Nirmit Mehta
Introduction
The Finance (No. 2) Act, 2014 proposed to introduce a more streamlined method to compute Arm’s Length Price (“ALP”) in a situation where more than one price is determined, on adoption of Most Appropriate Method(“MAM”). The first and second provisos were made redundant for all transactions undertaken on or after 01/04/2014. This was done so as to remove the vagueness that prevailed in the computation of ALP, by way of arithmetic mean.
Hence, in pursuance with the above, the CBDT issued Notification no 83/2015 dated 19/10/2015, in which Income-tax (16th Amendment) Rules, 2015 were introduced, so as to amend Income-tax Rules, 1962.
Current Year
The nomenclature of financial year, in which international transaction or specified domestic transaction has been undertaken, has been changed to current year. This amendment has been made for putting emphasis on the usage of current year data at the time of comparison with comparable uncontrolled transactions.
In regards to the transactions undertaken, on or after 01/04/2014, the benefit of considering data relating to 2 years prior to the current year will not be available even if such data reveals facts which could have an influence on the determination of transfer prices in relation to the transactions being compared.
In case of transactions undertaken on or after 01/04/2014, for which the MAM adopted is either Resale Price Method (“RPM”) or Cost Plus Method (“CPM”) or Transactional Net Margin Method (“TNMM”), the data of comparable uncontrolled transaction should belong to current year. However, if the data of the current year is not available at the time of filing return of income for the current year, the data of the FY immediately preceding the current year shall be used.
If during the assessment proceedings for the assessment year relevant to current year, the data of the current year is available, then such data shall be used, even if such data was not available at the time of filing return of income for current year. This may have an adverse effect on the enterprise because if as per the current data, the ALP computed is unfavourable, it may result in an adjustment.
Data Set
Rule 10CA has been inserted after Rule 10C, which provides determination of ALP in case where more than one price is determined:
Where more than one price is arrived at, a data set is to be constructed by arranging all the prices in ascending order. ALP is computed on the basis of the data set so constructed.
Notwithstanding the above para, if the transaction has been undertaken on or after 01/04/2014, for which the MAM adopted is either RPM or CPM or TNMM:
When current year data is available
Where the current year data of an external comparable enterprise has been taken to compute the ALP and such comparable enterprise has undertaken same or similar comparable uncontrolled transactions in either or both of 2 years immediately preceding the current year, comparable price should also be computed for the aforesaid period.
The weighted average of the prices computed above and the prices of current year shall be included in the data set.
When current year data is not available
Where the data of an external comparable enterprise, belonging to FY immediately preceding the current year, has been taken to compute the ALP and such comparable enterprise has undertaken same or similar comparable uncontrolled transactions in the FY immediately preceding abovementioned FY, the comparable price should also be computed for aforesaid period.
The weighted average of the prices of the aforesaid period of 2 years (2 FYs immediately preceding the current year) shall be included in data set.
When current year data is subsequently available
Where the data of current year is subsequently available and it is established that the comparable enterprise has not entered into any comparable uncontrolled transaction during the current year or the uncontrolled transaction entered into during the current year is not comparable, then such enterprise shall be excluded from the dataset even if they have entered into comparable uncontrolled transaction in FY immediately preceding the current year or FY preceding such FY.
Weighted Average
The weighted average shall be computed when the enterprise has entered into comparable uncontrolled transaction in more than one year. Consequently, the weighted average covered in the above topic shall be computed as follows:
1) If the MAM adopted is RPM, then the weights shall be assigned to the quantum of sales which has been considered for arriving at the prices
2) If the MAM adopted is CPM, then the weights shall be assigned to the quantum of costs which has been considered for arriving at the price.
3) If the MAM adopted is TNMM, then the weights shall be assigned to the quantum of costs incurred or sales effected or assets employed or to be employed, or as the case may be, any other base which has been considered for arriving at the respective prices.
Range
When the MAM adopted is a method other than Profit split method (“PSM”) or other method prescribed by Board (“OM”) and the dataset consists of 6 or more comparables, the arm’s length range shall begin from the 35th percentile of the dataset and end at 65th percentile.
35th percentile means lowest value in the dataset such that atleast 35% of the total number of values in the dataset are equal to or less than such value. Where the total number of values, less than or equal to the value arrived at as above, is a whole number, then the 35th percentile shall be the arithmetic mean of the such value and the value immediately succeeding it in the dataset.
Example: If there are 7 comparable enterprises, 35% of such enterprises arrive at 2.45. Now, 2.45 is rounded off to 3 since 3rd value would have at least 2.45 values less than or equal to it. Hence, the value at 3rd position shall be taken as 35th percentile. In case of 20 comparable enterprises, 35% of such enterprises arrive at 7. Since 7 is a whole number, the arithmetic mean of the values at 7th position and 8th position shall be taken as 35th percentile.
65th percentile means lowest value in the dataset such that atleast 65% of the total number of values in the dataset are equal to or less than such value. Where the total number of values, less than or equal to the value arrived at as above, is a whole number, then the 65th percentile shall be the arithmetic mean of the such value and the value immediately succeeding it in the dataset.
Example: If there are 6 comparable enterprises, 65% of such enterprises arrive at 3.9. Now, 3.9 is rounded off to 4 since 4th value would have atleast 3.9 values less than or equal to it. In this case, 35% of 6 enterprises arrive at 2.1, which will be rounded off to 3. Hence the range shall start from the 3rd value and end at 4th value. This can be taken as one of the drawbacks of the percentile system.
If the price at which the international transaction or the specified domestic transaction has taken place falls within the arm’s length range, such price shall be deemed to be arm’s length price.
If the price at which the international transaction or the specified domestic transaction has taken place falls outside the arm’s length range, the median of the dataset shall be deemed to the arm’s length price.
Median means lowest value in the dataset such that atleast 50% of the total number of values in the dataset are equal to or less than such value. Where the total number of values, less than or equal to the value arrived at as above, is a whole number, then the median shall be the arithmetic mean of the such value and the value immediately succeeding it in the dataset.
Arithmetic Mean
If the MAM adopted is PSM or OM or if the number of comparables is less than 6, then the arm’s length price shall be computed by way of arithmetic mean of all the values in the dataset.
In the above case, if the variation between the arm’s length price and the price at which international transaction or specified domestic transaction has taken place does not exceed 3% of the latter, the price at which international transaction or specified domestic transaction has been undertaken shall be deemed to be the arm’s length price.
