 € 50,000
Price actually paid by Khazana Ltd [€ 1,00,000 x Rs.50] 50 50
Less: Price Charged in Rupees (under ALP) [1,30,000 x 50] / [60,000 x 50] 65 30
Incremental Profit on adopting ALP [A] (15) 20
Total Income before adjusting for differences due to Arm's Length Price Add:
Difference on Account of Adopting Arm's Length Price (if [A] is positive)
90 90
20
Total Income of Khazana Ltd 90 110
Note: U/s 92(3), Taxable Income cannot be reduced on applying ALP. Therefore, difference on
account of ALP which reduces the Taxable Income is ignored.
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