The Government has finally notified the new set of rules for determination of Arm’s length price  (‘ALP’) under the Transfer pricing provisions. The new set of rules would also apply in relation to the international transaction entered during the fiscal 2014-15, for which Transfer pricing and filing compliance fall due by end of next month (30 November 2015)

The revised process of determination of ALP under the rules is summarized below:

(1) Arm’s Length Range concept introduced

Where the application of Most Appropriate method results in more than one price, then the Tax payer would have to construct a ‘data set’ for determination of arm’s length mean or range, as  applicable.

(2) The mean concept will apply for smaller data sets

Arm’s length range would apply if there are six or more entries in the data set and the mean would apply if the number is less than six.

(3) Multi-year data (current year+ 2 previous years) to be used for margin-based methods

Where the margin-based methods (i.e. Transaction Net margin method, cost plus method or Resale price method) are used for determination of ALP, then the weighted average margin for the current year (i.e. the year under analysis) and two prior years would have to be considered for determination of the arm’s length price (margin).

(4) Previous year data can be used for comparable selection

While applying the margin-based methods, if current year data is not available for a company, then its comparability would be analysed based on the previous year’s data, and if a company meets the comparability criteria, then two prior years’ data would be considered for constructing the data set.

(5) Comparable companies selected on Previous year data to be re-validated upon availability of current year data

While applying the margin-based methods, if a company is selected as a comparable based NOT on current year data, but instead on previous year data (as discussed under point 4 above),  and subsequently current year data for such a ‘comparable’  is available at the time of assessment, then the suitability for inclusion as a comparable would be re-determined based on current year data. If the current year data reveals that a selected company was not really a comparable, then such a company would have to be excluded from the analysis. Should the current year data however validate the selection, there is no provision to ‘update’ the weighted average margin of such a comparable with the current year’s result, as is the practice normally adopted by the Transfer Pricing officers currently.

(6) Range defined

Where the data set consists of six or more ‘entries’, then the values in data set lying between the 35th and 65th percentile would be regarded as the arm’s length range.

Practically, on account of the way the 35th and 65th percentile have been defined, the actual range would be slightly higher at both the lower and the higher bounds of the range, than the actual / ‘pure statistical’ values.

(7) Mean ALP to apply for smaller data sets

Where the number of the ‘entries’ in the data set is less than six, then the ALP would be determined at the mean of the values or a permitted deviation (not exceeding 3%) from such a mean, which may be notified.  This is the same as the method which was in use till now.

(8) No impact on Profit Split Method / Residual Method

The revised process would not impact the application of the Profit Split method and the ‘residual method’ – both rarely used in practice in the Indian context.

Our Comments

The introduction of the Arm’s length range concept and use of earlier years data are steps which are in line with the Taxpayers expectation, although the use of multi-year data can prove to be a double-edge sword and can result in unrealistically higher ALP in a period of secular decline in margins in an industry.

The new rules however would have little impact on the core of the Transfer Pricing problem being faced by Taxpayers, which revolve around the selection of comparables per se, with both Taxpayers and the Taxman seldom agreeing on comparables which are fit for inclusion / exclusion in the data set to be used for determining the ALP.