Methods to determine the arm length price
As per the Indian transfer pricing provisions, income arising from an international transaction with an associated enterprise must be computed having regard to the arm’s length price. The calculation of the arm’s length price must be done by using the most appropriate method and we need to select the most appropriate method from the following methods:
Comparable Uncontrolled Price [‘CUP’] Method;
Resale Price Method (‘RPM’);
Cost Plus Method [‘CPLM’];
Profit Split Method [‘PSM’];
TNMM; and
The Other Method.
Rule 10C (2) of the Rules lists the factors that should be considered in selecting the most appropriate method. Some of the factors are:
The reliability, availability and coverage of data necessary for the application of the method;
Reliability and accuracy of adjustments to account for differences, if any, between the international transaction between the associated enterprises and the comparable uncontrolled transaction; and
The nature, extent and reliability of assumptions required to be made in the application of the method.
CUP
The CUP Method should be applied where AEs do the same/comparation transactions with unrelated enterprises also, as is being done between the AEs. Internal CUP involves a comparison of prices paid/charged between one of the parties to the controlled transaction and an unrelated third party in uncontrolled conditions, whereas in external CUP involves we need to compare prices charged/paid between two unrelated parties for comparable transactions. If transactions are not exactly comparable, then some adjustments need to be made according to the nature of transactions so that transactions could be compared.
RPM
The RPM determines the arm’s length price by reference to the gross profit margin realised in a comparable uncontrolled transaction. The RPM method is appropriate in cases of the purchase and resale of tangible goods/services in which no substantial addition/alteration done by the buyer/reseller. Gross profit margin needs to be determined in uncontrolled resale transactions and the same GP Margin can be applied in controlled transaction to determine the arm length price.
CPLM
The CPLM can be applied in cases of manufacturing or processing of tangible goods that are sold to related parties. In this method, we determine gross profit margin on cost (both direct and indirect) earned by the manufacturer in uncontrolled transactions and the same gross profit margin can be applied in controlled transaction to determine the arm length price. In some cases, the gross profit margin needs to be adjusted to take into account differences between the international transaction and the comparable uncontrolled transaction, which could materially affect the mark-up in the open market.
PSM
The PSM is mainly applicable in international transactions involving the transfer of unique intangibles or in multiple international transactions that are so interrelated that they cannot be evaluated separately for the purpose of determining the arm’s length price of any one transaction. Profit can be divided between two AEs on the basis of the function performed, assets employed and risk assumed by both the AEs.
TNMM
The TNMM compares the normal net profit margin, computed in relation to costs incurred or sales effected, or assets employed or having regard to any other relevant base, realised by an AE to the net profit margin realised by unrelated enterprises from comparable uncontrolled transactions. Further, the standard of comparability between the transaction being evaluated and comparable transactions is comparatively less strict, compared to other methods.
Other Method
Under the Other Method, the arm’s length price of an international transaction can be determined by taking into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transaction, with or between non-AE, under similar circumstances, considering all the relevant facts.
Groomtax transfer pricing expert team can assist in transfer pricing study, in determining the arms length price and transfer pricing audit (Form 3CEB) and litigation. You can reach out to us for more information