Range Concept and Multi-year data
Introduction:-
Since the
time the Transfer Pricing (TP) provisions were first introduced in India in
2001 and the concept of the arm’s length price introduced, taxpayers have been
grappling with issues arising from the requirement to use the arithmetic mean
to defend the arm’s length nature of their transactions.
This
approach leads to the single point of ALP instead of a range and did not
provide any flexibility to the taxpayers.
So, Shri Arun
Jaitley in the Budget 2014, introduced range concept and allowed the use of
multiple year data in order to align the transfer pricing practices to the
transfer pricing practices followed in the developed economies like U.S,
Australia, UK etc.
The rules are applicable for both international
transactions and specified domestic transactions (SDT).
So let’s understand how Range concept
is flexible to the taxpayers
Range Concept:-
Previously
when we calculate the ALP, we will be using Arithmetic Mean of the comparables
and then we arrive at the ALP. This allows the prices or margins to be compared
with the point rather than a range.
The Range
concept is applicable for all the transactions including international
transactions and specified transactions from Apr 2014.
The range
concept is used for all the methods except the Profit Split Method (PSM) and
the “other method”.
In other
words, Arithmetic Mean concept has to be used for calculating the Arms Length
Price (ALP) under PLM or other method.
There should
be a minimum of 6 comparables for applicability of Range concept.
If the
number of comparables less than 6 then arithmetic concept is applicable.
The arms
length range is defined as 35th percentile and the 65th
percentile of the dataset arranged in the ascending order.
If the
transaction falls within this range, then it is deemed to be arms length price.
If the
transaction doesn’t fall between this, then the median of the dataset has to be
calculated.
In case the
provisions of sub-rule (4) of Rule 10CA are not applicable (i.e. if there are
less than 6 comparables, or if the MAM is calculated in accordance with PSM or
‘other method’ then the rule 10CA is not applicable)
In those cases,
arithmetic mean has to be calculated.
Rule 10B:-
The newly
introduced sub-rule (5) of the Rule 10B allows taxpayers to use multi-year data
instead of single year data.
So, the
taxpayers can use previous financial year data for comparability analysis only
when the current year data is not available to the taxpayer at the time of
filing of return.
However, if
the current year data becomes available during the course of transfer pricing
proceedings, then the same needs to be taken into account even if the current
year data is not available at the time of the filing of return of income.
Computation of Arm’s Length Price
(Rule 10CA):-
During the
assessment proceedings, if the data relating to the current year is available,
then the same needs to be considered irrespective of the fact that current year
data was not available at the time of the furnishing of the return of income.
Multiple
year data will be considered for the Computation of ALP irrespective of the
fact that range concept is applicable or not.
Where the
application of the MAM results in more than one uncontrolled price, then the
ALP has to be calculated as below:-
Data for the
current year in which the transaction has been undertaken and two years
preceding the financial has to be taken.
The dataset
has to be arranged in the ascending order.
Then the
weighted average of the prices for three years has to be calculated, which is
being depicted in the rules and also in the Illustration 1.
Data for the
current year should be compulsorily taken. The data for the previous years can
be taken only if passes through qualitative/quantitative filters.
In case
where the company is found incomparable for the current year in which the
transaction is undertaken by the taxpayer, the company cannot be acceptable as
comparable for the earlier years even if it is found to be comparable for the
earlier years.
The arm’s
length range will constitute of the values falling between 35th and
the 65th percentile of the comparable entries that are arranged in
the ascending order.
35th Percentile = Total
no. Of Entries * 35/100 (Lowest value in the dataset)
65th Percentile = Total
no. Of Entries * 65/100 (Highest value)
If the price
as calculated in the 35th Percentile is a whole number, then the 35th
percentile shall be the arithmetic mean of such value and the value immediately
succeeding in the dataset.
If the value
derived from the formula is not a whole
number, then the comparable entry in the next data place should be considered
as the 35th percentile.
The same has
to be followed for the 65th percentile and the 50th percentile
(Median).
If the price
at which an international transaction or specified domestic transaction has
actually been undertaken is within the range, the price at which the international
or specified domestic transaction is undertaken, it is deemed to be the arm’s
length price as per section 92C (1).
The price at
which an international transaction or the specified domestic transaction has
actually been undertaken is outside the arm’s length range referred in sub-rule
(4) of the rule 10 CA, the arm’s length price shall be taken to be the median
of the dataset.
If the
median is a whole number, it shall be the average of the prices of such value
and the next higher value.
If the provisions
of the sub-rule (4) of the Rule 10CA are not applicable then the arm’s length
price shall be the arithmetical mean of all the values included in the dataset,
provided the variation between the arm’s length price so determined and the
price at which an international transaction/specified domestic transaction has
actually been undertaken does not exceed 3% .
Illustration 1:-
S.No.
(1)
|
Name
of the Company
(2)
|
Year
1
(3)
|
Year
2
(4)
|
Year
3 (Current Year)
(5)
|
Aggregation
of OC and OP
(6)
|
Weighted
Average
(7)
|
1
|
A
|
OC=
200
OP
=30
|
OC=
300
OP
=35
|
OC=
450
OP
= 40
|
OC
= 950
OP
= 105
|
9.05
|
2
|
B
|
OC=
150
OP
=45
|
OC=
100
OP
=40
|
OC=
150
OP
=55
|
OC
= 400
OP
= 140
|
2.86
|
3
|
C
|
OC=
225
OP=
45
|
OC=
250
OP
=25
|
OC=
180
OP
=55
|
OC
= 655
OP
= 125
|
5.24
|
4
|
D
|
OC=
220
OP=
33
|
OC=
175
OP
=45
|
OC=
200
OP
=50
|
OC=
595
OP
= 128
|
4.65
|
5
|
E
|
OC=
140
OP
=10
|
OC=
150
OP
= 12
|
OC=
165
OP
= 28
|
OC
= 455
OP
= 50
|
9.1
|
6
|
F
|
OC=
75
OP
=10
|
OC=
115
OP
=15
|
OC=
155
OP
= 30
|
OC
=345
OP
= 55
|
6.27
|
7
|
G
|
OC=
150
OP
= 35
|
OC=
175
OP
= 30
|
OC=
225
OP
=45
|
OC
=550
OP
= 110
|
5
|
8
|
H
|
OC=
200
OP
=15
|
OC=
185
OP
=30
|
OC=
220
OP
=55
|
OC
= 605
OP
= 100
|
6.05
|
The dataset shall be constructed as
follows:-
S.No
|
1
|
2
|
3
|
4
|
5
|
6
|
7
|
8
|
Values
|
2.86
|
4.65
|
5
|
5.24
|
6.05
|
6.27
|
9.05
|
9.1
|
Total no.of
entries = 8
35th
Percentile is = 8*35/100 = 2.8
Since this
is not a whole number, the number succeeding the above no. is considered as the
35th percentile, i.e. 5.
65th
percentile is = 8*65/100 = 5.2
Since the
above no. Is not a whole number, the number succeeding the above no. will be
treated as 65th percentile, i.e. 6.27.
Therefore
the arms length range is 5 – 6.27.
So if the
transaction falls within this range, it is deemed to be the arms length price
and no adjustment is required.
If the
transaction falls outside this range, say 7.5, then the median has to be
calculated.
Median =
Total no. of entries * 50/100
= 8*50/100 = 4
Since this
is a whole number, the average of this value and the value succeeding this
value has to be calculated.
I.e. (5.24+6.05)/2
= 5.645.
Therefore
the arms length price is 5.645 and the necessary adjustment will be made.
Conclusion:-
The major
important drawback according to my observation is when the tax payer has taken
the comparable for the previous years and didn’t take the comparable for the
current year. However at the time of the assessment proceedings, the TPO added
the comparable for the current year and if the ALP differs significantly, then
this rule is not favourable to such assesses who are genuine in calculating the
arms length price.
And in the
developed economies like U.S use 25%-75%
as the arms length range and it didn’t specify the methods in which the
arms length range is applicable.
Also the
number of prior years has not been specified by the IRS.
However the
amended rules provide clarity and
flexibility in arriving at the arms length price of the transaction. It is
a sensible move by the government in bring the transfer pricing practices in
align with the practices followed by the developed economies.
The use of range concept, being a
statistical tool, enhances the reliability of analysis undertaken for
computation of ALP.
Use of
inter-quartile range is amongst the globally accepted best practice and also
closer to economic realities wherein prices, and or margins, are compared to
those within a range and not at to a
particular point.