The Finance Minister, in his Budget speech in 2014, had announced that range concept for determination of arm’s length price (ALP) will be introduced in the Indian transfer pricing regime where there is adequate number of comparables for determination of ALP. Furthermore, it was announced that use of multiple year data will be permitted for undertaking comparability analysis.
Accordingly, on 21 May 2015, the CBDT released a draft proposal wherein it has prescribed the manner of ALP computation for any international or specified domestic transaction (SDT) entered into by tax payers on or after 1 April 2014 (i.e., from Assessment Year 2015–16).
This step of the new Government of introducing the usage of the range concept and multiple year data indicates its intention to reduce the complexities of doing business in India and reduce TP litigation.
Introduction of range concept is definitely a welcome step, as the range concept is better suited for skewed distributions (being more robust and sensible) vis-à-vis the arithmetic mean, which is largely influenced by outliers.
However, the proposed range concept (due to reasons mentioned below), requires to be relooked at by the CBDT, to make it more effective.
Proposed Range concept vis-à-vis international practice
A. Range proposed (i.e., 40% to 60% percentile) and interquartile range:
Inter-quartile range, being a robust measure of scale, provides a wider arm’s length range. The proposed range of 40th to 60th percentile is quite narrow to represent the margins prevailing in the industry and hence, will be less effective.
To bring applicability and effectiveness of range at par with international standards, modifying the range proposed to the interquartile range (i.e., 25% to 75%) will be advisable.
Comparing a proposed range concept with the interquartile range (using hypothetical data sets):
|40%–60% (proposed range) – (A)||12.20% to 19.00%||15.20% to 21.00%||11.60% to 19.20%||15.80% to 22.20%|
|Tested party margin (assumed) – (B)||13.00%||13.00%||13.00%||13.00%|
|Interquartile range – (C)||11.38% to 22.50%||7.00% to 25.50%||(-)7.50% to 36.25%||(-)1.25% to 39.75%|
|Whether the tested party margins falls within the range (40%–60%)||Yes||No||Yes||No|
|Whether the tested party margins falls within the interquartile||Yes||Yes||Yes||Yes|
As can be observed, the tested margin fits in the interquartile range in all the scenarios. The purpose of shifting from the current arithmetic mean to the range concept and the broad purpose of reducing unwanted and protracted litigation may not be well served if range is very narrow.
B. Minimum no. of comparables for applying range:
It is prescribed that for applying a range there should be minimum nine comparable entities. Practically, in some of the business segments, not more than two to three comparables are available. Hence, keeping a parameter of nine comparables seems very restrictive. Furthermore, reducing the minimum number of comparables will reduce complexity of uncertainty during the time of audit of acceptance or rejection of comparables and thereby, use of arithmetic mean instead of range. Accordingly, reducing the requirement of minimum number of comparable entities will be advisable.
C. Methods for applying range:
It is prescribed that the range will be applied only when either of TNMM, CPM or RPM is used. It is pertinent to note here that even while applying the “CUP Method”, “PSM” and “Other method” there can be cases wherein two or more comparables may exist and therefore, the range concept should be made flexible to cover all the methods wherever it can provide economic justification.
D. Multiple year data (read in connection to para C):
Another condition for applying range is of presence of minimum two out of three years’ data. While using TNMM, CPM and RPM methods, use of two out of three years’ data is advisable and practical. However, while applying “CUP method”, “PSM method” “Other method”, use of multiple years will not be advisable or even practical.
Multiple year data (the classic issue addressed):
The proposed scheme of CBDT for use of multiple year data is widely seen upon as a tool, which will finally put an end to all unwarranted debates and also as a step further toward synchronising the approach followed by both, the tax payers as well as revenue authorities for determination of ALP. The proposed rules mandate use of three years data, whereas use of two years data is permitted in certain scenarios.
Practically, it has been observed that, all three years data for a comparable may not be available due to various other reasons, in addition to the ones prescribed by the CBDT. Accordingly, use of two years data should be permitted in other scenarios as well (such as functional non-comparability in any one year; non-availability of segmental data for any one out of three years etc.,).
Furthermore, it is also mentioned that the current year data can be used during the transfer pricing audit. Indian TP regulations require that as far as possible, the data relied upon should be “contemporaneous”. Accordingly, data available at the time of filing of return will only be allowed.
It will be interesting to see whether and to what extent CBDT incorporates suggestions/comments of various stakeholders that were asked to be submitted by the CBDT by 31 May 2015.