Search for Comparables Workshop on Transfer Pricing ICAI, Bangalore Chapter, 19 August 2006 Agenda Legislative framework Comparable Search Process Vishnu Bagri
Legislative Framework Determination of arm s length price (ALP) use of the most appropriate method amongst the prescribed ones most appropriate method to be applied in prescribed manner Criteria for selection of most appropriate method the nature and class of the international transaction; functions performed, assets employed and risks assumed by the associated enterprises; the availability, coverage and reliability of data necessary for application of the method; the degree of comparability; the extent to which reliable and accurate adjustments can be made to improve degree of comparability; the nature, extent and reliability of assumptions required to be made in application of a method.
Legislative Framework Application of the most appropriate method requires identification of price/margin in a comparable uncontrolled transaction performing adjustments to improve degree of comparability Factors for determining comparability specific characteristics of the property transferred or services provided functions performed, assets employed and risks assumed by the enterprises the contractual terms conditions prevailing in the markets in which the respective parties to the transactions operate, including the geographical location, legal framework, resource costs, competition, type of market, etc
Legislative Framework Comparable data the data to be used in analysing the comparability shall be the data relating to the financial year in which the international transaction has been entered into previous 2 years data can be adopted if such data reveals facts which could have an influence on the determination of transfer price Number of comparable transactions not specified in law provides for use of arithmetic mean of comparable prices to determine ALP assessee has option to adopt a range of +/- 5% from the arithmetic mean price Prescribed documentation includes a record of the comparability study
Comparable Search Process It is a series of steps. A scientific and objective approach provides quality documentation and acts as an effective audit defense tool. 1. Search strategy framework 2. Database search 3. Detailed review and elimination 4. Additional data search 5. Final comparable set 6. Financial analysis 7. Application of search results
Search Strategy Framework Factors of comparability characterization of entities choice of tested party Most appropriate method choice of method could also be influenced during the search process Project constraints data availability others Degree of comparability choice of rejection criteria Documentation standards
Database Search Should be considered if no internal comparables are available Choice of databases database of Indian companies Prowess and Capitaline database of foreign companies One Source Search approach use of query module audit trail Is the use of a database mandatory or select annual reports of companies would be sufficient?
Detailed Review & Elimination Review of company information information in database assess functional characterization of companies short-list potential comparables Use of an elimination matrix to document the process search-specific criteria functionally not comparable related party transactions non-comparable product / product range too broad inactive or sick companies
Additional Data Search Used to expand and / or validate potential comparables set client information trade associations industry analysts press & trade publications internet in-house knowledge
Final Comparable Set Review all information and finalize comparable set for application to tested party Additional reviews aimed to improve degree of comparability Evaluate need for adjustment to comparable data examples accounting inconsistencies asset intensity adjustments capacity utlization levels
Financial Analysis Select Profit Level Indicator Choice of PLI depends on method, economic circumstances and data availability gross margin (gross profit / turnover) operating margin (operating profit / turnover) total cost mark-up (operating profit / total cost) asset based methods (return on investment/capital/assets employed) Perform economic and / or financial adjustments
Application of Search Results Presentation of tested party results segmental margins Comparables PLI(s) should be compared to that of tested party use comparable PLIs and apply chosen method to determine arm s length price conclude on whether international transactions meet the arm s length standard discussion and explanation of variances effect the transfer pricing adjustment (if required) i.e. adjust total income in tax return
Concluding Remarks Transfer pricing assessment experience: documentation is critical internal comparable preferred authorities acknowledge database approach foreign comparables impose challenges in substantiation department evaluating access to a database of foreign companies Contentious issues use of prior-year data indirect indicators/secret comparables
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