Transfer pricing is a populated term prescribed under Income Tax Law. Its means, pricing at which transaction is executed. Under Transfer Pricing, we check the reasonableness of transactions like whether the transaction between the associate enterprise is executed at the correct value (Arm length Price) or not. To evaluate the same, some methods are prescribed like Comparable uncontrolled method (CUP), Resale price method (RPM), cost plus method (CPM), etc. There is no prescribed method for any particular transaction. Assessee can adopt the same based on various relevant factors.
The prescribed method for determination of Arm’s Length Price is as under:
- Comparable uncontrolled method (CUP)
CUP compares the price charged or received in controlled transactions with the price of the comparable uncontrolled transactions. It is price for identical or nearly identical property traded between the two independent parties under the same or similar circumstance
- Resale price method (RPM)
It evaluates arm’s length character of transfer price of a controlled transaction taking into consideration the gross margins realized in comparable uncontrolled transaction. This method is generally used in transactions involving selling and distribution function wherein reseller / distributor does not add significant value to the product through use of tangible or intangible property.
- Cost Plus method (CPM)
Cost plus method examines the arm’s length nature of transaction entered into the associated enterprise with reference to the gross mark-up realized in gross profit with direct and indirect cost of the transaction.
- Profit Split Method(PSM)
Profit split method examined whether allocation of combined profit or loss att4ributed to a controlled transaction is arm’s length by reference to the relative value of controlled taxpayer contribution to that combined profit or loss.
- Transactional Net Margin Method (TNMM)
Transaction net margin is a method for computing arm’s length price of a transaction where the object of comparison is net profit margin relative to an appropriate base. Under this method the net profit margin of transaction is calculated with reference to an appropriate base say cost, sale or assets.
- Such other method as may be prescribed by the board
The above methods are broadly classified under two categories namely, Transaction Based Method and Profit Based Method. Above first three Method CUP, RPM, and CPM are covered under Traditional Transaction based method and other two PSM and TNMM are Profit based Methods.
Under Transaction method, price of transaction with controlled enterprises and Independent enterprises is the main criteria for applying Arm Length Principle whereas operating profit at the transaction or entity level is looking into to determine Arm Length Price under Profit based Method.
For selecting the appropriate method following aspects considered:
- Nature of activity under consideration
- Availability, coverage, and reliability of data
- Degree of comparability existing between the controlled and uncontrolled transactions and extent of assumption made.
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