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Transfer Pricing Methods of Computation of Arms Length Price

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Transfer Pricing Methods of Computation of Arms Length Price

The Provisions of Transfer Pricing have been introduced to ensure that income arising from an International Transaction between Associated Enterprises shall be computed having regard to the Arm’s Length Price. Any cost or expense allocated or apportioned between two or more associated enterprises under a mutual agreement or arrangement shall also be at an Arm’s Length Price

 

Examples of such transactions could be where one associated enterprise carries out centralised functions which could also benefit one or more associated enterprises, or two or more associated enterprises agree to carry out a joint activity, such as research and development, for their mutual benefit

 

The arm’s length price in relation to Transfer Pricing in an international transaction shall be determined by any of the following Transfer Pricing Methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe, namely: –

 

1. Comparable Uncontrolled Price Method (CUP Method)

2. Resale Price Method

3. Cost Plus Method

4. Profit Split Method

5. Transactional Net Margin Method

6. Such Other Method as may be prescribed by the Board

 

 

Computation of Arm’s Length Price under CUP Method

Step 1: Determine the price charged or paid for the property transferred or services provided in a comparable
uncontrolled transaction
Step 2: Such Price is then adjusted to account for the Functional Differences between the International
Transaction & the Comparable Uncontrolled Transaction, which could materially affect the price in the open
market.
Step 3: Such Adjusted Price is the Arm’s Length Price

 

Computation of Arm’s Length Price under Resale Price Method

Step 1: The Price at which the Property purchased or the Services obtained by the enterprise from an associated
enterprise are sold to an unrelated enterprise is first determined.
Step 2: Such Resale Price is reduced by the Normal Gross Profit Margin accruing to the Enterprise from the
purchase and resale of Similar Goods in a comparable uncontrolled transaction. If there is no comparable
uncontrolled transaction, then take the Gross Profit of an unrelated person from purchase and resale of Similar
Goods
Step 3: Then reduce the expenses incurred by the enterprise in connection with purchase of property.
Step 4: The price so arrived is adjusted to account for the functional differences in the International Transaction
& the Comparable uncontrolled Transaction which could materially affect the Gross Profit Margin in the Open
Market.
Step 5: The adjusted Price is the Arm’s Length Price

 

Computation of Arm’s Length Price under Cost Plus Method

Step 1: Determine the Direct and Indirect Costs of Production in respect of Property transferred or Services
provided to an associated enterprise
Step 2: Determine the normal gross profit mark up to such costs which will arise from transfer of similar goods
or services to an unrelated enterprise or in a comparable uncontrolled transaction
Step 3: The normal gross profit mark up should be adjusted to account for the functional differences if any
between the International Transaction and comparable uncontrolled transaction which could materially affect
such profit mark­up in the open market
Step 4: The cost referred in step 1 shall be increased by the adjusted profit mark up arrived
Step 5: The sum so arrived is the arm’s length price

 

Computation of Arm’s Length Price under Profit Split Method

This Method is applied in multiple International Transactions which are so inter­related that they cannot be
evaluated separately.
Step 1:­ Compute the Net Profit of the Associated Enterprise arising from the International Transaction.
Step 2:­ Compute the Relative Contribution made by each of the associated enterprise to the earning of the
combined Net Profit
Step 3:­ Split the Combined Net Profit in proportion to their Contributions
Step 4:­ The Sum so arrived at is the Arms Length Price

Computation of Arm’s Length Price under Net Marginal Method

Step 1: Compute the Net Margin realised by the Enterprise from an International Transaction entered into with
an associated enterprise.
Step 2: Compute the Net Profit Margin realised by the enterprise or by an unrelated enterprise from a
comparable uncontrolled transaction.
Step 3: Adjust the Net Profit Margin computed in Step 2 to account for differences
Step 4: The Net Profit Margin computed in Step 1 is established to be the same as the net Profit Margin referred
to in Step 3
Step 5: The net profit margin thus established is then taken into account to arrive at an arm’s length price in
relation to the International Transaction

transfer pricing

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