On 21st May 2015, Central Board of Direct Taxes (CBDT) released draft scheme (via notification no.F.No.134/11/2015-TPL) of the proposed rules for computation of Arm’s Length Price (ALP) of controlled transactions entered during financial year 2014-15 and onward. Summary of such draft scheme is given below;
Multiple Year Data
- Multiple year data means financial data for three years including the year in which transaction has been undertaken (current year). For example: for transaction entered during financial year 2014-15, multiple year data means data for financial year 2014-15, 2013-14 and 2012-13.
- Use of multiple year data is mandatory for Resale Price Method (RPM), Cost Plus Method (CPM) and Transactional Net Margin Method (TNMM). Further use of multiple year data is restricted to only these three methods and not allowed for Comparable Uncontrolled Price Method (CUP) and Profit Split Method (PSM).
- In case if data for any of the comparable is not available for all the three years, data of any two out of relevant three years can be used.
- Draft scheme envisage 3 situations under which data for all the three years may not be available, (a) current year data not available in databases, (b) comparable not able to qualify quantitative filter in any one of the three years, and (c) comparable has commenced operations only in the least two years or may have closed down operations during the current year.
- Any comparable with only single year data cannot be considered for the purpose of computation.
- Wherein current year data is not available at the time of transfer pricing documentation, same can be used at the time of transfer pricing audit.
Arm’s Length Range – Percentile
- In addition to variation from arithmetic mean, another statistical tool “Percentile” has been introduced.
- Percentile can only be used for RPM, CPM and TNMM.
- For the purpose of application of percentile, minimum nine comparable entities (external comparables) are required. Wherein, minimum nine comparable entities are available, it would be mandatory to use Percentile.
- The data point lying within 40th to 60th percentile of the data set of series would constitute arm’s length range.
- Transfer price of the controlled transaction will be considered at arm’s length if it falls within the arm’s length range. However if it falls outside the arm’s length range, the median of the range would be taken as arm’s length price and adjustment to transfer price shall be made.
- For the purpose of computation of data point of each comparable, multiple year data would be considered and the weighted average of such multiple year data of each comparable would construct the data set.
- For calculating, the weighted average, the numerator and denominator of the chosen profit level indicator would be aggregateed for all the years for every comparable entity and the margin would be computed thereafter.
- In cases where ‘percentile range’ concept does not apply, the arithmetic mean concept shall continue to apply as per current rule.
Basic intention behind introduction of multiple year and percentile range concepts was to reduce transfer pricing litigation, however, if draft scheme implemented in its current form may not actually bring down litigation. On a minimum, CBDT:
- instead of making multiple year data mandatory, should clearly define scenarios under which multiple year data can be used;
- should allow use of multiple year data for other methods as well;
- minimum requirement of 9 comparable entities should be removed; and
- Instead of 40th to 60th percentile, inter-quartile range should be introduced.
For further discussion
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