{"id":7896,"date":"2020-06-18T10:01:17","date_gmt":"2020-06-18T04:31:17","guid":{"rendered":"https:\/\/itatonline.org\/articles_new\/?p=7896"},"modified":"2020-06-18T10:01:17","modified_gmt":"2020-06-18T04:31:17","slug":"transfer-pricing-most-appropriate-method-for-computing-arms-length-price-alp-of-an-international-transaction","status":"publish","type":"post","link":"https:\/\/itatonline.org\/articles_new\/transfer-pricing-most-appropriate-method-for-computing-arms-length-price-alp-of-an-international-transaction\/","title":{"rendered":"Transfer Pricing: Most Appropriate Method For Computing Arm’s Length Price (ALP) Of An International Transaction"},"content":{"rendered":"

\"PC-Yadav\"Advocate P. C. Yadav has explained the concept of “Most Appropriate Method” as referred to in section 92C of the Income-tax Act, 1961 read with Rule 10C of the Income-tax Rules. He has collated all the important judgements on the subject and pointed out the various factors that a taxpayer has to take into account while choosing one of the several methods to benchmark his international transaction and prove that it is at arm’s length<\/strong><\/p>\n

Most Appropriate Method- As per the discussions made in various case laws and rules of the Income Tax Rules:- In selecting most appropriate method the following factors shall be taken into account <\/p>\n

What method is to be applied or what method not to be applied is always a point of dispute in transfer pricing matters. The undersigned has tried to analyse this issue in the light of relevant provisions of law and recent development of case laws. It is my humble request to the readers of this note that if they think that I have missed certain things or case laws then they please update me so that I can improve my note.<\/p>\n

<\/p>\n

Recently the AP high Court in the case of Alumeco India Extrusion Ltd reported at TIOL = 2014-TII-33-HC-AP-TP<\/u><\/strong> has held that TPO cannot reject the method applied by assessee for computing the ALP without assigning any cogent reasons. <\/em>Earlier also so many courts have time and again has held that TPO is a quasi-judicial authority and hence he has to act in a judicious manner, he cannot act on his whims and fancies. <\/em> Therefore, what method would be appropriate for computing the Arm Length price of an International Transaction is an issue which requires deep study as it plays important role in the TP matters. The basic law on which the TP provisions are propounded is that a Country would get its legitimate taxes and the Taxpayer would also not be taxed in an unreasonable manner. That is why so many methods are prescribed under the provisions of Income Tax law (Act+ Rules). <\/p>\n

Selection of the most appropriate method for determining arm’s length price under the transfer pricing provisions, in a particular fact and situation, is not an academic exercise which can be decided de hors the peculiar facts of that situation, and, therefore, there cannot be any straight-jacket formula holding application of a particular method in case of a particular type of product or service. <\/p>\n

In fact the OECD guidelines and US regulations has introduced the Best Method rule and gave freedom to a taxpayer as well as to the revenue authorities to employ any of the method as Most Appropriate method, which is commonly used in Judicial orders in abbreviated form as (MAM). It is also not necessary for a taxpayer to go through all the methods to find out the most appropriate methods, the trained brains who have been entrusted with the task of taxation, depending on the facts of case, apply one of the methods to justify the Arm’s Length Price(ALP) of international transactions. <\/p>\n

The Special Bench of ITAT in the case of Aztec Software reported in 107 ITD 141(SB)<\/strong> has held that the selection of the most appropriate method (MAM) is based on the nature of transaction, the availability of relevant data and the possibility of making appropriate adjustments. <\/p>\n

Methods under the Indian Provisions- <\/p>\n

Section 92C of the Indian Income Tax<\/strong> provides about the methodology of computing the arm’s length price. It reads as under:-<\/strong><\/p>\n

(1) The arm’s length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following 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 :—<\/em><\/p>\n

\n (a) comparable uncontrolled price method;<\/em><\/p>\n

\n (b) resale price method;<\/em><\/p>\n

\n (c) cost plus method;<\/em><\/p>\n

\n (d) profit split method;<\/em><\/p>\n

\n (e) transactional net margin method;<\/em><\/p>\n

\n (f) such other method as may be prescribed by the Board.<\/em><\/p>\n

\n(2) The most appropriate method referred to in sub-section (1) shall be applied, for determination of arm’s length price, in the manner as may be prescribed<\/em>:<\/em><\/p>\n

\n Provided<\/strong> that where more than one price is determined by the most appropriate method, the arm’s length price shall be taken to be the arithmetical mean of such prices:<\/em><\/p>\n

Provided further<\/em><\/strong> that if the variation between the arm’s length price so determined and price at which the international transaction <\/em>or specified domestic transaction has actually been undertaken does not exceed <\/em>such percentage <\/em>not exceeding three per cent] of the latter, as may be notified<\/em><\/a><\/u><\/em> by the Central Government in the Official Gazette in this behalf], the price at which the international transaction <\/em>or specified domestic transaction] has actually been undertaken shall be deemed to be the arm’s length price.<\/em><\/p>\n

The following third proviso shall be inserted after the second proviso to sub-section (2) of section 92C by the Finance (No. 2) Act, 2014, w.e.f. 1-4-2015 :<\/em><\/strong><\/p>\n

Provided also<\/em><\/strong> that where more than one price is determined by the most appropriate method, the arm’s length price in relation to an international transaction or specified domestic transaction undertaken on or after the 1st day of April, 2014, shall be computed in such manner as may be prescribed and accordingly the first and second proviso shall not apply.<\/em><\/p>\n

Explanation.—For the removal of doubts, it is hereby clarified that the provisions of the second proviso shall also be applicable to all assessment or reassessment proceedings pending before an Assessing Officer as on the 1st day of October, 2009.<\/em><\/p>\n

(2A) Where the first proviso to sub-section (2) as it stood before its amendment by the Finance (No. 2) Act, 2009 (33 of 2009), is applicable in respect of an international transaction for an assessment year and the variation between the arithmetical mean referred to in the said proviso and the price at which such transaction has actually been undertaken exceeds five per cent of the arithmetical mean, then, the assessee shall not be entitled to exercise the option as referred to in the said proviso.<\/em><\/p>\n

(2B) Nothing contained in sub-section (2A) shall empower the Assessing Officer either to assess or reassess under section 147<\/u> or pass an order enhancing the assessment or reducing a refund already made or otherwise increasing the liability of the assessee under section 154<\/u> for any assessment year the proceedings of which have been completed before the 1st day of October, 2009.<\/em><\/p>\n

(3) Where during the course of any proceeding for the assessment of income, the Assessing Officer is, on the basis of material or information or document in his possession, of the opinion that—<\/em><\/p>\n

(a) the price charged or paid in an international transaction <\/em>or specified domestic transaction] has not been determined in accordance with sub-sections (1) and (2); or<\/em><\/p>\n

(b) any information and document relating to an international transaction or specified domestic transaction have not been kept and maintained by the assessee in accordance with the provisions contained in sub-section (1) of section 92D<\/u> and the rules made in this behalf; or<\/em><\/p>\n

(c) the information or data used in computation of the arm’s length price is not reliable or correct; or<\/em><\/p>\n

(d) the assessee has failed to furnish, within the specified time, any information or document which he was required to furnish by a notice issued under sub-section (3) of section 92D<\/u>,<\/em><\/p>\n

the Assessing Officer may proceed to determine the arm’s length price in relation to the said international transaction 99<\/u>[or specified domestic transaction] in accordance with sub-sections (1) and (2), on the basis of such material or information or document available with him:<\/em><\/p>\n

\n Provided<\/em><\/strong> that an opportunity shall be given by the Assessing Officer by serving a notice calling upon the assessee to show cause, on a date and time to be specified in the notice, why the arm’s length price should not be so determined on the basis of material or information or document in the possession of the Assessing Officer.<\/em><\/p>\n

\n (4) Where an arm’s length price is determined by the Assessing Officer under sub-section (3), the Assessing Officer may compute the total income of the assessee having regard to the arm’s length price so determined :<\/em><\/p>\n

\n Provided<\/em><\/strong> that no deduction under section 10A<\/u> 1<\/a><\/u>[or section 10AA<\/u>] or section 10B<\/u> or under Chapter VI-A shall be allowed in respect of the amount of income by which the total income of the assessee is enhanced after computation of income under this sub-section :<\/em><\/p>\n

\n Provided further<\/em><\/strong> that where the total income of an associated enterprise is computed under this sub-section on determination of the arm’s length price paid to another associated enterprise from which tax has been deducted <\/em>or was deductible] under the provisions of Chapter XVIIB, the income of the other associated enterprise shall not be recomputed by reason of such determination of arm’s length price in the case of the first mentioned enterprise.<\/em><\/p>\n

Relevant Rule applicable in this regard is as under-<\/strong><\/p>\n

While rule 10B(1) of the Income Tax Rules 1962, provides that arm’s length price in relation to an international transaction shall be determined by any of the methods, "being the most appropriate method", set out therein<\/strong>, <\/em><\/p>\n

Rule 10 C(1) provides the mechanism for selecting the most appropriate method "which is best suited to the facts and circumstances of each particular transaction" and "which provides the most reliable measure of arm’s length price of the international transaction"<\/strong>. <\/em><\/p>\n

Rule 10C (2) further provides that in selecting the most appropriate method as specified in rule 10C(1), certain factors are to be taken into account:<\/em> <\/p>\n

(a) the nature and class of the international transaction;<\/em> <\/p>\n

\n (b) the class or classes of associated enterprises entering into the transaction and the functions performed by them taking into account assets employed or to be employed and risks assumed by such enterprises;<\/em> <\/p>\n

\n (c) the availability, coverage and reliability of data necessary for application of the method;<\/em> <\/p>\n

\n (d) the degree of comparability existing between the international transaction and the uncontrolled transaction and between the enterprises entering into such transactions;<\/em> <\/p>\n

\n (e) the extent to which reliable and accurate adjustments can be made to account for differences, if any, between the international transaction and the comparable uncontrolled transaction or between the enterprises entering into such transactions; (f) the nature, extent and reliability of assumptions required to be made in application of a method [Emphasis, by underlining, supplied by us]<\/em><\/p>\n

\n Interpretation-<\/u><\/strong><\/p>\n

\n What is clear from the above analysis is that a method for determining arm’s length price, to be held as a ‘most appropriate method’ (MAM), should be, as provided in rule 10C(1)<\/strong>. <\/p>\n

\n A method "which is best suited to the facts and circumstances of each particular transaction" and a method and "which provides the most reliable measure of arm’s length price of the international transaction"<\/p>\n

\n Under rule 10C(2)(c)<\/strong>, "the availability, coverage and reliability of data necessary for application of the method" is one of the crucial factors determining suitability of a method of determination of arm’s length price in a particular fact situation. Similarly, it is also important to determine whether accurate adjustments can be made for the differences between the international transactions and the comparable uncontrolled transactions, and unless such adjustments can be made the related method cannot be said to be most appropriate method.<\/p>\n

\n Types of Method prescribed under Income Tax Act<\/u><\/strong><\/p>\n

\n CUP-Comparable Uncontrolled Price Method(CUP):- Rule 10B(a) lays down provisions about the CUP method.  <\/p>\n

\n This method is a direct method and always applicable where the facts and circumstances of two transactions are similar in all aspects. Generally speaking CUP is applied when a price charged for a product or service. Under this method prices charged in a controlled transaction is compared with the price charged for same or similar property or services transferred in a comparable uncontrolled transaction. Being a direct method CUP is give preference over the other methods. However, that does not mean that it will always prevail over the other methods, the applicability of the same requires high degree of comparability in terms of products sold & services provided <\/p>\n

\n In the OECD Guidelines for Multinational Enterprises and Tax Administrators<\/u><\/strong>, it is clearly stated that application of CUP method "requires high degree of comparability not only in the products sold and services provided but also in the economic circumstances in which the respective AE and non AE transactions take place". <\/em><\/p>\n

\n In the UN Transfer Pricing Manual<\/u><\/strong>, it is observed that "degree of comparability between controlled and uncontrolled transactions is typically determined on the basis of a number of attributes of the transactions or parties that could materially affect prices or profits and the adjustment that can be made to account for differences" <\/em>and then it is observed that "these attributes, which are usually referred to as the five comparability factors, include: (i) Characteristics of the property or service transferred; (ii) Functions performed by the parties taking into account assets employed and risks assumed, in short referred to as the "functional analysis" (iii) Contractual terms; (iv) Economic circumstances; and (v) Business strategies pursued". Clearly, therefore, the significant variations in economic circumstances and contractual terms can take seemingly comparable transactions outside the ambit of comparability.<\/em><\/p>\n

\n U.S.Regulations 1.482-3(b)(5) provide that when CUP method is to be applied on the basis of Public data, the following requirements must be met<\/p>\n