Guidance Note Sec 92E Transfer Pricing

GUIDANCE NOTE ON REPORT
UNDER SECTION 92E OF
THE INCOME-TAX ACT, 1961
(TRANSFER PRICING)
[Based on the law as amended by the Finance Act, 2022]

(Revised 2022)

Committee on International Taxation
The Institute of Chartered Accountants of India
(Set up by an Act of Parliament)
New Delhi

i
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First Edition : April, 2002
Second Edition : February, 2008
Third Edition : February, 2013
Fourth Edition : August, 2013
Fifth Edition : October, 2016
Sixth Edition : October, 2017
Seventh Edition : November, 2019
Eighth Edition : August, 2020
Ninth Edition : October, 2022

Committee / Department : Committee on International Taxation

E-mail : citax@icai.in

Website : www.icai.org

Price :

ISBN No : 978-81-8441-108-9

Published by : The Publication Department on behalf of the
Institute of Chartered Accountants of India,
ICAI Bhawan, Post Box No. 7100,
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Printed by :

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 Foreword to the Ninth Edition
The Committee on International Taxation is one of the important non-
standing Committees of the Institute of Chartered Accountants of India
(ICAI). As a partner in nation building, ICAI through this Committee submits
Pre and Post-budget Memoranda pertaining to International Taxation. Apart
from the same, the Committee time to time examines the tax laws, rules,
circulars, notifications etc. relating to International taxation issued by the
CBDT and sends suitable suggestions for improvements. The Committee
also submits inputs/submissions to OECD from time to time on behalf of ICAI
which have been duly acknowledged by OECD. Besides conducting various
activities regularly like Diploma Course on International Taxation, oragnising
Workshops/Seminars/ Conferences/ Refresher Courses/ Residential course,
and preparing e-learning modules, one of the core activities of the Committee
is to release publications relating to international taxation and transfer pricing
and to revise its existing publication regularly.
The ICAI through Committee on International Taxation has been issuing
guidance for its members in respect of the Report under Section 92E of the
Income-tax Act, 1961. The obligation of the members of ICAI is to express
opinion on the accounts, records and documentation pertaining to
international transactions and specified domestic transactions and therefore,
it is expected from the members to have a through knowledge of transfer
pricing and recent developments. The Committee has brought out the ninth
edition of the Guidance Note on Report under Section 92E of the Income-tax
Act, 1961 in which all the amendments made upto Finance Act, 2022, have
been incorporated.
I appreciate the efforts of CA. Sanjay Kumar Agarwal, Chairman, CA. Cotha
S. Srinivas, Vice-Chairman and other members of the Committee on
International Taxation who took timely steps to revise the Guidance Note on
Report under section 92E of the Income Tax Act, 1961.
I hope this publication would provide a lot of insight on the reporting
requirements expected from members.

Place: New Delhi CA. (Dr.) Debashis Mitra
Date : 10-10-2022 President, ICAI
 Preface to the Ninth Edition
After opening up the economy the Government of India took note of the
possibility of manipulation of transfer pricing resulting in shifting of income
out of India on the one hand, and inadequacy of the then taxation regulations
in dealing with that, on the other hand. Consequently, to deal with such
situations in an effective manner, the Government, in 2001, introduced
comprehensive transfer pricing regulations as Chapter X of Income-tax
Act,1961(the Act), which deals with special anti-avoidance provisions
regarding international transaction. One of the innovative measures to
ensure self-compliance of the regulations was incorporation of requirement of
filing of accountant’s report as per section 92E of the Act read with Rule 10E
of Income Tax Rules, 1962 in Form 3CEB.
Even though the duty to comply with the transfer pricing regulation rest upon
the taxpayer, the responsibility of accountant is to examination of documents
and information and provides report thereon. In this revised publication the
committee has covered all the important update related to associated
enterprises, international transactions, guidance related to selection of most
appropriate methods, computation of ALP, adjustment thereof and
documentation etc.
In the emerging international transactions, some transactions are made
which may not have bearing on profit of the enterprise. In those cases,
identification of shifting of profit are to be identified and reported. Similarly,
Base Erosion and Profit Shifting (BEPS) Action Plan 8, 9 and 10 which deals
with intangible, Risk & Capital and high-risk transactions respectively explain
how transfer pricing outcome determined in accordance with the actual
conduct of related parties in context of contractual terms of transactions.
Another important development in the area of international taxation, which is
likely to impact transfer pricing concepts in future, is BEPS 2.0 pillar two
approach recommended by the Organisation for Economic Co-operation and
Development (OECD). The major objective of BEPS 2.0 pillar two is to
prevent jurisdictions having lower tax and shorter economic activities but
gaining higher tax advantages.
In this age of digitalisation of economic activities, long existing concepts of
taxation, including arm’s length principle are under threat. The way business
is being, and likely to be conducted, there are going to be newer challenges
to tax administrations and tax advisors in ensuring true and full compliance of
regulations. It is essential for the members of ICAI to be on top of the
developments. This Guidance Note may be helpful in achieving this goal.
I would like to express my sincere thanks to CA. (Dr.) Debashis Mitra
President, ICAI and CA. Aniket S. Talati, Vice-President, ICAI , for being a
guiding force behind all initiatives being taken by the Committee on
International Taxation.
I would also like to extend my appreciation to Mr. S. P. Singh (Ex-IRS) who
made sincere and timely efforts to update the Guidance Note in a
comprehensive manner. His experience as a member of the Expert group
constituted by the Government for drafting Transfer Pricing regulations and in
implementing the regulations were very useful in updating the Note. He was
actively assisted by CA. Ankit Arora. His efforts are highly appreciable. I
would also like to thank CA. Dilip Gupta, CA Harpreet Singh, CA. Naman
Shrimal, CA. Neha Gupta, CA. Parul Jolly, and CA. Raju Kumar for their
contribution in reviewing the revised draft of the publication.
I would also like to thank CA. Cotha S Srinivas, Vice-Chairman, Committee
on International Taxation of ICAI for his support in all activities of the
Committee. I gratefully acknowledge the assistance provided by the
Committee Council members CA. Chandrashekhar Vasant Chitale,
CA. Vishal Doshi, CA. Purushottamlal Khandelwal, CA. Mangesh Pandurang
Kinare, CA. Priti Savla, CA. Umesh Sharma, CA. Sridhar Muppala,
CA. Rajendra Kumar P, CA. Sushil Kumar Goyal, CA. Rohit Ruwatia,
CA. Anuj Goyal, CA. Gyan Chandra Misra, CA.(Dr.) Raj Chawla,
CA. Pramod Jain, CA. Charanjot Singh Nanda, CA.(Dr.) Sanjeev Kumar
Singhal, Shri Ritvik Ranjanam Pandey, Co-opted members: CA. Avinash
Gupta, CA. Rajat Sharma, CA. Mithilesh Sai Sannareddy, CA. Anup Kumar
Sanghai, CA. Kaushik Mukerjee, CA. Nandkishore Chidambar Hegde,
CA. Sanjay Bhattacharya, Special invitees: CA. Aseem Chawla, CA. Kriti
Chawla Khanna, CA. Gaurav Singhal, CA. Sachin Sinha, CA. Manoj Kumar
Mittal, CA. Smita Patni, CA. Ajay Rotti, CA. Akshay Kenkre, CA. Akshat
Maheshwari, CA. Dilip Gupta, CA. Naman Shrimal, CA. Hari Om Jindal,
CA. Deepender Kumar Agarwal, CA. Raju Kumar, CA. Parthasarathi
Dasgupta, CA. Tejveer Singh, CA. Raj Kumar Nahata, CA. Parul Jolly,
CA. Gaurav Geol, CA. Harpreet Singh, CA. Vikas Gupta, CA. Neha Gupta
and CA. Surinder Kumar Kalra.

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Last, but not the least, I appreciate the efforts made by CA. Mukta Kathuria
Verma, Secretary, Committee on International Taxation and CA. Vikas
Kumar, Assistant Secretary for coordinating the project and for rendering
technical and secretarial assistance.
I am hopeful that this revised edition will be of immense use to the members.
Place: New Delhi CA. Sanjay Kumar Agarwal
Date: 10-10-2022 Chairman,
Committee on International Taxation, ICAI

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 Foreword to the Eighth Edition
The emergence of unprecedented crisis due to Covid-19 pandemic has given
rise to significant economic challenges across the world. Amidst the spread
of the pandemic and the imposition of social and economic lockdowns, the
world has come to an abrupt halt which has impacted production, demand
and supply chain significantly.
The delayed closure of books of accounts and availability of limited
comparable data in public domain affects a suitable comparable transaction.
In the present situation, the use of the comparable data related to last two
financial years may not be the most ideal as those years were not disrupted
by COVID-19. The existing transfer pricing approach may therefore be
reviewed in current scenario which may consider the impact of significant
decrease in business activities. The potential comparable transactions,
comparability analysis including required adjustment therefore needs to be
made appropriately and the same needs to be documented so as to
substantiate the results.
In light of the Covid pandemic, the reporting and disclosure requirement
towards the international transactions is certainly challenging for the
members of Institute of chartered accountants of India (ICAI). The ICAI
through its Committee on International Taxation has been issuing guidance
for its members in respect of Report under Section 92E of the Income-tax
Act, 1961. The Committee has brought out the eighth edition of this
Guidance Note in which all the amendments made upto Finance Act, 2020
have been incorporated.
I would like to appreciate the efforts of CA. Nandkishore Chidamber Hegde,
Chairman, CA. G. Sekar, Vice-Chairman, and all members of the Committee
on International Taxation of ICAI for the initiative taken to revise the said
publication in a timely manner for the benefit of the members and other
stakeholders at large.
I am sure that this revised and updated publication would be of immense use
for our members practising in the area of Transfer Pricing in effectively
discharging their professional responsibilities.
Best Wishes,

Place: New Delhi CA. Atul Gupta
Date : 10-08-2020 President, ICAI
x
 Preface to the Eighth Edition
The objective of transfer pricing is to curb the practices of shifting profits from
associated entities in higher tax jurisdiction to associated entities in relatively
lower tax jurisdiction through intra-group trade which ultimately reduces an
MNE's worldwide taxes. The arm length price is a machinery provision which
determines what an independent party would have paid under the same or
similar circumstances. The transfer pricing analysis cannot be effective
without understanding the associated enterprises, nature of transactions,
industry, other regulatory factors. Also unlike many other countries, transfer
pricing documentation and reporting is a statutory obligation cast on
enterprises under the Income-tax act 1961.
This Guidance Note was last revised in the year 2019. Keeping in view, the
changes brought by the Finance Act 2020, the Committee on International
taxation thought it was important to keep the members appraised and
updated and thus decided to bring out the eighth edition of this Guidance
Note. I am confident that this will benefit members and will enable them to
discharge their reporting responsibilities.
I extend my thanks to CA. Atul Kumar Gupta, President and CA. Nihar N.
Jambusaria, Vice-President of the Institute of Chartered Accountants of India
for being a guiding force behind the activities being undertaken by the
Committee.
I also whole heartedly acknowledge the efforts undertaken by Mr. S.P. Singh,
Ex-IRS in revising this Guidance Note in a timely manner. Notably, Mr. S.P.
Singh had been a part of the team that conceptualized Transfer Pricing law
was introduced in India. We also appreciate the efforts of CA. Ankit Arora
who assisted him in revision of this Guidance Note. I must make a mention of
the large number of suggestions were received on the exposure draft of the
Guidance Note hosted on ICAI’s website. The team lead by Mr SP Singh was
pleased to examine each and every suggestion and recommended
incorporation as felt necessary. I thank the members who took out their
valuable time and shared their inputs/ observations with the Committee.
I am also grateful for the unstinted support provided by Vice-Chairman
CA. G. Sekar and also other Committee Council members CA. Tarun
Jamnadas Ghia, CA. Chandrashekhar Vasant Chitale, CA. Dayaniwas
Sharma, CA. Rajendra Kumar P, CA. Sushil Kumar Goyal, CA. Anuj Goyal,
CA. Kemisha Soni, CA. Satish Kumar Gupta, CA. Hans Raj Chugh,
CA. Pramod Jain, CA. (Dr.) Sanjeev Kumar Singhal, CA. Charanjot Singh
Nanda, Shri Manoj Pandey, Shri Chandra Wadhwa, Dr. Ravi Gupta;
Co-opted members: CA. Sachin Sastakar, CA. T.P. Ostwal, CA. Ujwal
Nagnath Landge, CA. B.M. Agrawal, CA. Nidhi Goyal and Special Invitees:
CA. Kriti Chawla and CA. Amar deep Singhal .
Last, but not the least, I appreciate the efforts made by CA. Mukta Kath uria
Verma, Secretary, Committee on International Taxation and CA. Vikas
Kumar, Assistant Secretary for co-ordinating the project and for rendering
secretarial assistance.
I am hopeful that this revised edition will be of immense use to the members.

Place: New Delhi CA. Nandkishore Chidamber Hegde
Date: 10-08-2020 Chairman
Committee on International Taxation, ICAI

xii
 Foreword to the Seventh Edition
Borderless economies and free trade order coupled with advancements in
information technology tools, have brought to the forefront numerous
opportunities for Chartered Accountants in the area of domestic and
International taxation. Sections 92A to 92F were inserted for the first time in
the Income-tax Act, 1961, in the year 2001. Since the time transfer pricing
was introduced in India; the Government is making amendments in the tax
laws every year to protect the revenue base.
The Institute of Chartered Accountants of India (ICAI) through its Committee
on International Taxation has been issuing guidance note for members to
equip them to deal with complexities involved in the laws of transfer pricing
which will enable them to effectively discharge their responsibilities towards
reporting requirements under section 92E of the Income-tax Act, 1961. The
publication “Guidance Note on Report under section 92E of the Income tax
Act, 1961 (Transfer Pricing)” has been updated in order to keep our members
abreast of changes that have taken place over the period of time.
My sincere appreciation for CA. Nihar N. Jambusaria, Chairman, CA. Pramod
Jain, Vice-Chairman and other members of Committee on International
taxation for initiating and completing the task of revising this publication in a
timely manner for the benefit of members and other stakeholders at large.
I am sure that this revised publication will be immensely useful and beneficial
for all the members by providing insight into the intricate issues in
discharging the reporting requirements of section 92E of the Act.

Place : New Delhi (CA. Prafulla P. Chhajed)
Date : November 6, 2019 President
 Preface to the Seventh Edition
Globalization is not new, but the pace of integration of national economies
and markets has increased substantially in recent years. It has a significant
impact on a country’s corporate income tax regimes. The increasing
participation of multinational groups in economic activities in India has given
rise to new and complex issues arising from transactions entered into
between two or more enterprises belonging to the same multinational group.
Transfer Pricing provisions thus have an important role to play.
In order to facilitate our members in effective discharge of their
responsibilities towards the reporting requirements of section 92E, the
Committee on International Taxation decided to revise its “Guidance Note on
Report under section 92E of the Income tax Act, 1961” The exposure draft of
this Guidance Note was hosted on ICAI’s website for inputs from members at
large. The suggestions so received have been considered and appropriately
incorporated.
I extend my thanks to CA. Prafulla Premsukh Chhajed, President and
CA. Atul Kumar Gupta, Vice-President of the Institute of Chartered
Accountants of India for being a guiding force behind the activities being
undertaken by the Committee.
I place on record my deep appreciation for the efforts of CA. Arun Saripalli
for his contribution towards this revised seventh edition of the publication. I
also extend my appreciation to his team members CA. Hema Panchal,
CA. Sunny Bilaney, CA. Abhishek Gupta, CA. Abhay Saboo, CA. Keyur
Shah, CA. Mit Gaglani, CA. Bipin Pawar and CA. Prajvit Shetty who
supported him in the revision process.
My sincere thanks to CA. Manoj Pardasani who spared his valuable time to
review this revised Guidance Note.
I express my gratitude to CA. Pramod Jain, Vice-Chairman of the Committee
and also other Committee Council members, CA. Tarun Jamnadas Ghia,
CA. Nandkishore Chidamber Hegde, CA. Chandrashekhar Vasant Chitale,
CA. Aniket Sunil Talati, CA. Dayaniwas Sharma, CA. G Sekar, CA. Pramod
Kumar Boob, CA. Satish Kumar Gupta, CA. Hans Raj Chugh, Shri Sunil
Kanoria, Shri Chandra Wadhwa, Dr. Ravi Gupta, co-opted members CA. T.P.
Ostwal, CA. Padam Khincha, CA. Ameya Kunte and CA. Yogesh Thar who
have contributed towards revision of this Guidance Note by providing their
valuable inputs.
I also appreciate the efforts made by CA. Mukta Kathuria Verma, Secretary
Committee on International Taxation, CA. Vikas Kumar, Assistant Secretary
and team members of the Secretariat of Committee on International Taxation
for effectively co-ordinating this project. For sure, this revised seventh edition
of the Guidance Note also, will be of immense use to our members, like the
earlier ones.

Place: New Delhi CA. Nihar N. Jambusaria
Date : November 5, 2019 Chairman
Committee on International Taxation of ICAI

xvi
 Foreword to the Sixth Edition
Since 2001, when sections 92A to 92F were inserted for the first time in the
Income-tax Act, 1961, there has been rapid evolvement of the field of
Transfer Pricing. Application of the complex provisions of transfer pricing
require determination of proper income arising from international transactions
where either or both the parties involved happen to be non-resident(s).
Global existence of the multinational enterprises has augmented the number
of cross border transactions with the associated enterprises. At the same
time, the related law has also evolved and has posed various challenges for
stakeholders.
The responsibility of examining the records and issuing the report under
section 92E is on our members. Laws in respect of transfer pricing are
complex but our members have been discharging their responsibilities ably.
ICAI too guides its members in respect of the ever changing complex laws of
Transfer Pricing. This Guidance note on Report under section 92E of the
Income tax Act, 1961 provides guidance to the members in this regard.
The publication was last revised in the year 2016. However, in order to keep
our members updated, the Committee on International Taxation of ICAI took
up the task of revising the publication this year also.
It is a pleasure to note that Committee on International Taxation of ICAI has
brought out the sixth edition of “Guidance Note on report under section 92E
of the Income-tax Act, 1961 (Transfer Pricing)” in a timely manner. I
compliment CA. Sanjiv K. Chaudhary, Chairman, Committee on International
Taxation of ICAI and CA. N.C. Hegde, Vice-Chairman, Committee on
International taxation for initiating and completing the task of revising this
publication in a timely manner.
The revised edition of the Guidance Note will surely be of immense use to
the members as it will assist them in fulfilling their attest function in ably
manner.

Place : New Delhi CA. Nilesh S. Vikamsey
Date : October 30, 2017 President
xviii
 Preface to the Sixth Edition
Taxation laws pertaining to cross border transactions have always been
complex as also interesting. Frequent changes in the taxation laws have
made the area more dynamic. Having dynamism and the complexity
involved, over a period of time, Transfer Pricing has surfaced as a distinct
area of practice for our members.
The onerous responsibility of examining the records and thereafter issuing
Report in Form No. 3CEB under section 92E of the Income tax Act, 2017 is
being discharged efficiently by our members. Time and again changes in law
pose challenges which are to be addressed in a most professional manner.
In order to guide and support the members, ICAI through its dedicated
Committee on International Taxation takes all efforts in the said direction.
Issuance of this revised version of the “Guidance Note on Report under
section 92E of the Income tax Act, 1961” is also a step in the said direction.
Even though the Guidance Note was recently revised in the year 2016,
considering the changes effected by the Finance Act, 2017 and OECD TP
Guidelines (2017), the Committee thought it fit to update the same this year
also. The exposure draft of this Guidance Note was hosted on ICAI’s website
for inputs from members at large. The suggestions so received have been
considered and appropriately incorporated.
I extend my heartiest thanks to CA. Nilesh S. Vikamsey, President and
CA. Naveen N.D.Gupta, Vice-President of the Institute of Chartered
Accountants of India for being a guiding force behind the activities being
undertaken by the Committee.
I must place on record my deep appreciation for the efforts of CA. Vijay Iyer
and CA. Ashwin Vishwanathan for their contribution consecutively for the
third time towards revision of sixth edition. It is worthwhile to mention that
they had contributed in the revision of fourth edition and also the fifth edition.
I also extend my appreciation to their team members CA. Rahul Bansal and
CA. Sriram Soundararajan who supported them in the revision process.
My sincere thanks to CA. Manoj Pardasani and Ms. Esha Tuteja who spared
their valuable time to review this revised Guidance Note. For sure the well-
timed inputs from all these experts have resulted in timely issuance of this
Guidance Note.
I express my gratitude to CA. N.C. Hegde, Vice-Chairman of the Committee
and also other Committee Council members, CA. Prafulla Premsukh Chhajed
CA. Tarun Jamnadas Ghia, CA. Nihar Niranjan Jambusaria, CA. Dhinal
Ashvinbhai Shah, CA. Madhukar Narayan Hiregange, CA. G. Sekar,
CA. Sushil Kumar Goyal, CA. Mukesh Singh Kushwah, CA. Sanjay Kumar
Agarwal, CA. Atul Kumar Gupta, Shri Sunil Kanoria and Dr. Ravi Gupta;
Co-opted members CA. Dharini Shah, CA. Pinky Mehta, CA.Mahesh
P. Sarda, CA G. Karthikeyan and CA. Gopal Choudhury; and special invitees
CA. Parul Jolly, CA. T G Suresh, CA. Surabhi Agarwal, CA. Arun Gupta and
CA. Vipin Verma who have contributed by giving valuable inputs in revising
this Guidance Note.
Last but not the least, I appreciate the efforts made by CA. Mukta Kathuria
Verma, Secretary Committee on International Taxation, CA. Vikas Kumar,
Assistant Secretary and team members of the Secretariat of Committee on
International taxation for effectively co-ordinating this project. For sure, this
revised sixth edition of the Guidance Note also, will be of immense use to our
members, like the earlier ones.

Place: New Delhi CA. Sanjiv K. Chaudhary
Date: October 30, 2017 Chairman
Committee on International Taxation of ICAI

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 Foreword to the Fifth Edition
Change is inevitable when it comes to Indian tax laws. Time and again,
frequent changes in laws have presented their own challenges before our
members. Increasing cross border transactions, use of technology and the
like have added more complexity to the tax laws. With increase in number of
multinational companies having subsidiaries and branches all over the world,
there has been a tremendous augment in the number of transactions with the
associated enterprises.
Our members have an onerous responsibility of examining the documents so
maintained by the enterprises operating in India and express an opinion
thereof in Form No.3CEB with regard to the compliance of the legal
requirements. This Guidance note provides a support to the members in
respect of the manner of exercising due diligence while inspecting
international transactions and also specified domestic transactions. The
document was last revised in the year 2013.Since then many changes have
been made in the related rules.
I am pleased to mention that Committee on International Taxation of ICAI
has done a commendable task by bringing out with the fifth edition of
“Guidance Note on report under section 92E of the Income-tax Act, 1961
(Transfer Pricing)”. With these little steps, ICAI endeavors to ensure that its
members are always well equipped to face challenges in this complex area
also.
I compliment CA. Nihar Niranjan Jambusaria, Chairman and CA. Sanjiv K.
Chaudhary, Vice-Chairman, Committee on International taxation of ICAI for
taking this initiative to revise the publication.
I am sure that the revised edition of the Guidance Note will be immensely
useful to the members in discharging their attest function in an effective
manner.

Place : New Delhi CA. M. Devaraja Reddy,
Date : October 28, 2016 President
 Preface to the Fifth Edition
With the increased level of cross border transactions and Capital mobility,
Transfer Pricing has emerged as a distinct field of practice for our members.
In fact, our professionals have been taking up the challenges involved in this
area with great spirit. ICAI too is duty bound to support them in respect of the
required knowledge up-dation. The Committee on International Taxation of
ICAI which is dedicated Committee for this field is making all efforts to
update the members in this area.
The recently launched Diploma in International Taxation imparts 60 hours out
of 120 hours of Professional training in Transfer Pricing by various experts in
the field. The Committee has been regularly contributing in the CA Journal
for up-dation of its members. Apart from the above there have been one day
or two days programmes that are organized in respect of International
Taxation.
One of the important effort made by the Committee for providing guidance to
the members in discharging their reporting responsibility in an effective
manner is to revise the Guidance Note on Report under section 92E of the
Income-tax Act, 1961(Transfer Pricing). This Guidance Note was last revised
in August 2013, when Part C was inserted in Form No.3CEB to report
specified domestic transactions under section 92BA. Since then there hav e
been various developments in law; identifying some; notification of safe
harbor rules in respect of arm’s length price under section 92C or section
92CA; notification of provisions/rules for roll back mechanism; range concept
and use of multiple year data for determination of arm’s length price;
increased threshold limit for the applicability of the specified domestic
transaction and the like. This revised version of the Guidance Note contains
all these important changes for guidance of the members practicing in this
area.
My sincere thanks to CA. M. Devaraja Reddy, President and CA. Nilesh
Vikamsey, Vice-President of the Institute of Chartered Accountants of India
who have been the guiding force behind the revision of this publication.
I have no words to effectively appreciate the untiring efforts of CA. Vijay Iyer
and CA. Ashwin Vishwanathan who had not even extended their support in
revising the fourth edition but also this fifth edition of the Guidance Note. I
am also thankful to CA. Arun Saripalli and CA. Rachesh Kotak who spared
their valuable time to review this revised Guidance Note. The revised edition
would not have seen light of the day without their untiring efforts.
I express my gratitude to CA. Sanjiv Kumar Chaudhary, Vice-Chairman of the
Committee and also other Committee Council members CA. Tarun Jamnadas
Ghia, CA. Hegde Nandkishore, CA. Dhinal Ashvinbhai Shah, CA. Madhukar
Narayan Hiregange, CA. G. Sekar, CA. Goyal Sushil Kumar, CA. Agrawal
Manu, CA. Soni Kemisha, CA. Sanjay Agarwal, CA. Atul Kumar Gupta, Shri
Sunil Kanoria, Ms. Indu Malhotra and Co-opted members CA. Arpan Kiran
Mehta, CA. T G Suresh, Ms. Parul Jolly, CA. P V S S Prasad and CA.M V
Purushottama Rao who have contributed by giving valuable inputs in revising
this Guidance Note.
I appreciate the efforts made by CA. Mukta Kathuria Verma, Secretary
Committee on International Taxation and her team for co-ordinating this
project. I am sure that this revised guidance note will be useful to our
members in responsibly discharging their attest function.

Place : New Delhi CA. Nihar N. Jambusaria
Date : 28-10-2016 Chairman,
Committee on International Taxation of ICAI

xxiv
 Foreword to the Fourth Edition
Third edition of the Guidance Note on Report under section Sec. 92 E of the
Income Tax Act, 1961 (Transfer Pricing) (Based on the Law as amended by
the Finance Act, 2012) was approved by the Council on 11th February, 2013.
Under this Guidance note, Chapter 4A related to Specified Domestic
Transaction mentioned that if and when a new revised format of Form No.
3CEB is notified, contents of this Guidance Note may need to be reviewed,
and an addendum issued, or separate or amended Guidance Note issued.
Subsequent to this, there is a change in Form No. 3CEB for reporting
International Transactions between Associated Enterprises. Further Part C of
3CEB has been inserted to report Specified Domestic Transactions u/s 92
BA.
Therefore, urgent need to update the third edition of Guidance Note was
widely felt. The Guidance Note is mainly revised to give guidance to the
members for reporting the transaction between Associated Enterprises u/s
92E of Income Tax Act, 1961.
I express my appreciation to CA. Dhinal A Shah, Chairman, Committee on
International Taxation of ICAI for the initiative taken to revise the publication.
I thank to CA. Vijay Iyer, Mr. Ashwin Vishwanathan, CA. Nehal Sheth,
CA. Pradeep A for contribution in giving a concrete shape to this publication.
I am sure that as in the case of the earlier edition, this revised edition of the
Guidance Note will be immensely useful to the members in discharging their
responsibilities.

Place: New Delhi CA. Subodh Kumar Agrawal
Date: 1st August, 2013 President, ICAI
xxvi
 Preface to the Fourth Edition
With the increase in Cross Border transactions, particularly between
Associated Enterprises, the applicability of transfer pricing provisions under
Income Tax Act & other statues gained importance. Further, Finance Act,
2012 also introduced similar transfer provisions for domestic transactions.
This Guidance Note was revised in February, 2013. However no form was
prescribed for reporting specified domestic transactions u/s 92BA.
Now, rules relating to Transfer Pricing Provisions & reporting Form no. 3CEB
has been amended by Income Tax (Sixth amendment) Rules, 2013. Part-C to
Form no. 3CEB has also been inserted by this rule. Further, from Financial
Year 2013-14, Form no. 3CEB is required to be filed through e-filing before
the due date.
In view of above substantial reporting amendments, this Guidance Note is
again revised (Amendments made till 26/07/2013 have been considered) to
incorporate this changes & to provide guidance to members to their reporting
responsibility.
I am happy to state that CA. Vijay Iyer, Mr. Ashwin Vishwanathan, CA. Nehal
Sheth and CA. Pradeep A has readily accepted our request to revise the
edition. I place on record our sincere appreciation of the contribution made
by each of them.
I express my gratitude to CA. Subodh Kumar Agrawal, President and CA. K.
Raghu, Vice-President for their motivation and guidance. I thank CA. Sanjiv
Kumar Chaudhary Vice-Chairman, CA. Jay Ajit Chhaira, CA. Tarun
Jamnadas Ghia, CA. Nihar Niranjan Jambusaria, CA. Sanjeev Maheshwari,
CA. Shiwaji Bhikaji Zaware, CA. S. Santhana Krishnan, CA. G. Sekar, CA. J.
Venkateswarlu, CA. Manoj Fadnis, CA. Sanjay Agarwal, CA. Naveen N.D.
Gupta, CA. Vijay Kumar Gupta, Shri Manoj Kumar, Shri Bhaskar Chatterjee,
CA. T.P. Ostwal, CA. Gurunath Kanathur, CA. Mahesh P. Sarda, CA. Vivek
Newatia, CA. Kuntal Dave, CA. Rajneesh Agarwal, CA. Sachin Vasudeva
and CA. (Dr.) Girish Ahuja who have contributed by giving valuable inputs in
revising this Guidance Note.
I appreciate the efforts made by Mr. Ashish Bhansali, Secretary, Committee
on International Taxation for co-ordination and Mr. Govind Agarwal for
rendering secretarial assistance.
I am sure that this revised Guidance Note will be immensely helpful to
members in discharging their responsibilities.

Place: New Delhi CA. Dhinal A. Shah
Date: 1st August, 2013 Chairman,
Committee on International Taxation, ICAI

xxviii
 Foreword to the Third Edition
The law relating to transfer pricing is dynamic and the members of the
Institute are getting acquainted with the practical implications of the law and
the rules relating to transfer pricing. The Finance Act, 2012 has made major
Amendments such as Advance Pricing Agreement (APA), Specified Domestic
Transaction, Expansion of TPO Power etc.
Guidance has been introduced with regard to how the accountant should
exercise due diligence while inspecting international transactions in view of
the increased scope of the definition of International Transactions.
Therefore, the Committee on International Taxation decided to bring out this
revised edition Guidance Note on Report under Section 92E of the Income-
Tax Act, 1961 (Transfer Pricing) for its members.
The legal, Financial and accounting aspects relating transfer pricing are
highly complex and have global ramifications. It is indeed a matter of honour
to chartered accountants who have been given the onerous responsibility of
reporting on International as well as specified domestic transactions. I am
sure that the members will discharge this responsibility to the satisfaction of
the government.
I express my gratitude and appreciation to CA. Mahesh P. Sarda, Chairman,
Committee on International Taxation of ICAI for the initiative taken to revise
the publication. I thank CA. Sanjay Agarwal, Chairman, Direct Taxes
Committee and CA. Dhinal Shah, Vice-Chairman, Direct Taxes Committee
and convener for this publication for immense support provided by them.
I thank to CA. Vijay Iyer, Mr. Ashwin Vishwanathan, CA. Nehal Sheth,
CA. Pradeep A, CA. Manoj Pardarsani and CA. Esha Tuteja for contribution
in giving a concrete shape to this publication.
I am sure this book will be immensely useful and benefit all its readers by
providing an insight into the complex aspects of Transfer Pricing with due
clarity on the subject matter and in a simplified manner.

Place: New Delhi CA. Jaydeep Narendra Shah
Date: 11th February, 2013 President, ICAI
xxx
 Preface to the Third Edition
In the era of globalization, when multinational Enterprises (MNEs) have
branches, divisions, subsidiaries and offices operating across the globe; it is
common for them to transact goods and services from one jurisdiction to an
associated enterprise in another tax jurisdiction.
The Finance Act, 2012 has made significant changes such as Advance
Pricing Agreement (APA), expansion of Transfer Pricing Officer’s (TPO’s)
Power, amendments relating to penalties, etc. Also, the Finance Act, 2012
introduced a new section 92BA in the Income-tax Act. Such provisions deal
with the meaning of Specified Domestic Transaction. The proposed new
section 92BA provides the meaning of "specified domestic transaction" with
reference to which the income is computed under section 92 having regard to
the arm’s length price.
The members of our profession are expected to do the examination of the
information and documentation so maintained and expresses an opinion
thereof in Form No.3CEB as to the compliance of the legal requirements. The
report also requires opinion to be expressed about the truth and correctness
of the particulars given in the annexure to Form No. 3CEB.
Therefore, urgent need to update the publication was widely felt.
I am happy to state that CA. Dhinal Shah readily accepted our request to
revise the edition and who has been actively supported by CA. Vijay Iyer,
Mr. Ashwin Vishwanathan, CA. Nehal Sheth and CA. Pradeep A. I place on
record our sincere appreciation of the contribution made by each of them. I
thank CA. Manoj Pardarsani, for carrying out thorough vetting process and
who has been supported by CA. Esha Tuteja.
I thank CA. Sanjay Agarwal, Chairman, Direct Taxes Committee and its
Committee members for immense support provided by them.
I appreciate the efforts made by Mr. Ashish Bhansali, Secretary, Committee
on International Taxation and CA. Mukta K. Verma, Secretary, Direct Taxes
Committee for co-ordination and CA. Govind Agarwal for rendering
secretarial assistance.
I believe the efforts in bringing out this publication will get amply rewarded if
it proves to be useful to members of the Institute. It will be our endeavor to
revise the edition more frequently.

Place: New Delhi CA. Mahesh P. Sarda
Date: 11th February, 2013 Chairman,
Committee on International Taxation, ICAI

xxxii
 Foreword to the Second Edition
The first edition of the Guidance Note on Report on International
Transactions under section 92E of the Income-tax Act, 1961 (Transfer
Pricing) was published in the year 2002. Subsequent Finance Acts made
some significant amendments to the law relating to transfer pricing.
The globalization of the Indian economy has resulted in considerable
increase in foreign institutional investments, a huge expansion in the
production and service base and also a multiplicity of international
transactions. As a result of this development international taxation is
assuming great importance. The subject of international transaction covers a
wide spectrum like cross border transactions, e-commerce, Double Taxation
Avoidance Agreement, transfer pricing etc. Members of the Institute are more
and more required to deal with many issues related to transfer pricing.
Since the law relating to transfer pricing is in the process of development,
several new issues would naturally arise during the implementation of the
requirements of the legislation. Further, this branch of law is relatively new to
the Income-tax Act and it would take some time before the law gets settled
down.
During the course of about five years the members have gained experience
in dealing with the requirements of the law and the rules relating to transfer
pricing. It was thought fit that these insights could be incorporated in the
guidance note for the benefit of our members.
The Fiscal Laws Committee of the Institute constituted Study Groups in
Delhi, Chennai and Bangalore to analyse all the practical issues in-depth and
bring out the revised edition of the Guidance Note. I compliment the
Chairman, Fiscal Laws Committee CA. G. Ramaswamy for his initiatives in
getting the Guidance Note revised. I also record my appreciation for CA.
Padam Chand Khincha, Convenor of the Bangalore Study Group, CA. R.
Bupathy, Convenor of the Chennai Study Group and CA. Vijay Iyer,
Convenor of the Delhi Study Group for their sincere efforts in bringing out
this Guidance Note.

Date: 3.2.2008 Sunil Talati
Place: New Delhi President
xxxiv
 Preface to the Second Edition
Following the enactment of sections 92A to 92F in the Income-tax Act, 1961
providing for the computation of income from an international transaction
having regard to arm’s length price, by the Finance Act, 2001, some
significant amendments were made by the subsequent Finance Acts. These
amendments were made to address the issues arising out of the practical
implementation of the transfer pricing regulations.
The law relating to transfer pricing is in the process of evolution and t he
members of the Institute are getting acquainted with the practical implications
of the law and the rules relating to transfer pricing. Out of their practical
experience some important issues relating to determination of arm’s length
price, responsibilities of the Assessing Officer to determine the total income
of the assessee in conformity with the arm’s length price determined by the
Transfer Pricing Officer and maintenance and keeping of information and
documents relating to international transactions have arisen.
The Fiscal Laws Committee thought it fit to consider the above developments
in their proper prospective and incorporate them in the revised edition of the
Guidance Note. Accordingly, Study Groups were constituted in Delhi,
Chennai and Bangalore under the Convenorship of CA. Vijay Iyer, CA. R.
Bupathy and CA. Padam Chand Khincha respectively. The Study Groups
considered the matter in-depth and came out with their valuable inputs. I
must compliment CA. K. K. Chythanya, CA. Murali Mohan, CA. Nitin Garg,
CA. Shikha Gupta and CA. Tarun Arora, for their excellent contributions in
the preparation of this Guidance Note.
I express my gratitude to CA. Sunil Talati, President and CA. Ved Jain, Vice-
President for their motivation and guidance. I thank CA. K. Raghu, Council
Member, CA. Mahesh P. Sarda, Vice-Chairman and other members of the
Fiscal Laws Committee who have contributed in giving a concrete shape to
this Guidance Note.
I also appreciate CA. R. Devarajan, Secretary, Fiscal Laws Committee and
his team comprising Ms. Mukta Kathuria, Sr. Executive Officer and Mr. Y. S.
Rawat, Private Secretary for coordinating this project.
I am sure that as in the case of the earlier edition, this revised edition of the
Guidance Note will be useful to the members in discharging their
responsibilities.

Date: 3.2.2008 G. Ramaswamy
Place: New Delhi Chairman
Fiscal Laws Committee

xxxvi
 Foreword to the First Edition
The Finance Act, 2001 has introduced sections 92 to 92F in the Income-tax
Act, 1961 with effect from Assessment Year 2002-2003. These provisions
are commonly referred to as transfer pricing regulations.
Such provisions deal with the methods of computation of income from
international transactions, the documentation to be maintained by the
enterprises, certification by a chartered accountant and penalty for non-
compliance thereof. Every person who has entered into an international
transaction during a previous year shall obtain a report from a chartered
accountant and furnish such report on or before the specified date in the
prescribed form.
The legal, financial and accounting aspects relating to transfer pricing are
highly complex and have global ramifications. It is indeed a matter of honour
to chartered accountants who have been given the onerous responsibility of
reporting on international transactions. I am sure that the members will
discharge this responsibility to the satisfaction of the government.
The Fiscal Laws Committee has closely involved itself with transfer pricing
right from the stage of drafting of transfer pricing rules. It has constituted
study groups in Delhi and Bangalore, got the issues closely examined and
brought out this guidance note.
I record my appreciation for the initiatives taken by the Fiscal Laws
Committee and more particularly I thank Mr. T.N. Manoharan, Chairman of
the Committee, Mr. Ved Jain, Convenor of the Delhi Study Group and Mr.
Padam Chand Khincha, Convenor of the Bangalore Study Group for their
excellent efforts in bringing out this guidance note. I also appreciate Mr. R.
Devarajan, Secretary, Fiscal Laws Committee for his coordination of the
project.

Place: New Delhi Ashok Chandak
Date: 2.4.2002 President
xxxviii
 Preface to the First Edition
The Finance Act, 2001 has substituted a new section 92 and inserted
sections 92A to 92F with a view to compute income from an international
transaction having regard to arm’s length price. These provisions are
intended to facilitate determination of proper income arising from
international transactions where either or both the parties involved happen to
be non-resident(s). These provisions read with relevant rules 10A to 10E
stipulate the maintenance and keeping of information and documents by
persons entering into an international transaction. Further, an obligation is
cast under section 92E on every such person to obtain and furnish a report
from a Chartered Accountant.
The members of our profession are expected to do the examination of the
information and documentation so maintained and kept with effect from
assessment year 2002-03 and express an opinion thereof in Form No.3CEB
as to the compliance of the legal requirements. The report also requires
opinion to be expressed about the truth and correctness of the particulars
given in the annexure to Form No.3CEB.
The Fiscal Laws Committee has considered it appropriate to bring out this
Guidance Note for the benefit of the members so as to enable them to
perform their attest function under section 92E of the Income-tax Act in an
effective manner.
The inputs for this Guidance Note have been received from the Study Group
constituted in Bangalore with Shri Padamchand Kincha as the Convener and
from the Study Group constituted in Delhi with Shri Ved Jain as the
Convener. I must compliment Sarvshri Arjun Vaidyanathan, K. K. Chythanya,
D. Devaraj, S. Ramasubramanian, Rajendra Rao, Sandeep Dinodia, Sanjiv
K. Choudhary, K. R. Sekar, Tarun Arora, Vijay Iyer, H. Vishnumoorthi, and
the Conveners but for whose contributions the preparation of this Guidance
Note could not have fructified. Their devotion to the task has enabled the
bringing of the Guidance Note in a timely manner.
I express my gratitude to Shri Ashok Chandak, President and Shri R.
Bupathy, Vice-President for their motivation and guidance. I thank Mrs.
Bhavna G. Doshi, Vice Chairperson, Shri Sunil Goyal, Shri Jayant Gokhale,
Shri Gopal Dokania, members of the Fiscal Laws Committee, and the co-
opted members who have contributed in giving a final shape to this Guidance
Note. My sincere thanks are due to all the other Council Members, more
particularly, Shri N.V. Iyer for the valuable suggestions given. Many members
across the country have also sent in their comments and views for which I
remain thankful to them.
I will be failing in my duty if I do not acknowledge the initiative taken b y Shri
N.D. Gupta, Immediate Past President in ensuring the constitution of study
groups during 2001 and for the periodical guidance and persistent follow-up
on the progress of the guidance note till date.
Finally, my appreciation is due in abundance to Shri R Devarajan, Secretary,
Fiscal Laws Committee and his team comprising of Mrs. Ishita Sengupta,
Assistant Director of Studies and Shri Y. S. Rawat, Steno-typist for the
methodical and efficient manner in which the bringing out of the guidance
note was co-ordinated.
It is fervently desired that this effort of the Fiscal Laws Committee will prove
to be of immense use to the members in enabling them to discharge their
responsibility justifying the faith and confidence reposed on the profession by
the Government.

Date: 9th April, 2002 T. N. Manoharan
Place: New Delhi Chairman,
Fiscal Laws Committee

xl
 Contents
Particulars Page No.

Chapter 1 – Introduction 1–27
Legislative framework 1
Terms and abbreviations used 6
Objective of the Guidance Note 8
Applicability of the provisions 9

Chapter 2 - Responsibility of an Enterprise and the Accountant 28–39
Responsibility of an enterprise 28
Accountant’s responsibility 30
Professional misconduct 39

Chapter 3 - Associated Enterprise 40–54
Associated enterprises and deemed associated enterprises 40
Source definition [Section 92A(1)] 41
Deemed definition of Associated Enterprise [Section 92A(2)] 43
Relationship between Head Office and Permanent Establishment 52
(Branch Office and any fixed place of business)
Associated Enterprises in relation to ‘Specified Domestic 53
Transactions’ (SDT)

Chapter 4 - International Transaction 55–79
Definition 55
Tangible and Intangible property 69
Services, finances and costs etc. 73
Capital financing Transactions 76
Cost Contribution arrangement 76
Free of cost transfer of goods or services 77
Cross-border transactions- Interplay of section 9 and section 92A 78
Chapter 4A - Specified Domestic Transactions 80-86
Definition 80
Threshold limit 81

Chapter 5 - Arm’s Length Price 87–114
Meaning and determination 87
Uncontrolled transaction 95
Comparable uncontrolled transactions 96
Distinctive nature of the property and services 96
Analysis of functions performed 98
Analysis of assets employed 99
Analysis of risks assumed 100
Characterisation 101
Tested Party 103
Contractual terms 104
Market conditions 106
Business strategies, commercial considerations and economic 107
principles
Power of Assessing Officer 112

Chapter 6 - Methods of computation of arm’s length price 115-182
Meaning of relevant terms 115
Comparable Uncontrolled Price Method (CUP Method) 116
Resale Price Method (RPM) 124
Cost Plus Method (CPM) 136
Profit Split Method (PSM) 146
Transactional Net Margin Method (TNMM) 153
Other Method (OM) of determination of arm’s length price 166
Most appropriate method 168

Chapter 7 - Documentation and verification 183–211
Types of information and documents 183

xlii
Ownership, profile and business 184
Associated Enterprises relationship with the Assessee 189
Details of international transactions/Specified domestic transactions 191
Records having a bearing on international transaction/Specified 194
domestic transactions
Description of methods considered and working thereof 198
Relief from maintenance of specific records 202
Supporting documents 203
Contemporaneity of data 204
Master File 206
Country by Country Reporting (CbCR) 209

Chapter 8 – Penalties 212–218
Penalty for concealment of income or furnishing inaccurate 212
particulars thereof
Penalty for under reporting and misreporting of income 213
Immunity from imposition of penalty 214
Penalty for failure to keep and maintain information and documents 214
in respect of international transaction or specified domestic
transaction
Penalty for failure to furnish report under section 92E 216
Penalty for failure to furnish information or document under section 216
92D
Penalty for failure to furnish information or documents under section 216
286
Penalty for failure incorrect information in reports and certificates 217

Chapter 9 - Scope of examination under section 92E 219–249
Report under section 92E 219
Other aspects 224
Annexure to Form No.3CEB 225

Annexure 251–512
I. Statutory Provisions 251

xliii
II. Relevant Rules and Forms 277
III. Extracts from the Memorandum explaining the provisions of 370
the respective Finance Bill(s)
IV. Circulars 414
V. Mandatory Communication - Relevant Extracts from the Code 454
of Ethics.
VI. Revision of recommended scale of fee chargeable for the 469
professional assignments done by Chartered Accountants
VII. Standard on Auditing (SA) 610 (Revised) Using the Work of 488
Internal Auditors

xliv
 Clarification Regarding Authority
Attached to the Documents Issued
by the Institute
"Guidance Notes' are primarily designed to provide guidance to members on
matters which may arise in the course of their professional work and on
which they may desire assistance in resolving issues which may pose
difficulty. Guidance Notes are recommendatory in nature. A member should
ordinarily follow recommendations in a guidance note relating to an auditing
matter except where he is satisfied that in the circumstances of the case, it
may not be necessary to do so. Similarly, while discharging his attest
function, a member should examine whether the recommendations in a
guidance note relating to an accounting matter have been followed or not. If
the same have not been followed, the member should consider whether
keeping in view the circumstances of the case, a disclosure in his report is
necessary".
(Volume I of the Handbook of Auditing Pronouncements - Compendium of
Standards and Statements (4th Edition, 2007), page I - 5, Para 5)
 Chapter 1
Introduction
Legislative Framework
1.1 In an era of liberalization and globalization of trade and investment
and the emergence of digital economy, the perceptible results have been -
increase in the number of cross-border transactions and the complexity and
speed with which global business can be transacted.
1.2 When transactions are entered into between independent enterprises,
the consideration therefore is determined by market forces. However, when
associated enterprises deal with each other, it is possible that the
commercial and financial aspects of the transactions are not influenced by
external market forces but are determined based on internal factors. In such
a situation, when the transfer price agreed between the associated
enterprises does not reflect market forces and the arm’s length principle, the
profit arising from the transactions, the consequent tax liabilities of the
associated enterprises and the tax revenue of the host countries could be
distorted.
1.3 The existence of different tax rates and rules in different countries
offers a potential incentive to multinational enterprises to manipulate their
transfer prices to recognise lower profit in countries with higher tax rates and
vice versa. This can reduce the aggregate tax payable by the multinational
groups and increase the after tax returns available for distribution to
shareholders.
1.4 In India, the Act for a long time did not deal with this problem in a
detailed manner. The erstwhile section 92 sought to determine the amount of
profits which may reasonably be deemed to have been derived from a
business carried on between a resident and a non-resident which, owing to
the close connection between them is so arranged that it produced, to the
resident, either no profits or less than the ordinary profits which might be
expected to arise in that business in case the transaction would have been
entered into between two entities having no close connection. Besides,
sections 40A(2); 80IA(10) and 80IB(13) of the Act provide powers to the
Assessing Officer to interfere with the pricing or costing of certain
transactions in certain cases in order to determine the correct quantum of
deduction permissible.
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

1.5 The Finance Act, 2001, recognised that international transactions
between Associated Enterprises may not be subject to the same market
forces that shape relations between two independent firms, and therefore
introduced a set of provisions in Chapter X of the Act under the title "Special
Provisions relating to avoidance of tax”. The statutory framework attempts to
monitor transfer prices for goods, facilities and services in order to determine
that they confirm to the “arm’s length principle”. Not only has section 92 of
the Act been completely recast but new sections 92A to 92F have also been
introduced to meet the desired objective of ensuring that the local tax base of
a taxpayer is fair.
1.6 The relevant provisions contained in Chapter X (sections 92 to 92F)
of the Act and the provisions dealing with the levy of penalties for non-
compliance thereof are reproduced in Annexure I. The Finance Act, 2002
made certain changes to the provisions contained in sections 92A, 92C, 92F
and 271F. The Finance Act, 2006 further amended section 92C. Further, the
Finance Act, 2007 inserted sub-sections (3A) and (4) in section 92CA.
Finance Act 2009 amended the proviso to section 92C, provided for
constitution of the dispute resolution panel and empowered the Board to
formulate safe harbour rules. Finance Act 2011 amended the allowable
variation as per second proviso to section 92C(2) to be notified by the
Central Government, and made changes to Section 92CA. The Finance Act
2012 has introduced significant amendments including inter alia clarifying the
coverage of the term ‘international transactions’, expanding the scope of
transfer pricing provisions to specified domestic transactions (Section 92BA)
and providing an Advance Pricing Agreement framework (Section 92CC and
Section 92CD) empowering the transfer pricing officer to determine arm’s
length price of an international transaction noticed during the course of
proceedings before him, even if the said transaction has not been referred by
the Assessing Officer, provided such transaction has not been reported by
taxpayer as per requirement of Section 92E of the Income Tax Act, 1961
[Section 92CA(2B)] and expanding the scope of penalties and amending
Section 147 of the Act to provide that non-reporting of transaction in report
as per Section 92E would be deemed to be case of escapement of income.
Further, changes specifically in respect of arm’s length price determination
were introduced vide Finance (No. 2) Act 2014 and the Finance Act 2015.
The Finance Bill 2014 introduced the use of multiple year data and the
Finance Act (No. 2), 2014 introduced range concept for determination of
arm’s length price and roll-back mechanism for APA. The final rules in

2
 Introduction

relation to the range concept and use of multiple year data were notified by
the Central Board of Direct Taxes in October, 2015.
1.7 Further, section 92B extended application of transfer pricing
provisions to transaction entered by an Indian entity with a resident
independent third party under specified circumstances. The Finance Act
2015 increased the threshold limit for the applicability of specified domestic
transaction from INR 5 crores to INR 20 crores with effect from Financial
Year 2015-16.
1.8 The Finance Act 2016, in line with recommendations of the BEPS
Action Plan 13, inserted section 286 for furnishing of country-by-country
report and inserted proviso to section 92D(1) for maintenance of Master File,
with effect from Financial Year 2016-17. Further, relevant rules and forms for
country-by-country and Master File were notified on 31 October, 2017.
1.9 Further, the existing penalty provisions have been rationalised along
with insertion of additional penalties for non-furnishing/ maintenance of
country-by-country report and Master File.
1.10 The Finance Act 2017, amended the applicability of specified
domestic transactions compliance by excluding expenditure made to person
referred to in Sec. 40A(2)(b) of the Act, from the ambit of the definition.
1.11 Provisions regarding secondary adjustments and limitation on interest
deduction were introduced and inserted as new sections (92CE and 94B
respectively) vide Finance Act, 2017.Finance Act 2017 also introduced
section 271J for levying penalty on accountants for furnishing incorrect
information in reports or certificates furnished under any provisions of the Act
or the rules made thereunder.
1.12 The Finance (No. 2) Act, 2019 made amendments to section 92CD,
92CE, 92D and 286 of the Act. These amendments are as follows:
 Section 92CD (3) was amended to clarify that in cases where
assessment or reassessment has already been completed and
modified return of income has been filed by the tax payer under sub-
section (1) of section 92CD, the Assessing Officers shall pass an
order modifying the total income of the relevant assessment year
determined in such assessment or reassessment, having regard to
and in accordance with the APA. This amendment is applicable from
1 September, 2019.
Section 92CE was amended to give clarification with regard to
applicability of provision of secondary adjustment and to give an

3
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

option to assessee to make one-time payment (discussed in detail at
Para 1.27 of this chapter)
Section 286 of the Act was amended to give clarification regarding
definition of the “accounting year” so as to provide that the
accounting year in case of the alternate reporting entity (‘ARE’) of an
international group, the parent entity of which is not resident in India,
shall be the one applicable to the parent entity of ARE. The said
amendment will take effect retrospectively from the 1st April, 2017
and will, accordingly, apply in relation to the assessment year 2017-
18 and subsequent assessment years.
1.13 The Finance Act, 2020 made certain amendments to sections 92CB,
92CC, 92F and 94B. These amendments are as follows:
 Section 92CB and 92CC of the Act was amended to include
attribution of profits to the PE of a non-resident under clause (i) of
sub-section (1) of section 9 of the Act.
Section 92F of the Act amended the definition of term “specified date”
to mean the date one month prior to the due date for furnishing the
return of income under sub-section (1) of section 139 for the relevant
assessment year.
Section 94B of the Act was amended to exclude interest paid or
payable in respect of a debt issued by a lender which is a permanent
establishment in India of a non-resident, being a person engaged in
the business of banking.
On 17 June 2022, Central Board of Direct Taxes (‘CBDT’) has issued
Notification No. 66 /2022/F. No. 370142/26/2022-TPL. Vide this
Notification, the CBDT has extended the Safe Harbour Rules (‘SHR’)
to Assessment Year (‘AY’) 2022-23 relevant to the previous year
2021-22
1.14 Faceless Assessment: The Taxation and Other Laws (Relaxation and
Amendment of Certain Provisions) Act, 2020 amended section 92CA of the
Act and inserted clause (8) to (10) w.e.f from 1.11.2020 to extend the
provision of faceless assessment to transfer pricing also.
Sub-section (9) of the said section further provides that for the
purposes of giving effect to the aforesaid scheme, the Central
Government may by notification in the Official Gazette direct that any
of the provisions of the Act shall not apply or shall apply with such

4
 Introduction

exceptions, modifications and adaptations as may be specified. It was
provide that no direction shall be issued after the 31st day of March,
2022.
 By virtue of Finance Bill, 2022, the last date for issuing
directions/notification for faceless determination of arm's length price
under section 92CA, faceless Dispute Resolution Panel under 144C,
Faceless appeal/proceedings before the Appellate Tribunal under
section 253/section 255 of the IT Act have now been extended from
March 31, 2022 to March 31, 2024.
1.15 Non filing of repetitive appeals - A new section 158AB has been
inserted after section 158AA by the Finance Act, 2022 in order to prevent
filing of repetitive appeals. Section 158AB provides as below:
‘(1) Notwithstanding anything contained in this Act, where the
collegium is of the opinion that––
(a) any question of law arising in the case of an assessee for any
assessment year (such case being herein referred to as the
relevant case) is identical with a question of law arising,–– (i) in
his case for any other assessment year; or (ii) in the case of any
other assessee for any assessment year; and
(b) such question is pending before the jurisdictional High Court
under section 260A or the Supreme Court in an appeal under
section 261 or in a special leave petition under article 136 of the
Constitution, against the order of the Appellate Tribunal or the
jurisdictional High Court, as the case may be, which is in favour
of such assessee (such case being herein referred to as the
other case),
the collegium may, decide and inform the Principal Commissioner or
Commissioner not to file any appeal, at this stage, to the Appellate
Tribunal under sub-section (2) of section 253 or to the jurisdictional
High Court under sub-section (2) of section 260A in the relevant case
against the order of the Commissioner (Appeals) or the Appellate
Tribunal, as the case may be.
(2) The Principal Commissioner or the Commissioner shall, on receipt
of a communication from the collegium under sub-section (1), direct
the Assessing Officer to make an application to the Appellate Tribunal
or the jurisdictional High Court, as the case may be, in such form as
may be prescribed within a period of sixty days from the date of

5
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

receipt of the order of the Commissioner (Appeals) or within a period
of one hundred and twenty days from the date of receipt of the order
of the Appellate Tribunal, as the case may be, stating that an appeal
on the question of law arising in the 78 relevant case may be filed
when the decision on such question of law becomes final in the other
case.
These amendments are also included in the said Annexure. The Rules
prescribed in this regard by the Central Board of Direct Taxes are
reproduced in Annexure II. The relevant extracts from the Memorandum
explaining the provisions of the Finance Act, 2001, Finance Act, 2002,
Finance Act, 2006, Finance Act, 2007, Finance Act, 2009, Finance Act, 2011,
Finance Act 2012, Finance (No. 2) Act 2014, Finance Act 2015, Finance Act
2016, Finance Act, 2017, Finance (No. 2) Act, 2019 Finance Act 2020, The
Taxation And Other Laws (Relaxation And Amendment Of Certain
Provisions) Act, 2020 and Finance Act, 2022 are given in Annexure III. The
Central Board of Direct Taxes has issued Circulars explaining the provisions
and clarifying certain related aspects. These circulars are given in Annexure
IV.

Terms and abbreviations used
1.16 In this Guidance Note the following terms and abbreviations occur
often in the text. A brief explanation of such terms and abbreviations is given
below. Further, reference to a section without reference to the relevant Act
means that the section has reference to the Income-tax Act, 1961.
(a) Act
The Income-tax Act, 1961.
(b) Accountant
Accountant means a chartered accountant within the meaning of the
Chartered Accountants Act, 1949 and as referred to in section 288 of the Act.
(c) Arm’s Length Price (ALP)
ALP as defined under section 92F(ii) of the Act.
(d) AS
The Accounting Standards issued, prescribed and made mandatory by the
ICAI or as under section 2(2) of Companies Act, 2013 and the Companies
(Accounting Standards) Rules, 2006.

6
 Introduction

(e) AS (IT)
Income Computation and Disclosure Standards notified by the Central
Government under section 145(2) of the Act.
(f) SA
Standards on Auditing prescribed under Section 143(10) of the Companies
Act 2013.
(g) Associated enterprises (AEs)
An AE as defined under section 92A of the Act.
(h) APA
Advance Pricing Agreement
(i) BEPS
Base Erosion and Profit Shifting
(j) Board/ CBDT
The Central Board of Direct Taxes constituted under the Central Boards of
Revenue Act, 1963.
(k) Circular
A circular or instructions issued by the Board under section 119(1) of the Act.
(l) CUT
Comparable Uncontrolled transaction
(m) CUP Method
Comparable Uncontrolled Price Method
(n) RPM
Resale Price Method
(o) PSM
Profit Split Method
(p) CPM
Cost Plus Method
(q) TNMM
Transactional Net Margin Method

7
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

(r) Enterprise
An enterprise as defined under section 92F (iii) of the Act.
(s) ICAI
The Institute of Chartered Accountants of India.
(t) International transaction
International transaction as defined under section 92B of the Act.
(u) OECD
Organisation for Economic Co-operation and Development.
(v) OECD Guidelines
Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations by OECD - provides guidance on the application of the
"arm’s length principle"
(w) Report
The report of an accountant under section 92E of the Act.
(x) Rules
The Income-tax Rules, 1962.
(y) Specified date
Specified date as stipulated under clause (iv) of section 92F of the Act.
(z) Specified domestic transaction
Specified domestic transaction as defined under section 92BA of the Act.
(za) Transaction
A transaction as defined under section 92F(v) of the Act.
(zb) Transfer Pricing Officer (TPO)
An officer as defined in explanation to section 92CA.

Objective of the Guidance Note
1.17 The provisions relating to computation of income from international
transactions between AEs having regard to ALP are applicable with effect
from assessment year 2002-03. According to section 92E of the Act, every

8
 Introduction

person who has entered into an international transaction or a specified
domestic transaction 1 during a previous year shall obtain a report from an
accountant and furnish such report on or before the specified date in the
prescribed form. An accountant is required to discharge his function in this
regard from assessment year 2002-03.
1.18 The object of this guidance note is to provide guidance to
accountants in discharging their responsibilities under section 92E of the Act.
It intends to:
(i) assist in understanding the respective responsibilities of the taxpayer
enterprise and the accountant;
(ii) guide the accountant as to the nature and scope of information to be
obtained by him from the taxpayer enterprise to enable him to
conduct the examination;
(iii) provide guidance on the verification procedures to be adopted by the
accountant for giving the report and the prescribed particulars in the
annexure thereto; and
(iv) explain the circumstances where a disclosure or qualification or
disclaimer may be required from the accountant while giving his
report.

Applicability of the provisions
1.19 The provisions contained in Chapter X of the Act are applicable to an
international transaction entered into between two or more AEs either or both
of whom are non-residents. Also, in the case of a specified domestic
transaction, not being an international transaction as covered as per section
92BA of the Act these provisions are attracted.
1.20 International transaction covers transaction in the nature of purchase,
sale or lease of tangible or intangible property or provision of services or
lending or borrowing money or any other transaction having a bearing on the
profits and income, losses or assets of such enterprises and includes a
mutual agreement or arrangement between two or more AEs for the
allocation or apportionment of, or any contribution to, any cost or expense

1 The provisions relating to Specified Domestic Transactions are applicable with
effect from assessment year 2013-14.

9
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

incurred or to be incurred in connection with a benefit, service or facility
provided or to be provided to any one or more of such enterprises. Further,
the expression ‘international transaction’ has been clarified vide Finance Act
2012 with retrospective effect from 1 April 2002 to include a wide variety of
arrangements.
1.21 According to section 92B(2) of the Act, a transaction entered into by
an enterprise with a person other than an AE, shall be deemed to be a
transaction between two AEs if there exists a prior agreement in relation to
the relevant transaction between such other person and the AE or the terms
of the relevant transaction are determined in substance between such other
person and the AE. Consequently the provisions of this chapter shall apply
even in the aforementioned cases. This provision has been further amended
to include transactions irrespective of whether such unrelated person is a
resident or non-resident, as long as either the enterprise or the AE is non-
resident.
1.22 As per section 92(3), these provisions are not intended to be applied
in cases where the effect of application of these provisions reduces income
chargeable to tax in India or increases the loss, as the case may be.
1.23 Safe Harbour (Section 92CB of the Act)
The Finance Act 2009 empowered the Board to frame safe harbour rules.
Safe harbour means circumstances in which the tax authorities shall accept
the transfer price as declared by the taxpayer. The safe harbour rules (‘SHR’)
were notified in September 2013. In the rules, safe harbour rates were
prescribed for specific nature of international transactions.
The CBDT, vide a notification dated 7 June 2017, revised the existing SHRs
in India.
The revised SHRs apply for Assessment Year (AY) 2017-18 and two
immediately following AYs i.e. upto AY 2019-20. The earlier SHRs were
applicable from AY 2013-14 and four immediately following AYs i.e. upto AY
2017-18. For AY 2017-18, the taxpayer can choose from old or new rules
whichever is more beneficial.
CBDT by way of notification dated May 20, 2020 has extended provisions of
safe harbour rules to AYs 2020-21 and 2021-22 (Substituted for "assessment
years 2020-21 and 2021-22" by the Income-tax (Eighteenth Amendment)
Rules, 2022) as well.

10
 Introduction

1.24 Key highlights
Rationalisation of safe harbour rates -The safe harbour rates for all contract
services have been moderated.
Upper turnover threshold of INR 200 crore introduced for all contract service
providers [Software Development, (ITeS), KPO, R&D for IT and generic
pharmaceutical drugs].
Introduction of safe harbour for receipt of low value adding intra group
services- The safe harbour provisions have been extended to receipt of such
services by Indian entities under the revised SHRs. The revised SHRs in this
regard also lay down a requirement for the applicant to get the method of
cost pooling, exclusion of shareholder costs and duplicate costs from cost
pool and the reasonableness of the allocation keys used for allocation of
costs certified by an accountant. In this regard, the definition of an
accountant has also been incorporated in the revised SHRs.
Introduction of safe harbour rates on loans advanced in foreign currency -
The revised SHRs have prescribed safe harbour rates based on London
Inter-bank Offer Rate (LIBOR) for loans advanced to AEs denominated in
foreign currency and based on State Bank of India’s marginal cost of funds
lending rate for loans advanced to AEs denominated in INR. The revised
SHRs have also prescribed staggered rates (spread over the applicable base
rates) depending upon the credit rating of the overseas borrower, subject to
such credit ratings being approved by CRISIL (formerly Credit Rating
Information Services of India Limited)
1.25 The Safe harbour rates as per the old and new rules are tabulated
below:

11
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Categories of Safe harbour rates - Safe Harbour rates -
international old rules [as per sub revised rules [as per
transactions Rule (2) of rule 10TD sub Rule (2A) of rule
of Income-tax Rules, 10TD] applicable
1962] applicable from AY 2017-18
from AY 2013-14 to to AY 2019-20
AY 2017-18 (extended to be
applicable for AYs
2020-21 and 2021-22
also)
Provision of Software Operating profit Operating profit margin
development services margin to operating to operating expense
and Information expense where the
Technology Enabled where the aggregate value of
services (ITeS), with aggregate value of such transactions
insignificant risks such transactions does not exceed
does not exceed INR100 crore – not
a sum of INR500 less than 17 per
crore – not less cent
than 20 per cent where the
where the aggregate value of
aggregate value of such transactions
such transactions exceeds INR100
exceeds INR500 crore but does not
crore – not less exceed INR200
than 22 per cent. crore - not less
than 18 per cent.
Provision of KPO Operating profit The value of
services, with margin to operating international
insignificant risks expense not less than transaction does not
25 per cent exceed INR200 crore
and the operating profit
margin to operating
expense is –
Not less than 24
per cent, if the
employee cost to
operating expense

12
 Introduction

Categories of Safe harbour rates - Safe Harbour rates -
international old rules [as per sub revised rules [as per
transactions Rule (2) of rule 10TD sub Rule (2A) of rule
of Income-tax Rules, 10TD] applicable
1962] applicable from AY 2017-18
from AY 2013-14 to to AY 2019-20
AY 2017-18 (extended to be
applicable for AYs
2020-21 and 2021-22
also)
is at least 60 per
cent
Not less than 21
per cent, if the
employee cost to
operating expense
is 40 per cent or
more but less than
60 per cent; or
Not less than 18
per cent, if the
employee cost to
operating expense
does not exceed
40 per cent.
Provision of Intra- Interest rate equal to The threshold of INR50
group loan to Wholly or greater than the crore has been
Owned Subsidiary base rate of State removed
(WOS) Bank of India (SBI) as Different safe harbour
on 30th June of the rates have been
relevant previous prescribed for
year: Loan denominated
plus 150 basis in Indian Rupees
points where the (INR)
amount of loan Refer table 1 below
does not exceed Loan denominated
INR50 crore in foreign currency
plus 300 basis Refer table 1 below
points where

13
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Categories of Safe harbour rates - Safe Harbour rates -
international old rules [as per sub revised rules [as per
transactions Rule (2) of rule 10TD sub Rule (2A) of rule
of Income-tax Rules, 10TD] applicable
1962] applicable from AY 2017-18
from AY 2013-14 to to AY 2019-20
AY 2017-18 (extended to be
applicable for AYs
2020-21 and 2021-22
also)
amount of loan
exceeds INR50
crore
Provision of Corporate where the amount The differential rates of
guarantee to WOS guaranteed does 2 per cent and 1.75 per
not exceed cent have been
INR100 crore - moderated down to a
Commission or standard rate of 1 per
fee of 2 per cent cent irrespective of the
or more per amount guaranteed.
annum However the
where the amount requirement for the
guaranteed credit rating of the
exceeds INR100 borrower to be certified
crore, and the by a SEBI registered
credit rating of the agency and such credit
borrower, by a rating to be of
Securities and adequate to highest
Exchange Board safety still remains for
of India (SEBI) amount guaranteed
registered agency exceeding INR100
is of the adequate crore
to highest safety–
Commission or
fee of 1.75 per
cent or more per
annum
Provision of specified Operating profit The operating profit
contract research and margin to operating margin to operating

14
 Introduction

Categories of Safe harbour rates - Safe Harbour rates -
international old rules [as per sub revised rules [as per
transactions Rule (2) of rule 10TD sub Rule (2A) of rule
of Income-tax Rules, 10TD] applicable
1962] applicable from AY 2017-18
from AY 2013-14 to to AY 2019-20
AY 2017-18 (extended to be
applicable for AYs
2020-21 and 2021-22
also)
development services expense not less than expense not less than
(Contract R&D 30 per cent 24 per cent, where the
services), with value of the
insignificant risks, international
wholly or partly relating transaction does not
to software exceed INR200 crore.
development
Provision of contract Operating profit The operating profit
R&D services, with margin to operating margin to operating
insignificant risks, expense not less than expense not less than
wholly or partly relating 29 per cent 24 per cent, where the
to generic value of the
pharmaceutical drugs international
transaction does not
exceed INR200 crore.
Manufacture and Operating profit Operating profit margin
export of: margin to operating to operating expense:
core auto expense: not less than 12
components not less than 12 per cent
non-core auto per cent not less than 8.5
components not less than 8.5 per cent
where 90 per cent or per cent
more of total turnover
relates to Original
Equipment
Manufacturer sales
Receipt of low value- Aggregate value of
adding intra-group such transactions

15
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Categories of Safe harbour rates - Safe Harbour rates -
international old rules [as per sub revised rules [as per
transactions Rule (2) of rule 10TD sub Rule (2A) of rule
of Income-tax Rules, 10TD] applicable
1962] applicable from AY 2017-18
from AY 2013-14 to to AY 2019-20
AY 2017-18 (extended to be
applicable for AYs
2020-21 and 2021-22
also)
services (including a mark-up
not exceeding 5 per
cent), does not exceed
INR10 crore.
Method of cost pooling,
exclusion of
shareholder costs and
duplicate costs from
cost pool and the
reasonableness of the
allocation keys used
for allocation of costs
to be certified by an
accountant.

Table 1 – Safe harbour rates prescribed for loans advanced to AE
CRISIL credit rating Loan in INR - Interest Loan in Foreign
of AE rate not less than currency - Interest rate
one-year marginal not less than six-month
cost of funds lending London Inter-Bank Offer
rate of State Bank of Rate of the relevant
India as on 1 April of foreign currency as on
the relevant previous 30 September of the
year plus basis points relevant previous year
as below plus basis points as
below
between AAA to A or 175 basis points 150 basis points
its equivalent

16
 Introduction

CRISIL credit rating Loan in INR - Interest Loan in Foreign
of AE rate not less than currency - Interest rate
one-year marginal not less than six-month
cost of funds lending London Inter-Bank Offer
rate of State Bank of Rate of the relevant
India as on 1 April of foreign currency as on
the relevant previous 30 September of the
year plus basis points relevant previous year
as below plus basis points as
below
BBB-, BBB or BBB+ 325 basis points 300 basis points
or its equivalent
between BB to B or 475 basis points 450 basis points
its equivalent
between C to D or its 625 basis points 600 basis points
equivalent
Credit rating not 425 basis points 400 basis points
available and
aggregate amount of
loan advanced to all
AEs as on 31 March
of the relevant
previous year <
INR100 crore
Further, safe harbour provisions have also been prescribed for the following
specified domestic transactions:
S Nature of specified Circumstances
No. domestic transaction
1. Supply of electricity, The tariff in respect of supply of
transmission of electricity, electricity, transmission of electricity,
wheeling of electricity wheeling of electricity, as the case
referred to [in clause (i), (ii) may be, is determined [or the
or (iii) of rule 10THB, as the methodology for determination of the
case may be] tariff is approved] by the Appropriate
Commission in accordance with the
provisions of the Electricity Act, 2003
(36 of 2003).

17
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

S Nature of specified Circumstances
No. domestic transaction
2. Purchase of milk or milk The price of milk or milk products is
products referred to in determined at a rate which is fixed on
clause (iv) of rule 10THB. the basis of the quality of milk,
namely, fat content and Solid Not Fat
(SNF) content of milk; and-
(a) the said rate is irrespective of,-
(i) the quantity of milk
procured;
(ii) the percentage of shares
held by the members in
the co-operative society;
(iii) the voting power held by
the members in the
society; and
(b) such prices are routinely
declared by the cooperative
society in a transparent manner
and are available in public
domain.”.
To exercise the option of safe harbour, the taxpayer is required to file
specified form (Form No 3CEFA for International Transactions and Form 3
CEFB for Specified Domestic Transactions) with the AO on or before due
date of furnishing the return of income with required details for:
the relevant assessment year, in case the option is exercised only for
that assessment year; or
the first of the assessment years, in case the option is exercised f or
more than one assessment years.
The taxpayer can opt out of the safe harbour regime from the second year
onwards, by filing a declaration to that effect with the AO.
The revised safe harbour rules were applicable for a period of three years
until AY 2019-20. CBDT vide its power under section 92CB by way of
notification dated May 20, 2020 has extended provisions of safe harbour
rules to AY 2020-21 and AY 2021-22 as well.

18
 Introduction

1.26 APA (Section 92CC of the Act): Finance Act 2012 introduced APAs
wherein the Board, with the approval of the Central Government may enter
into APAs with any person to determine the ALP or specify the manner in
which the ALP is to be determined, in relation to an international transaction
to be entered into by that person. The scope is enhanced by Finance Act,
2020 to include income referred to in clause (i) of sub-section (1) of section
9.
APAs presents a proactive measure for resolving transfer pricing disputes in
a cooperative manner. The Indian APA regulations, in short, provide for the
following:
(a) Unilateral / bi-lateral/ multilateral APAs - Unilateral APA is an
arrangement between the taxpayer and the Indian tax administration
(CBDT) whilst a bilateral / multilateral APA involves not only the
taxpayer and the Indian tax administration but also the taxpayer’s
affiliates (with whom he transacts) and their tax administration.
(b) APA would be applicable for existing as well as new transactions. For
an existing transaction, the taxpayer seeking an APA needs to file its
application before the commencement of the fiscal year for which it
seeks to apply.
(c) The provision to provide for a roll back mechanism was brought into
the Act vide Finance Act (No. 2) 2014, with effect from 1 October
2014. The Board has announced detailed rules explaining the roll
back provisions and the procedure for giving effect to them. The roll
back is available for 4 previous years.
(d) There are procedures in place for renewal, amendments, withdrawals
and revisions of APA.
1.27 Roll-back provisions
The roll back provision was brought into the Act vide Finance (No. 2) Act
2014, with effect from 1 October, 2014. The Board has announced detailed
rules explaining the roll back provisions and the procedure for giving effect to
them. Apart from that, the Board has made another key amendment, wherein
pre-filing consultation has been made optional for the taxpayer.
Roll back is available for four previous years, preceding the first previous
year covered in the APA. Further:
 Application requesting for roll back should be made in Form 3CEDA
for the relevant roll back years.

19
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

International transactions covered under roll back should be same as
covered in the APA.
Return of income of the applicant for roll back year ought to be
furnished on or before the due date for filing return.
Accountant’s Report in Form 3CEB for the roll back years should
have been filed on or before the due date.
Roll back application should cover all the roll back years (i.e., the
years falling with the block of four years) in which the international
transaction has taken place.
Roll back provisions shall not be provided, in respect of an
international transaction, if the Income-tax Appellate Tribunal has
passed an order disposing off an appeal relating to determination of
ALP of the international transaction, at any time before signing of the
APA agreement; or application of roll back has the effect of reducing
total income or increasing the total loss.
 The manner of determining ALP in the roll back years with respect to
any particular international transaction will be same as the manner
agreed in the regular APA.
1.28 Annual Compliance Report (‘ACR’) and ACR Audit (Rule 10O and
10P)
Once the APA is entered into, the assesse is required to furnish ACR
to Director General of Income-tax (International Taxation) for each
year covered in the APA.
The ACR is required to be furnished in quadruplicate in Form 3CEF
for each year covered in the APA within 30 days from the due date of
filing return of income for that year or within 90 days of entering into
an APA whichever is later.
Director General of Income-tax (International Taxation) would send
one copy of ACR to competent authority of India, one copy to
Commissioner of Income-tax who has jurisdiction over the income-tax
assessment of the assesse and one copy to the Transfer Pricing
Officer having jurisdiction over the assesse
Transfer Pricing Officer would carry out compliance audit for each
year covered in the APA and shall furnish his compliance audit report
to Director General of Income-tax (International Taxation) in case of
unilateral APA and to the competent authority in case of bilateral or

20
 Introduction

multilateral APA within 6 months from end of the month in which ACR
is received by Transfer pricing Officer from Director General of
Income-tax (International Taxation)
Regular transfer pricing assessment of transactions covered under
APA would not be undertaken by the Transfer Pricing Officer
CBDT released its Third Report (2018-19)on APA in November 2019
(available at
https://www.incometaxindia.gov.in/Lists/Latest%20News/Attachments
/360/FINAL_ANNUAL_REPORT_29_11_19.pdf). As per the report a
total of 944 unilateral and 211 Bilateral APA were filed till date out of
which 271 (i.e. 240 unilateral and 31 bilateral) agreements were
signed with the taxpayer while remaining were in process. The
agreement signed covered diverse nature of transactions including
Provision of Software Development Services, Provision of IT enabled
Services, Receipt of Intra-group Services, Provision of Sales /after
Sales Support Services, Payment of Guarantee Fee and Merchanting
Trade. In majority of cases Transactional Net Margin Method was
followed, while there are a few cases where Profit Split Method was
followed. Further as per the Press release dated 31 st March 2022, 62
APAs were signed in 2021-22, 31 APAs were signed in the year
2020-21 and 57 APAs were signed in 2019-20. (Source CBDT
website:
https://incometaxindia.gov.in/Lists/Press%20Releases/Attachments/1
068/Press-Release-Signing-of-62-Advance-Pricing-Agreements-by-
CBDT-in-FY-2021-22-dated-31-03-2022.pdf)
1.29 Use of multiple year data and the range concept:
Central Board of Direct Taxes (CBDT) on October 20, 2015 issued the final
rules ie, Rule 10B(5) and Rule 10CA to give effect to the use of ‘multiple year
data’ and ‘range concept’. These rules are applicable to international
transactions and specified domestic transactions that are entered into by
taxpayers on or after 1 April, 2014. Rule 10CA contains illustrations of
application of the arm’s length range concept.
Multiple year data
 Multiple year data (of the comparable companies for the purpose of
comparability analysis) is applicable only in cases where Resale
Price Method (RPM), Cost Plus Method (CPM) or Transactional Net

21
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Margin Method (TNMM) has been selected as the Most Appropriate
Method.
 Thus, in cases where CUP, PSM or Other Method are selected as the
Most Appropriate Method, multiple year data of comparable
companies cannot be used.
 For each comparable selected (under RPM, CPM or TNMM), the data
of the current year is required to be considered. In case such data is
not available at the time of furnishing the return of income, data
pertaining to upto two preceding financial years may be used.
To illustrate, say if the current year is Year zero and the financial year
preceding that is Year 1 and the year prior to such year is Year 2,
then it is worth noting that the rules do not envisage a situation
wherein a comparable is selected only if it has data relating to Year 2.
 If a comparable is selected on the basis of preceding year data (say
Year 1 and Year 2), but is not found to be comparable for the current
year (Year 0) for qualitative or quantitative reasons, then such
comparable would need to be rejected from the data set.
 When using multiple year data, data for each comparable shall be the
weighted average of the selected years. An illustration explaining the
computation is provided below:
Year 0 Year 1 Year 2 Total
Operating 250 300 350 900 OP/TC for the
Profit comparable
Total Cost 1700 1800 1900 5400 would be 900/
5400 = 16.7%
 Further, the rules provides that in the event current year data
becomes available during the course of the assessment proceedings,
then the same shall be used by the TPO for the purpose of the
analysis.
Application of range
 As per the rules, the ‘range concept’ shall be applicable when: (a) the
MAM is either; Comparable Uncontrolled Price (CUP) Method, RPM,
CPM, or TNMM; and (b) there are at least 6 entries in the dataset.
Where these conditions are not fulfilled, ‘arithmetic mean’ shall
continue to apply, as before, along with the tolerance range benefit
(3% or 1%)

22
 Introduction

For determination of the range, the margins in the data set (i.e., set of
comparable companies) are required to be arranged in ascending order and
the arm’s length range would be data points lying between the 35th and 65th
percentile of the data set. The computation mechanism of range, is
explained by way of illustrations below:
Illustration 1: Where the data set comprises 7 data points (arranged in
ascending order), and the percentiles computed are not whole numbers
Percentile Formula Result Value to be selected
35th Total no. of data points in 2.45 3rd value*
dataset * 35% = [7 * 35%]
65th Total no. of data points in 4.55 5th value*
dataset * 65% = [7 * 65%]
Median Total no. of data points in 3.50 4th value*
datasets * 50% = [7 * 0.5]
* Value referred to here is the place value in the data set as arranged in ascending
order.
Illustration 2: Where the data set comprises 20 data points (arranged in
ascending order), and the percentiles computed are whole numbers.
Percentile Formula Result Value to be selected
35th Total no. of data points in 7 Mean of 7th & 8th value
dataset*35% = [20 * 35%]
65th Total no. of data points in 13 Mean of 13th & 14th
dataset*65% = [20* 65%] value
Median Total no. of data points in 10 Mean of 10th & 11th
datasets*50% = [20 * 0.5] value
If the transaction price falls within the range, then the same shall be deemed
to be the ALP. If the transaction price falls outside the range, the ALP shall
be taken to be the Median of the data set.
1.30 Three tier documentation structure
The three-tiered documentation structure (applicable with effect from
Financial Year 2016-17) would consist of a “Master File”, “Local File” and
“Country-by-Country Report” (CbC Report). The Master File seeks to capture
information regarding the taxpayer’s global operations and their transfer
pricing policies. Rule 10DA prescribes information to be furnished in Master
File and related rules. The Local File would capture entity-specific
information with reference to the related party transactions. In the Indian

23
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

context, the existing transfer pricing documentation requirements as per Rule
10D of the Income Tax Rules, 1962 (the Rules) already encompasses the
Local File requirements. The CbC Report would be applicable for large
multinational enterprises (MNEs) 2 and would capture key metrics of all
entities in the group such as revenue, taxes paid, capital employed,
headcount, etc (as defined in section 286 of the Act). Further, Rule 10DB
prescribes rules relating to CbC Report.
1.31 Secondary adjustment
Secondary adjustment means an adjustment in the books of accounts of the
taxpayer and its associated enterprise to reflect that the actual allocation of
profits between the taxpayer and its associated enterprise are consistent with
the transfer price determined as a result of primary adjustment, thereby
removing the imbalance between cash account and actual profit of the
taxpayer. The taxpayer shall be required to carry out secondary adjustment
where the primary adjustment to transfer price:
 has been made suo motu by the taxpayer in his return of income; or
made by the Assessing Officer or the appellate authority 3, as the case
may be has been accepted by the taxpayer; or
is determined by an advance pricing agreement entered into by the
taxpayer under section 92CC. Finance (No. 2) Act, 2019 amended
this clause to restrict the secondary adjustment provisions to only
those advance pricing agreements which have been signed on or
after 1 April 2017. This is a retrospective amendment meant to apply
from AY 2018-19; or
is made as per the safe harbour rules framed under section 92CB; or
is arising as a result of resolution of an assessment by way of the
mutual agreement procedure under an agreement entered into under
section 90 or 90A.

2 Having annual consolidated group turnover of over INR 5500 Crores million in the

immediately preceding financial year
3 Section 92CE of the Income Tax Act 1961 only refers to Assessing Officer but the

notification No GSR 590(E) [52/2017 (F.No. 370142/12/2017-TPL)], dated 15-6-2017
refers to Appellate Authority along with the Assessing Officer. The term Appellate
Authority has not been defined in the notification.

24
 Introduction

Where as a result of primary adjustment to the transfer price, there is an
increase in the total income or reduction in the loss, as the case may be, of
the taxpayer, the excess money which is available with its associated
enterprise, if not repatriated to India within the time as prescribed (see table
below), shall be deemed to be an advance made by the taxpayer to such
associated enterprise and the interest on such advance, shall be computed
as the income of the taxpayer, in the manner as prescribed4 below.
Type of primary Time limit for Applicable interest rate for
adjustment repatriation delayed receipts
Transaction in Transaction in
INR foreign currency
Adjustment made On or before One year Six month
by the Indian Tax 90 days from marginal cost of London Interbank
Authority and the date of fund lending Offered rate as of
accepted by the relevant order rate of State 30 September of
taxpayer Bank of India as the relevant FY
Suo-moto On or before of 1 April of the plus 300 basis
adjustment by 90 days from relevant FY plus points
the taxpayer the due date of 325 basis points
Adjustment filing return of
pursuant to, Safe income
Harbour (or modified
return as may
be applicable in
case of an
APA)
Adjustment On or before
pursuant to APA 90 days from:
a) from the
date of filing of
return of
income if the
APA has been
entered into on
or before the

4 Rules in relation to secondary adjustment provisions have been notified vide CBDT

Notification No. 52/2017, F.No.370142/12/2017 -TPL

25
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Type of primary Time limit for Applicable interest rate for
adjustment repatriation delayed receipts
Transaction in Transaction in
INR foreign currency
due date of
filing of return
for the relevant
previous year
(b) from the
end of the
month in which
the APA has
been entered
into if the said
agreement has
been entered
into after the
due date of
filing of return
for the relevant
previous year.
Adjustment On or before
pursuant to MAP ninety days
from the date
of giving effect
by the
Assessing
Officer under
rule 44H to the
resolution
arrived at
under MAP
Excess money means the difference between the arm’s length price
determined in primary adjustment and the price at which the international
transaction has actually been undertaken.
Primary adjustment to a transfer price means the determination of transfer
price in accordance with the arm’s length principle resulting in an increase in
the total income or reduction in the loss, as the case may be, of the taxpayer.

26
 Introduction

Finance (No. 2) Act, 2019 further amends section 92CE to:
 enable Assessee to repatriate excess money from any of the
Associated enterprises of the Assessee which is not resident in India;
and
 provide an option to Assessee to pay additional income-tax at the
rate of 18% on such excess money or part thereof which is not
repatriated to India, instead of treating it as deemed advance made
by the taxpayer to such associated enterprise and calculating the
interest income on such advance, as discussed in above table.
Secondary adjustment would not be applicable, if (i) the amount of primary
adjustment made in the case of a taxpayer in any previous year does not
exceed one crore rupees and (ii) the primary adjustment is made in respect
of an assessment year commencing on or before 1 April2016.5

5Finance (No. 2) Act, 2019, has made it clear that the two conditions relating to

applicability of secondary adjustment are alternate conditions by replacing the word
“and” with an “or”. Further this amendment is retrospective from assessment year
2018-19

27
 Chapter 2
Responsibility of an Enterprise and the
Accountant
Responsibility of an Enterprise
2.1 Section 92D provides that every person who has entered into an
international transaction or specified domestic transaction, during a previous
year, shall keep and maintain such information and documents, prescribed
by the Board, as will assist the Assessing Officer/ Transfer Pricing Officer to
compute the income arising from that transaction, having regard to the ALP.
2.1.1. Rule 10D prescribes the information and documents required to be
kept and maintained under section 92D ie, Local File. Further Rule 10DA
prescribes information and document to be kept and maintained under
proviso to sub-section (1) of section 92D ie, Master File. Master file needs to
be submitted to the prescribed authority on or before the due date for
furnishing the return of income as specified under sub-section (1) of section
139.
2.1.2. Section 286 provides that every parent entity or alternate reporting
entity (designated by parent) of an international group that is resident in
India, shall for every reporting accounting year, furnish a report in the form
and manner as may be prescribed, within the due date provided in Rule
10DB(4). In case of a constituent entity resident in India, the parent of which
is not resident in India, such entity shall notify whether it is the alternate
reporting entity of the international group or the details of the parent entity/
alternate reporting entity and the country of which such entities are resident.
Further, Rule 10DB prescribes rules relating to furnishing of CbC Report.
2.2 This responsibility of an enterprise to keep and maintain prescribed
documents arises because of its unique position of being in control and
custody of information that is necessary to verify whether the international
transaction or specified domestic transaction to which it was party was
carried out on the arm’s length principle.
2.3 OECD in Transfer Pricing Guidelines, 2017 asserts the three main
objectives of maintaining transfer pricing documentation:
 Responsibility of an Enterprise and the Accountant

“1. To ensure that taxpayers give appropriate consideration to
transfer pricing requirements in establishing prices and other
conditions for transactions between associated enterprises and in
reporting the income derived from such transactions in their tax
returns;
2. to provide tax administrations with the information necessary to
conduct an informed transfer pricing risk assessment; and
3. to provide tax administrations with useful information to employ in
conducting an appropriately thorough audit of the transfer pricing
practices of entities subject to tax in their jurisdiction, although it may
be necessary to supplement the documentation with additional
information as the audit progresses.”
2.4 The requirement to keep and maintain such information and
documents as prescribed in Rule 10D ie, Local File with respect to an
international transaction has, however, been waived in the case of those
persons who have entered into international transactions the aggregate value
of which, as recorded in the books of account, does not exceed one crore
rupees - Rule 10D(2).
2.5 Persons who are so exempted from the mandatory requirement of
keeping and maintaining information and documents prescribed as per Rule
10D shall, nevertheless, on the basis of the material in their possession,
have to substantiate that the income on the international transactions
entered into by them has been computed in accordance with the provisions
of section 92 -proviso to Rule 10D(2).
2.6 By virtue of sub-section (2) of section 92D, the Board is empowered
to prescribe the period for which the assessee must maintain the prescribed
information and records. Pursuant thereto, the Board has stipulated that the
prescribed information and documents prescribed as per Rule 10D (ie, Local
File) and Rule 10DA (ie, Master File) be kept and maintained for a period of
eight years from the end of the relevant assessment year - Rule 10D(5) and
Rule 10DA(7). For example: For Financial Year 2018-19, an Assessee has to
maintain prescribed information and documents for 8 years from the end of
the relevant assessment year (2019-20), i.e. until Financial Year 2028-29.
2.7 Under section 92D (3), the Assessing Officer or the Commissioner
(Appeals) during the course of any proceeding under the Act may require a
person who has entered into an international transaction or specified
domestic transaction to furnish any information or document, which he was
expected to maintain under section 92D (1). The person shall furnish the

29
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

information or document called for within thirty days from the date of receipt
of a notice issued in this regard.
2.8 Where, for any reason, the person is unable to produce the required
information or documents within the stipulated period of thirty days, the
Assessing Officer or Commissioner (Appeals) may, on an application made
by the person, extend the period by a further period or periods not
exceeding, in all, thirty days.
2.9 Under section 92E, every person who has entered into an
international transaction or specified domestic transaction during a previous
year shall obtain a report from an accountant and furnish such report on or
before the specified date in the prescribed form duly signed and verified in
the prescribed manner by such accountant and setting forth such particulars
as may be prescribed. "Specified date" means the date one month prior to
the due date for furnishing the return of income under sub-section (1) of
section 139 for the relevant assessment year.
The above-mentioned Explanation reads as under:
“In case of an assessee who is required to furnish a report referred to in
section 92E, the due date means the 31st day of October of the assessment
year.”

Accountant’s responsibility
2.10 The term “accountant” has been defined in clause (i) of section 92F
as under:
“accountant” shall have the same meaning as in the Explanation
below sub-section (2) of section 288.
The above-mentioned Explanation reads as under:
"accountant" means a chartered accountant as defined in clause (b)
of sub-section (1) of section 2 of the Chartered Accountants Act,
1949 (38 of 1949) who holds a valid certificate of practice under sub-
section (1) of section 6 of that Act, but does not include [except for
the purposes of representing the assessee under sub-section (1)]—
(a) in case of an assessee, being a company, the person who is not
eligible for appointment as an auditor of the said company in
accordance with the provisions of sub-section (3) of section 141
of the Companies Act, 2013 (18 of 2013); or

30
 Responsibility of an Enterprise and the Accountant

(b) in any other case,—
(i) the assessee himself or in case of the assessee, being a
firm or association of persons or Hindu undivided family,
any partner of the firm, or member of the association or the
family;
(ii) in case of the assessee, being a trust or institution, any
person referred to in clauses (a), (b), (c) and (cc) of sub-
section (3) of section 13;
(iii) in case of any person other than persons referred to in sub-
clauses (i) and (ii), the person who is competent to verify
the return under section 139 in accordance with the
provisions of section 140;
(iv) any relative of any of the persons referred to in sub-clauses
(i), (ii) and (iii);
(v) an officer or employee of the assessee;
(vi) an individual who is a partner, or who is in the employment,
of an officer or employee of the assessee;
(vii) an individual who, or his relative or partner—
(I) is holding any security of, or interest in, the assessee:
Provided that the relative may hold security or interest
in the assessee of the face value not exceeding one
hundred thousand rupees;
(II) is indebted to the assessee:
Provided that the relative may be indebted to the
assessee for an amount not exceeding one hundred
thousand rupees;
(III) has given a guarantee or provided any security in
connection with the indebtedness of any third person to
the assessee:
Provided that the relative may give guarantee or
provide any security in connection with the
indebtedness of any third person to the assessee for an
amount not exceeding one hundred thousand rupees;
(viii) a person who, whether directly or indirectly, has business
relationship with the assessee of such nature as may be
prescribed;

31
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

(ix) a person who has been convicted by a court of an offence
involving fraud and a period of ten years has not elapsed
from the date of such conviction.
2.10.1 Therefore, the meaning of "accountant" now applies for the definition
of an "Authorised Representative" under section 288(2). As a result, in order
to be appointed as an Authorised Representative for an assessee for any
proceedings under the Act, a Chartered Accountant must have a certificate of
practice. However, a Chartered Accountant having any other qualification
specified in section 288 may be appointed as an Authorised Representative.
2.10.2 Therefore, after this amendment, a Chartered Accountant who does
not satisfy both the following conditions cannot be appointed as an
Authorised Representative for an assessee:
• He/she does not have a certificate of practice; and
• He/she does not have any other specified qualification.
2.11 Though the section refers to the accounts being examined by an
accountant, which means a chartered accountant as defined above, the
examination can also be done by a firm of chartered accountants. This has
been a recognised practice under the Act. In such a case, it would be
necessary to state the name of the partner who has signed the report on
behalf of the firm. The accountant signing the report as a partner of a firm or
in his individual capacity should give his membership number below his
name.
2.12 As per the decision taken by the Council of the ICAI, all attest functions
undertaken by the members have to bear a UDIN issued by the ICAI. The
same needs to be mentioned on the document being signed/ attested by the
member.
2.13 Section 92E does not stipulate that only the statutory auditor
appointed under the Companies Act or other similar statute should perform
the examination. The examination can, therefore, be conducted either by the
statutory auditor or by any other chartered accountant in practice having
certificate of practice.
2.14 The issue of a report under section 92E, being a recurring
assignment for expressing a professional opinion, the accountant accepting
the assignment should communicate with the accountant who had done the
examination in the earlier year, as provided in the Chartered Accountants
Act. In the case of a person whose accounts of the business or profession
have been audited under any other law (i.e. a company, a co-operative

32
 Responsibility of an Enterprise and the Accountant

society, etc. which is required to get the accounts audited under a Statute), it
is not necessary to communicate with the statutory auditor if he had not done
the examination in the earlier year. Attention of the members is invited to the
detailed discussion in the publication of ICAI, “Code of Ethics” under clause
(8) of Part I of the First Schedule to the Chartered Accountants Act, 1949
vide Annexure V.
2.15 The accountant should obtain from the assessee a letter of
appointment for conducting the examination as mentioned in section 92E. It
is advisable that such an appointment letter should be signed by the person
competent to sign/verify the return of income in terms of the provisions of
section 140 or by any person who has been authorized by the company to
make such an appointment. The accountant should get the statement of
particulars, as required in the annexure to the report, authenticated by the
assessee before he proceeds to verify the same. The accountant is required
to submit his report to the person appointing him viz. the assessee.
2.16 The appointment of the accountant in the case of a company need
not be made at the general meeting of the members. It can be made by the
Board of Directors or even by any officer, if so authorised by the Board in this
behalf. The appointment in the case of a firm or a proprietary concern can be
made by a partner or the proprietor or a person authorised by the assessee.
It is possible for the assessee to appoint two or more chartered accountants
for carrying out the examination, in which case, the report will have to be
signed by all the chartered accountants. In case of disagreement, they can
give their reports separately. In this regard, attention is invited to SA –
299(Revised) Joint Audit of Financial Statements, wherein the principle is
laid down as under:
The joint auditors are required to issue common audit report, however, where
the joint auditors are in disagreement with regard to the opinion or any
matters to be covered by the audit report, they shall express their opinion in
a separate audit report. A joint auditor is not bound by the views of the
majority of the joint auditors regarding the opinion or matters to be covered in
the audit report and shall express opinion formed by the said joint auditor in
separate audit report in case of disagreement. In such circumstances, the
audit report(s) issued by the joint auditor(s) shall make a reference to the
separate audit report(s) issued by the other joint auditor(s). Further, separate
audit report shall also make reference to the audit report issued by other joint
auditors. Such reference shall be made under the heading “Other Matter
Paragraph” as per SA 706(Revised), “Emphasis of Matter Paragraphs and
Other Matter Paragraphs in the Independent Auditor’s Report”.

33
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

The same analogy shall apply to the report to be given under section 92E.
2.17 The Act prohibits a relative or an employee of the assessee being
appointed as an accountant under section 92E. Also, as per a decision of the
Council (reported in the Code of Ethics under clause (4) of Part I of Second
Schedule), a chartered accountant who is in employment of a concern or in
any other concern under the same management cannot be appointed as an
auditor of that concern. Therefore, an employee of an assessee or an
employee of a concern under the same management cannot examine the
accounts and records of an assessee under section 92E.
2.18 An accountant responsible for writing or the maintenance of the
books of account of the assessee should not examine such accounts. This
principle will apply to the partner of such an accountant as well as to the firm
in which he is a partner. In view of this, an accountant who is responsible for
writing or the maintenance of the books of account, his partner or the firm in
which he is a partner should not accept the examination assignment under
section 92E in the case of such an assessee.
2.19 In view of the Explanation 2 of section 288 of the Income tax Act,
1961 and provision of Code of Ethics (Revised 2020), an internal auditor of
the assessee cannot conduct the examination under section 92E of the
Income Tax Act, 1961 whether or not he is an employee of the company.
However, an accountant or a firm of accountants appointed as tax
consultants of the assessee can conduct the examination under section 92E .
2.20 No separate guidelines have been prescribed for fees under section
92E. The Institute has recommended fees for professional services on the
basis of time devoted by the accountant and his assistants. The scale of fees
recommended by the Committee for Capacity Building of CA firms and Small
& Medium Practitioners for professional assignment is given in Annexure VI.
The Council has also clarified that the scale does not include fees
chargeable in respect of non-qualified assistants and that the chartered
accountants are free to negotiate the terms in respect of such assistants with
the clients.
2.21 It will be appreciated that no uniform fees can be recommended for
the reporting function exercised under section 92E of the Act. The
accountant should charge fees depending upon the responsibility involved
and taking into consideration the work involved in such examination. It is
necessary that members of the profession should also maintain reasonable
standards of professional fees.

34
 Responsibility of an Enterprise and the Accountant

2.22 A question may arise whether an accountant appointed under section
92E can be held responsible if he does not complete the examination and
give his report before the specified date. The answer to this question will
depend on the facts and circumstances of the case. Normally, it is the
professional duty of a chartered accountant to ensure that the examination
accepted by him is completed before the due date. If there is any
unreasonable delay on his part, he is answerable to the Institute if a
complaint is made by the client. However, if the delay in the completion of
examination is attributable to his client, the accountant cannot be held
responsible. In view of the fact that the Act does not give any discretion to
the tax authorities to extend the time limit for furnishing of the report, th e
examination has to be completed within the time limit provided in the Act. It
is, therefore, necessary that a chartered accountant should not accept
assignments which he cannot complete within the specified date.
2.23 In the case of an examination, the accountant is required to express
his opinion as to whether the assessee has maintained the proper
information and documents, as prescribed, in respect of the international
transactions entered into by him. As regards the statement of particulars to
be annexed to the report, he is required to give his opinion as to whether the
particulars are true and correct. In giving his report the accountant will have
to use his professional skill and expertise and apply such tests as the
circumstances of the case may require, considering the contents of the
report.
2.24 Section 143 of the Companies Act, 2013 gives certain powers to the
auditors to call for the books of account, information, documents,
explanations, etc. and to have access to all books and records whether kept
at the registered office of the Company or at any other place. The accountant
is advised to obtain all the books of accounts, information, documents,
explanation etc. from the enterprise to enable him to discharge his
responsibility under the Act in a satisfactory manner. If, however, the
assessee does not produce any particular record or fails to provide any
specific information or explanation called for, the accountant will be required
to report the same and accordingly qualify his report.
2.25 The report by the accountant given under section 92E sets forth such
particulars as have been prescribed in Form 3CEB. In order that the
accountant may be in a position to explain any question which may arise
later on, it is necessary that he should keep detailed notes about the
evidence on which he has relied upon while conducting the examination and

35
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

also maintain all his working papers. Such working papers should include his
notes on the following, amongst other matters:
(a) work done while conducting the examination and by whom;
(b) explanations and information given to him during the course of the
examination and by whom;
(c) decision on the various points taken;
(d) the judicial pronouncements relied upon by him while making the
report;
(e) certificates issued by the client
(f) representation letter issued by the management of the assessee; and
(g) annexure to Form No.3CEB duly filled in and authenticated by the
client.
2.26 Attention is also invited to the “SA 230 - Audit Documentation” which
provides that documentation should serve as a sufficient and appropriate
record of the basis for the accountant’s report. Further, the documentation
should be prepared on a timely basis and the accountant should document
all matters which are important in providing evidence that the examination
was planned and performed in accordance with the applicable legal and
regulatory requirements.
2.27 While test checks may suffice in the conduct of a statutory audit for
the expression of the accountant's opinion as to whether the accounts depict
a true and fair' view, the accountant may be required to apply reasonable
tests on the total information to be prepared by the assessee in respect of
certain items in the prescribed form. While the entity may have to prepare the
details for the entire year, the accountant may have to ensure that no items
have been omitted in the information furnished and a reasonable test ch eck
would reveal whether or not the information furnished is correct. Accountant
should exercise professional judgement while placing reliance on the
documents, information and evidences provided by the assesse. The
Accountant should take an appropriate Management Representation Letter
from the assessee.
2.28 The extent of check undertaken would have to be indicated by the
accountant in his working papers. The accountant is advised to design his
examination programme in such a manner, which will reveal the extent of
checking undertaken by the accountant and ensures that adequate
documentation in maintained in support of the information being certified by
him.

36
 Responsibility of an Enterprise and the Accountant

2.29 The accountant may rely upon the audit conducted by an internal
auditor or by an outside professional firm appointed as internal auditor, by
using his own judgement as to the degree of reliance which he wishes to
place on the work of the internal auditor relevant to the examination. The
degree of reliance would depend on the areas of work covered by the
internal auditor and relevant for purposes of the examination, particularly by
reference to working papers/documents of the internal auditor and ensuring
that reasonable checks/tests have been applied to transactions covered by
the internal auditor, to satisfy himself about the authenticity of the ultimate
information.
2.30 It would be in the interest of the accountant to obtain and scrutinise
the programme of work and procedures adopted and the relevant working
papers and documents obtained by the internal auditor in evidence of the
work carried out by him. Further, the accountant will have the sole
responsibility for the report issued and the responsibility will not be reduced
by the accountant’s use of the work of the internal auditors. Further, the
accountant shall determine:
(a) Whether the work of the internal auditors is likely to be adequate for
the purposes of the examination; and
(b) If so, the planned effect of the work of the internal auditors on the
nature, timing or extent of the external auditor’s procedures
Reference may be made to the Standards on Auditing: Using the Work of
Internal Auditors [SA 610 (Revised)] – vide Annexure VII.
2.31 Primarily, it would be necessary for the accountant to identify and
assess the risks of material misstatement, whether due to fraud or error, at
the financial statement and assertion levels, through understanding the entity
and its environment, including the entity’s internal control, thereby providing
a basis for designing and implementing responses to the assessed risks of
material misstatement. This will help him to reduce the risk of material
misstatement to an acceptably low level. Reference may be made to the
Standards on Auditing: SA 315 Identifying and Assessing the Risks of
Material Misstatement through Understanding the Entity and its Environment
(and SA 520, Analytical Procedures.
2.32 The accountant must ensure that he receives a standard
Management Representation Letter in respect of all oral representations
explicitly or implicitly given to him. The letter should indicate and document
the continuing appropriateness of the representations made to him and
reduce the possibility of any misunderstanding concerning the matters which

37
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

are the subject of the representations. Further, in relation to certain
transactions, such as deemed international transactions, free of cost
services/ goods, etc. the extent of reliance placed by the Accountant on the
assessee is higher as compared to transactions such as sales/ purchase of
goods, provision of services, etc. In these cases while the Accountant should
exercise due professional judgement and care, the onus to identify and
disclose such transactions (i.e., deemed international transactions, free of
cost services/ goods, etc.) is with the assessee. Therefore in such scenario
Accountant is entitled to place reliance on management representation letter
issued by the assessee. However, it may be noted that in respect of matters
that may be directly verified by the accountant, mere obtaining of a
management representation letter will not be sufficient compliance with the
Generally Accepted Auditing Standards.
2.33 If the assessee is unable to obtain relevant information in respect of
the overseas branches duly certified by the overseas accountant, the
relevant facts should be suitably disclosed and reported upon.
2.34 Where Accountant’s Report is issued to non-resident assessee and
such non-resident is not statutorily required to maintain books of accounts in
India under any law, the Accountant should place reliance on Form 26AS,
invoices, agreements etc. The Accountant may also place reliance on
documents, information and accounts maintained by the Indian assessee
with whom the non-resident assessee has entered into international
transaction(s).
2.35 Paragraph 3 of Form No. 3CEB requires the accountant to state
whether the prescribed particulars are furnished in the annexure to the report
and whether in his opinion and to the best of his information and according to
the explanations given to him, they are true and correct. The accountant may
have a difference of opinion with regard to the particulars furnished by the
assessee and he has to bring these differences under various clauses in
Form No.3CEB. The accountant should make a specific reference to those
clauses in Form No. 3CEB in which he has expressed his reservations,
difference of opinion, disclaimer etc. in this paragraph.
2.36 In case the prescribed particulars are given in part or piecemeal to
the accountant or the relevant form is incomplete and the assessee does not
give the information against all or any of the clauses, the accountant should
not withhold the entire report. In such a case, he can qualify his report on
matters in respect of which information is not furnished to him. In the
absence of relevant information, the accountant would have no option but to
state in his report that the relevant information has not been furnished by the

38
 Responsibility of an Enterprise and the Accountant

assessee. As a good practice, the Accountant should provide a note detailing
the rationale of Accountant. Such note should be provided along with the
Accountant’s Report.
2.37 Accountant should communicate basis for each position taken to the
Enterprise in writing.

Professional misconduct
2.38 When any question relating to professional misconduct in connection
with the examination arises, the accountant would be liable under the
Chartered Accountants Act, 1949 and the ICAI's disciplinary jurisdiction will
prevail in this regard.
2.39 Finance Act 2017 has introduced section 271J for levying penalty on
accountants for furnishing incorrect information in reports or certificates
furnished under any provisions of the Act or the rules made thereunder. The
Assessing Officer or the Commissioner (Appeals), in such cases, may direct
the accountant to pay a sum of ten thousand rupees for each such report or
certificate.

39
 Chapter 3
Associated Enterprises
Associated enterprises and deemed associated
enterprises
The term “associated enterprise” is defined in two parts – the term
“enterprise” is defined in section 92F (iii) of the Act while the term
“associated enterprise” is defined in section 92A of the Act.
Meaning of enterprise:
The term ‘enterprise’ is defined under clause (iii) of section 92F of the Act
wherein “enterprise” means a person (including a permanent establishment
of such person) who is, or has been, or is proposed to be, engaged in any
activity, relating to,
— the production, storage, supply, distribution, acquisition or control of
articles or goods, or know-how, patents, copyrights, trademarks,
licences, franchises or any other business or commercial rights of
similar nature, or any data, documentation, drawing or specification
relating to any patent, invention, model, design, secret formula or
process, of which the other enterprise is the owner or in respect of
which the other enterprise has exclusive rights, or
— the provisions of services of any kind, or
— in carrying out any work in pursuance of a contract, or
— in investment, or
— providing loan or
— in the business of acquiring, holding, underwriting or dealing with
shares, debentures or other securities of any other body corporate,
— whether such activity or business is carried on, directly or through
one or more of its units or divisions or subsidiaries, or whether such
unit or division or subsidiary is located at the same place where the
enterprises is located or at a different place or places.
While the term is defined to mean a person engaged in the past, present or
in the future in any activity relating to tangibles, intangibles, facilities or
 Associated Enterprises

services with widest possible modes, forms or pattern of operation, it also
includes a permanent establishment of such person. “Permanent
Establishment” referred to in clause (iii)(a) of section 92F of the Act, includes
a fixed place of business through which the business of the enterprise is
wholly or partly carried on.
3.1 Two or more enterprises can be regarded as ‘associated enterprises’
only if the provisions of section 92A are satisfied. Section 92A defines
‘associated enterprise’, wherein sub-section (1) provides a source definition,
whereas, sub-section (2) provides for deeming provision which enumerates
13 situations, fulfilment of any of which at any time during the relevant
previous year would deem to make the two enterprises an associated
enterprises.

Source definition [Section 92A(1)]
3.2 According to sub-section (1), an enterprise which participates directly
or indirectly or through one or more intermediaries, in the management or
control or capital of the other enterprise shall be regarded as an associated
enterprise. This can be understood as follows:
Situation 1 - Direct Participation:

Participates in
A management/ B
capital/control

Situation 2 - Participation through Intermediary

A I Participates in B
management/
capital/control

Intermediary

In both the situations detailed above, B will be an associated enterprise of A.
3.3 Similarly, an enterprise in respect of which one or more persons who
participate in its management or control or capital, directly or indirectly, or
through one or more intermediaries are the same persons who participate in

41
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

a similar manner in the management or control or capital of the other
enterprise shall be regarded as an associated enterprise. This proposition
can be understood by the following diagrammatic presentation:

A

Participates in Participates in
management/ management,/
capital/control management/
capital/ control

C D

In the above situation, C and D are associated enterprises by virtue of A
participating in the management or capital or control of both C and D.

A B

I
Participates in Intermediary
management/
capital/control
Participates in
Management/
C capital/control

D

In the above example, A and B, conjointly and simultaneously, participate in
the management, capital and control of C and D. Consequently, C and D are
to be construed as associated enterprises.

42
 Associated Enterprises

Deemed definition of Associated Enterprise
[Section 92A(2)]
3.4 The Finance Act, 2002 had amended sub-section (2) of section 92A
to the effect that for the purposes of sub-section (1), two enterprises shall
be deemed to be associated enterprises if, at any time during the previous
year any of the conditions mentioned in clauses (a) to (m) are satisfied. The
provisions of sub-section (2) of section 92A supplements the definition of
associated enterprise given in sub-section (1) by enlisting various situations
under which two enterprises shall be deemed to be associated enterprises.
It may be noted that when Finance Act, 2002 had amended sub-section (2) of
section 92A, the memorandum to the Finance Bill, 2002 explained the said
amendment as under:
“It is proposed to amend sub-section (2) of the said section to clarify
that the mere fact of participation of one enterprise in the
management or control or capital of the other enterprise or the
participation of one or more persons in the management or control or
capital of both the enterprises shall not make them associated
enterprise unless the criteria specified in sub-section (2) are fulfilled.”
Considering the above, for interpreting the AE relationship provided in sub-
section (1), the situations mentioned in sub-section (2) need to be referred.
In other words, sub-section (1) is dependent on situations given under sub-
section (2) of section 92A.
Each of these situations specified in clauses (a) to (m) of sub-section (2) of
section 92A are discussed here below with suitable illustration, wherever
considered necessary. It may be noted that for the purposes of these
clauses, two enterprises would be associated enterprises if the conditions
stipulated therein are fulfilled at any time during the previous year. Besides,
in clauses (c) to (m) the words ‘directly’ or ‘indirectly’ have not been used
which indicates the intention of the legislature that indirect control is not
envisaged in these clauses. Therefore, direct relationship between two
enterprises is relevant for the purposes of clauses (c) to (m) in order to
determine whether they are associated enterprises.
3.5 One enterprise holds, directly or indirectly, shares carrying not
less than twenty-six per cent of the voting power in the other
enterprise.
[Section 92A(2)(a)]

43
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Two enterprises shall be associated enterprises based on the shareholding
of one enterprise in the other if the investing enterprise holds shares carrying
not less than twenty-six per cent of the voting power in the other enterprise.
Holding for this purpose includes indirect holding too.
As the terms used are “shares” and “voting power”, it is apparent that this
clause applies only to those cases where the investee enterprise is a
company. However, the investor enterprise need not be company and could
be any person.
Further, this clause uses terms “….shares carrying not less than twenty-six
per cent of the voting power….”. Accordingly, it is essential that the “shares”
should carry voting power. If the shareholding in the investee company does
not carry any voting power (for example preference shares with no voting
rights) than such shareholding should not be taken into consideration for
computing threshold limit of twenty-six per cent.
3.6 Any person or enterprise holds, directly or indirectly, shares
carrying not less than twenty-six per cent of the voting power in each of
such enterprises.
[Section 92A(2)(b)]
Under this clause, two enterprises are deemed associated enterprises, even
though one enterprise may not hold any shares in the other enterprise. This
clause comes into play when one person or enterprise simultaneously holds
shares carrying not less than twenty-six per cent voting power in each such
enterprise.
Hence for this clause to apply:
• both the investee enterprises have to be companies.
• one person or enterprise simultaneously holds shares carrying 26%
or more voting power in each of them.
• Both the enterprises need not hold any shares in each other if they
have common 26% or more voting right held by a company.
• Shareholding may be direct or indirect.
For example, if AA of UK holds 26% voting power in BB of Germany and also
in CC of India, then BB and CC shall be deemed to be associated
enterprises. Even for this clause, shareholding may be direct or indirect
holding and shares should carry voting power.

44
 Associated Enterprises

3.7 A loan advanced by one enterprise to the other enterprise
constitutes not less than fifty-one per cent of the book value of the total
assets of the other enterprise.
[Section 92A(2)(c)]
Where the lender enterprise’s loans to the borrower enterprise constitute
51% or more of the ‘book value’ of the total assets of the borrowing
enterprise, then both the lender and the borrower enterprises would be
treated as ‘associated enterprises’. ‘Book value’ of assets means value of
assets appearing in books of account.
It is important to note that requirement is whether the loan advanced is 51% or
more of the book value of total assets of the borrower enterprise and not 51% or
more of the market value of assets of the borrower-enterprise.
Example:
Suppose Enterprise X gives a loan of $100 million to Enterprise Y on 01-04-
2020. At that time, the book value of assets of enterprise B was $200 million. On
26-4-2020, enterprise Y repays $ 10 million. On 31-3-2021, due to booking of
impairment losses, the book value of assets of enterprise Y is $ 180 million. At
that time, loan outstanding is $ 90 million (i.e., $ 100 million minus $ 10 million
repaid).
Loan outstanding on book value of the assets of Y comes out 50% (90/180 x 100
= 50%), However, the requirement is to check the % of loan advanced on book
value i.e., 55% (100/180 x 100 = 55%). So, in this case, X and Y will be
associated enterprises.
Book value of assets: The term ‘book value’ has been defined by ICAI in its
Guidance Note on Terms used in Financial Statements as the amount at which
an item of asset is shown in the books. The term asset is defined in the
Framework for Preparation and Presentation of Financial Statements (hereafter
referred as “the Framework”) issued by ICAI. The following are the features of an
asset :
• It is a resource.
• It arises out of past transactions or events.
• It is controlled by the enterprise.
• Future economic benefits are expected from it

45
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Apart from the above, the following are, also, important:
• Intangible Assets: Intangible assets are assets so these must be
included in book value of assets.
• Accumulated Losses: The accumulated losses, shown in assets side
only because they have debit balance, are not assets and will not be
included in book value of assets because there is no future economic
benefits.
• Deferred Revenue Expenditure: The enterprise does not control the
expected future economic benefits from deferred revenue expenditure.
Hence, they are not assets.
• All the items on asset side of balance sheet which satisfy the definition
of ‘assets’ in the Framework should be taken at ‘book value’. Moreover,
the book value of assets only should be taken without deducting book
value of liabilities.
3.8 One enterprise guarantees not less than ten per cent of the total
borrowings of the other enterprise.
[Section 92A(2)(d)]
Where the guarantor enterprise guarantees 10% or more of the total
borrowing of the enterprise seeking guarantee, then they would become
‘associated enterprises’.
Rule 10TA(c) provides the definition of term corporate guarantee. Corporate
guarantee means explicit corporate guarantee extended by a company to its
wholly owned subsidiary being a non-resident in respect of any short-term or
long-term borrowing.
Explanation.—For the purposes of Rule 10TA (c), explicit corporate
guarantee does not include letter of comfort, implicit corporate
guarantee, performance guarantee or any other guarantee of similar
nature;
It may be mentioned that as the clause does not specify the nature of
guarantee, a view is possible that it includes all types of guarantees.
3.9 More than half of the board of directors or members of the
governing board, or one or more executive directors or executive
members of the governing board of one enterprise, are appointed by the
other enterprise.
[Section 92A(2)(e)]

46
 Associated Enterprises

Where one enterprise has appointed
(a) more than one-half of the board of directors or members of the
governing board; or
(b) one or more executive directors or executive members of that board
in another enterprise
the two enterprises shall be deemed to be associated enterprises.
This clause refers to “board of directors” and “governing board”. As per
section 2(10) of the Companies Act, 2013, the term “board of directors”
would refer to the “collective body of directors of a company”. The term
“governing board”, correspondingly, would refer to a body or council that has
the executive authority to manage the affairs of the enterprise to which it
relates. These enterprises could be artificial juridical non-corporate bodies.
For the purposes of this clause, the appointment of even one person to the
post of executive director or executive member would make the enterprises
associated enterprises.
It is important to note that merely having the power to appoint (50% of
directors/one or more executive directors) is not enough. Actual exercise of
the power is necessary to make both enterprises associated enterprises.
3.10 More than half of the directors or members of the governing
board, or one or more of the executive directors or executive members
of the governing board of each of the two enterprises are appointed by
the same person or persons.
[Section 92A(2)(f)]
Clause (f) is an extension of the principle laid down in clause (e). This clause
is applicable where the same person has:
(a) appointed more than one-half of the board of directors or members of
the governing board; or
(b) appointed one or more executive directors or executive members of
the governing board of two or more enterprises or
(c) As combination of (a) and (b), same person(s) appoints one or more
executive directors or executive members in one enterprise and 50%
or more of the directors/ members in the other.
For example, the appointment of seven out of twelve members of board of
directors of B Ltd. and six out of ten members of the board of directors of C

47
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Ltd. is controlled and has been made by A Ltd. By virtue of clause (f), B Ltd.
and C Ltd. are associated enterprises.
Further, if the appointment of the executive director of B Ltd. and six out of
ten members of the board of directors of C Ltd. have been made by A Ltd.,
then B Ltd. and C Ltd. shall be regarded as associated enterprises.
For the purpose of both the clauses (e) and (f) , two enterprises shall be
deemed to be associated enterprises only when one of the enterprise
exercises its right and actually appoints one executive director/ member to
the board or more than half of the Board of directors at any time during the
year.
The mere right to appoint one executive director or executive member or
more than half of the Board of directors by one enterprise to the Board of
another enterprise, would not make both the entities as associated
enterprises.
3.11 The manufacture or processing of goods or articles or business
carried out by one enterprise is wholly dependent on the use of know-
how, patents, copyrights, trade-marks, licences, franchises or any other
business or commercial rights of similar nature, or any data,
documentation, drawing or specification relating to any patent,
invention, model, design, secret formula or process, of which the other
enterprise is the owner or in respect of which the other enterprise has
exclusive rights.
[Section 92A(2)(g)]
Two enterprises are deemed to be associated:
• if one is wholly dependent on the other
• for the use of know-how, patents, copyrights etc.
• for the manufacture or processing of goods or articles or business
carried on by such enterprise.
It should be noted that such know-how, patents, copyrights etc. must be
either owned by the other enterprise or the exclusive rights thereto must vest
with the other enterprise. If an Indian enterprise is wholly dependent on the
licence granted by a non-resident enterprise for manufacture or processing of
goods or articles or business carried out by the Indian enterprise both
enterprises shall be deemed to be associated enterprises. The clause will
equally be applicable in case where the overseas entity is wholly dependent
on the license / brand owned by the Indian entity.

48
 Associated Enterprises

Section 92A(2)(g) applies only if the manufacture or processing of or
business carried out by one enterprise is wholly dependent upon the
intangible assets of the other. That is, if an enterprise manufactures more
than one article or thing and it uses the know-how of the other for one article
or thing, manufacture of all the articles or goods carried out by the first
enterprise is not wholly dependent on the intangible asset of the other
enterprise and hence section 92A(2)(g) does not apply here.
The important phrase here is ‘wholly dependent’ and hence, it would first b e
imperative to determine whether a particular enterprise is dependent ‘wholly’
on the use of intangibles owned by the other enterprise. The word ‘wholly’
denotes complete dependence and hence, should be distinguished from the
word ‘mainly’.
Under this clause, all types of manufacturing, distribution and service-related
businesses are covered.
3.12 Ninety per cent or more of the raw materials and consumables
required for the manufacture or processing of goods or articles carried
out by one enterprise, are supplied by the other enterprise or by
persons specified by the other enterprise, and the prices and other
conditions relating to the supply are influenced by such other
enterprise.
[Section 92A(2)(h)]
There are two situations dealt with in this clause and they are as follows:
(i) 90% or more of the raw materials and consumables required for
manufacturing or processing of goods or articles are supplied by the
other enterprise,
or
(ii) 90% or more of the raw materials and consumables required for
manufacturing or processing of goods or articles are supplied by
persons specified by the other enterprise,
and
the prices and other conditions relating to supply (by the specified
person) are influenced by the other enterprise.
Since this clause relates to manufacture or processing of goods, it is
important to note that the 90% criteria should be applied exclusively to raw
materials and consumables used for manufacturing and processing only.

49
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

3.13 The goods or articles manufactured or processed by one
enterprise, are sold to the other enterprise or to persons specified by
the other enterprise, and the prices and other conditions relating
thereto are influenced by such other enterprise.
[Section 92A(2)(i)]
Where the goods or articles manufactured and processed by one enterprise,
(say, enterprise A) are sold
(i) to another enterprise (say, enterprise B)
or
(ii) sold to another enterprise (say, enterprise C) specified by enterprise
B,
and
the prices and other conditions relating thereto are influenced by
enterprise B, then enterprises A and B shall be associated
enterprises.
While in clause (h), a minimum criteria of 90% has been mentioned, no such
quantification has been done in clause (i). It would be imperative to analyze
the contractual terms & conditions, actual conduct of parties to the
transaction, etc. to conclude whether there exists any influence by an
enterprise on another enterprise and hence, whether the said clause is
triggered or not. This clause covers only sale of goods manufactured or
processed and not the sale of traded goods.
Prima facie, it may be inferred that even when sales of one enterprise to the
other enterprise is insignificant (assuming less than 1%) and that other
enterprise can influence the prices at which the goods are sold, these two
enterprises may be treated as associated enterprises. However, this may not
be the intention of the legislation, as this may not give rise to “control” by one
of the enterprise over the other, which is a sine qua non for invoking the
status of associated enterprises under third limb of test laid down by section
92A(1). Therefore, it is important that the test of ‘influence’ be established
with actual conduct and backed up by the documentary evidence.
In this clause, the Seller and buyer are deemed AEs u/s 92A(2)(i) only if
buyer’s influence on terms of sale is “dominant influence”. For deeming buyer
and seller enterprises to be AEs under section 92A(2)(i), buyer must have
dominant influence over prices and other conditions of sale amounting to de
facto control of buyer over seller.

50
 Associated Enterprises

3.14 Where one enterprise is controlled by an individual, the other
enterprise is also controlled by such individual or his relative or jointly
by such individual and relative of such individual.
[Section 92A(2)(j)]
This clause deals with a situation where one enterprise is controlled by an
individual and the other enterprise is also controlled by –
(i) such individuals; or
(ii) his relative; or
(iii) jointly by such individual and his relative then both the enterprises
shall be deemed as associated enterprises.
The word ‘control’ can be interpreted to mean that the individual along with
his relatives has the power to make crucial decisions regarding the
management and running of the two enterprises.
The word ‘relative’ is defined under section 2(41) of the Act as follows:
“relative”, in relation to an individual, means the husband, wife, brother or
sister or any lineal ascendant or descendant of that individual”
3.15 Where one enterprise is controlled by a Hindu undivided family,
the other enterprise is controlled by a member of such Hindu undivided
family, or by a relative of a member of such Hindu undivided family, or
jointly by such member and his relative.
[Section 92A(2)(k)]
This clause envisages control of the two enterprises by the same Hindu
undivided family and includes control by -
(i) a member of the Hindu undivided family, or
(ii) by a relative of a member of such Hindu undivided family, or
(iii) jointly by such member and his relatives.
3.16 Where one enterprise is a firm, association of persons or body of
individuals, the other enterprise holds not less than ten per cent
interest in such firm, association of persons or body of individuals
[Section 92A(2)(l)]
This clause seeks to cover non-corporate bodies like partnership firms,
association of persons and body of individuals. Sub-clause (v) of clause (31)
of section 2 of the Act defines the term ‘person’ to include these entities.

51
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

In case of partnership firm or association of persons or body of individuals,
the other enterprise must hold not less than 10% interest in such firm,
association of persons or body of individuals to be regarded as an associated
enterprise.
3.17 There exists between the two enterprises, any relationship of
mutual interest, as may be prescribed.
[Section 92A(2)(m)]
This residuary clause enables the CBDT to widen the scope by adding any
relationship of mutual interest from time to time that will make any two
enterprises as associated enterprises. However, no such relationship of
mutual interest has yet been prescribed.
3.18 If an assessee enters into a transaction where one of the parties
to the transaction is a person located in a notified jurisdictional area,
then all the parties to the transaction shall be deemed to be associated
enterprises within the meaning of section 92A
[Section 94A(2)(i)]
As per Section 94A(1), the Central Government may, specify a country or
territory as a notified jurisdictional area. The Central Government had
specified Cyprus as a notified jurisdictional area. However, the same has
been rescinded vide notification no. 114 dated 14-12-2016. Therefore, at
present there is no such notified jurisdictional area.
This clause seeks to cover transactions with persons located in notified
jurisdictional areas where there is a lack of effective exchange of information.
The relationship with the “person” is not specified in the section. Accordingly,
a person could be a related or an unrelated person and therefore a person
could also include an AE [i.e. an enterprise covered under section 92A(1)/(2)]

Relationship between Head Office and Permanent
Establishment (Branch Office and any fixed place
of business)
3.19 For a foreign enterprise, a branch office in India would qualify to be a
permanent establishment (‘PE’) and considered as a separate enterprise
than the foreign enterprise or the head office in terms of section 92F(iii) read
with section 92B(1). Accordingly, transfer pricing provisions would apply on
transactions between foreign enterprise and PE in India (branch office or any
fixed place of the business).

52
 Associated Enterprises

3.20. Attention here is invited to a situation where an Indian enterprise is
having a branch office in a foreign jurisdiction. In such a scenario, the
definition of permanent establishment as per section 92F(iii)(a) looses its
substance and there the transactions between the Indian head office and its
foreign branch office (branch office accounts being consolidated in the head
office / company-wide accounts) would not be subject to transfer pricing
provisions as per Indian Income tax Act. It is important to note that
transaction between the foreign branch of India enterprise and other foreign
associated enterprise will be subject to transfer pricing provision.
Example: I. Co has a branch in the USA. I. Co also has a subsidiary
company the USA, US Co. The USA branch is rendering certain services to
the US Co. Since I. Co and USA branch are same legal entity for the
application of Indian TP regulation, hence the transaction between US
branch and US Co. will be considered as transaction between I. Co and US
Co.

Associated Enterprises in relation to ‘Specified
Domestic Transactions (SDT)’
3.21 Rule 10A(a)(ii) of the Rules defines “Associated Enterprise” for purpose
of SDT as follows:
(a) the persons referred to in clause (b) of sub-section (2) of section 40A
of the Act in respect of a transaction referred to in section 40A(2)(a)
of the Act; (omitted by Finance Act 2017, with effect from 1 April 2017
(b) other units or undertakings or businesses of the same assessee in
respect of a transaction referred to in section 80A of the Act or, as
the case may be, sub-section (8) of section 80-IA of the Act;
(c) any other person referred to in sub-section (10) of section 80-IA of
the Act in respect of a transaction referred to therein;
(d) other units, undertakings, enterprises or business of the assessee, or
other person referred to in sub-section (10) of section 80-IA of the
Act, as the case may be, in respect of a transaction referred to in
section 10AA of the Act or the transactions referred to in Chapter VI-
A to which the provisions of sub-section (8) or, as the case may be,
the provisions of sub-section (10) of section 80-IA of the Act are
applicable;

53
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Associated Enterprises as per OECD and UN Framework
3.22 OECD Framework – The OECD Model tax convention defines
Associated Enterprise in Article 9, which reads as under:
1. Where:
(a) an enterprise of a Contracting State participates directly or
indirectly in the management, control or capital of an enterprise
of the other Contracting State, or
(b) the same persons participate directly or indirectly in the
management, control or capital of an enterprise of a
Contracting State and an enterprise of the other Contracting
State
and in either case conditions are made or imposed between the two
enterprises in their commercial or financial relations which differ from those
which would be made between independent enterprises, then any profits
which would, but for those conditions, have accrued to one of the
enterprises, but, by reason of those conditions have not so accrued, may be
included in the profits of that enterprise and taxed accordingly.
3.23 UN Framework – Para 1 of Article 9 of UN Model Convention defines
Associated Enterprise, which reads as under:
1. Where:
(a) an enterprise of a Contracting State participates directly or
indirectly in the management, control or capital of an enterprise
of the other Contracting State, or
(b) the same persons participate directly or indirectly in the
management, control or capital of an enterprise of a
Contracting State and an enterprise of the other Contracting
State,
and in either case conditions are made or imposed between the two
enterprises in their commercial or financial relations which differ from those
which would be made between independent enterprises, then any profits
which would, but for those conditions, have accrued to one of the
enterprises, but, by reason of those conditions, have not so accrued, may be
included in the profits of that enterprise and taxed accordingly.
3.24 As can be seen from above, the Indian TP Regulations cast a broad
net for two entities to be regarded as associated which is much wider in
scope than the definition as per OECD and UN model conventions.

54
 Chapter 4
International Transaction
Definition
4.1 The terms “international transaction” is defined in two steps – the
term “transaction” is defined in section 92F(v) of the Act, while the term
“international transaction” is defined in section 92B of the Act. Hence, before
proceeding to analyse the expression “international transaction”, it would be
useful to take note of the definition of the term “transaction”. The term
‘transaction’ has been defined in clause (v) of section 92F as under: -
“(v) transaction includes an arrangement, understanding or action in concert:
(i) whether or not such arrangement, understanding or action is formal
or in writing; or
(ii) whether or not such arrangement, understanding or action is intended
to be enforceable by legal proceedings”.
This definition is an inclusive definition and therefore wider in its scope. As
per this definition, a transaction includes any arrangement, understanding or
action, whether formal or informal, whether oral or in writing, whether legally
enforceable or not.
Therefore, in order to characterise a “transaction”as “international
transaction”, it has to be demonstrated that the transaction arose in pursuant
to an arrangement, understanding or action in concert. Such an arrangement
is between the two parties and not any unilateral action by one of the parties
without any binding obligation on the other or without any mutual
understanding or contract. If one of the party by its own volition is incurring
any expenditure for its own business purpose, then without there being any
corresponding binding obligation on the other party or without any such kind
of an arrangement actually existing in writing or oral or otherwise, it cannot
be characterized as international transaction within the scope and definitio n
of Section 92B (1).” Therefore, necessary factual analysis to be carried out to
establish that AEs have any arrangement, understanding or action in concert.
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

4.2 Section 92B defines an “international transaction” in the following
manner:
“For the purposes of this section and sections 92, 92C, 92D and 92E,
“international transaction” means a transaction between two or more AEs,
either or both of whom are non-residents, in the nature of purchase, sale or
lease of tangible or intangible property, or provision of services, or lending or
borrowing money or any other transaction having a bearing on the profits,
income, losses or assets of such enterprises and shall include a mutual
agreement or arrangement between two or more AEs for the allocation or
apportionment of, or any contribution to, any cost or expense incurred or to
be incurred in connection with a benefit, service or facility provided or to be
provided to any one or more such enterprises - section 92B(1)”.
“A transaction entered into by an enterprise with a person other than an AE
shall, for the purposes of sub-section (1), be deemed to be an international
transaction entered into between two AEs, if there exists a prior agreement in
relation to the relevant transaction between such other person and the AE; or
the terms of the relevant transaction are determined in substance between
such other person and the AE where the enterprise or the AE or both of them
are non-residents irrespective of whether such other person is a non-resident
or not - section 92B(2)”.
From the above, it can be seen that sub-section (1) of section 92B defines
the term “international transaction” in an exhaustive manner; and sub-section
(2) of section 92B deems a transaction entered into between two enterprises
in certain situations, as an international transaction between AEs.
4.3 The definition of international transaction under the transfer pricing
regulations is very wide in its scope and has been further clarified vide
Finance Act 2012 with retrospective effect from 1 April, 2002 to include:
(i) the purchase, sale, transfer, lease or use of tangible property
including building, transportation vehicle, machinery, equipment,
tools, plant, furniture, commodity or any other article, product or
thing; or

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 International Transaction

A Inc.

Sale of finished Payment for
goods purchases

ABC India

(ii) the purchase, sale, transfer, lease or use of intangible property,
including the transfer of ownership or the provision of use of rights
regarding land use, copyrights, patents, trademarks, licences,
franchises, customer list, marketing channel, brand, commercial
secret, know-how, industrial property right, exterior design or practical
and new design or any other business or commercial rights of similar
nature; or

A Inc.

License of IPs (i.e.
trademarks, Payment of
technology, royalty
design, etc.)

ABC India

(iii) capital financing, including any type of long-term or short-term
borrowing, lending or guarantee, purchase or sale of marketable
securities or any type of advance, payments or deferred payment or
receivable or any other debt arising during the course of business; or

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

A Inc.

Provision of Payment of
Loan Interest

ABC India

(iv) provision of services, including provision of market research, market
development, marketing management, administration, technical
services, repairs, design, consultation, agency, scientific research,
legal or accounting service; or

A Inc.

Provision of
marketing Return for such
support services services

ABC India

(v) a transaction of business restructuring or reorganization, entered into
by an enterprise with an AE, irrespective of the fact that it has a
bearing on the profits, income, losses, or assets of such enterprises
at the time of transaction or at any future date.

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4.3.1 It shall also include a mutual agreement or arrangement between two
or more AEs for the allocation or apportionment of, or any contribution to,
any cost or expense incurred or to be incurred in connection with a benefit,
service, facility provided or to be provided to any one or more such
enterprises.
Business Restructuring
4.3.2 It is relevant to note that a transaction of business restructuring or
reorganization has been clarified to be an international transaction
irrespective of whether it has a bearing on the profits, income, losses or
assets of the enterprise. However, the Act does not define business
restructuring. In this respect, guidance may be drawn from the OECD
guidelines, which defines business restructuring as cross border re-
organisation of the commercial or financial relations between AEs including
the termination or substantial renegotiation of existing arrangements.
Relationships with third parties (e.g. suppliers, sub-contractors, customers)
may be a reason for the restructuring or be affected by it.
4.3.3 Restructuring could be in the form of operational change (in
functional, asset and risk profile of the entity) or organizational change (in
ownership structure/management of the entity). It could include a change in
the nature or scope of transactions among controlled entities, a shift in the
allocation of risks, a change in responsibility for specific functions or
commencement or termination of a relationship, etc.
4.3.4 Explanation to 92B - Clause (i)(e) reads as under:
“a transaction of business restructuring or reorganization, entered
into by an enterprise with an associated enterprise, irrespective of the
fact that it has bearing on the profit, income, losses or assets of such
enterprises at the time of the transaction or at any future date”
‘Business restructuring or reorganization’ has not been defined in the Act,
nor any guidance is provided in other income tax legislations (rules, circulars
etc.)
Chapter IX of OECD TP Guidelines – Report on TP aspects of Business
Restructuring (July 2010) defines it as
“The cross-border redeployment, reallocation of functions, assets or
risks among affiliated entities of a MNE”

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

4.3.5 Examples of Business Restructuring (only indicative and not
exhaustive):
• Conversion of a full-fledged distributor into a LRD.
• Conversion of a full-fledged manufacturer into a contract
manufacturer
• Transfer of IP rights to a central entity within the group
• Business restructuring may also involve termination or substantial
renegotiation of existing arrangements, reallocation of risks/
intangibles, specialisation or de-specialisation of operations i.e.
manufacturing sites/ processes, R&D activities, sales activities etc.
• Transfer of valuable intangibles
• Termination or substantial renegotiation of existing arrangements
• Conversion of full-fledged manufacturers into contractors or toll
manufacturer
• Conversion of full-fledged distributor into LRD or commissionaires
• Outsourcing of manufacturing to AE in a low cost location
• Centralization of intangibles assets and of risks (eg. to so called “IP
Company”) or that of regional management
• Revision of business model rationalization/ specialization/ de-
specialization of operations (R&D, manufacturing, sales/ services)
including downsizing and closing operations
• The UN practical manual on TP for developing countries defines
Business restructuring as the cross-border redeployment of functions,
assets and risks by an MNE

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 International Transaction
Capital
4.3.6 reductio
n
Capital
Re-
organizat
ion Buy-back

Issue of
shares
Stock
Purchase
Ex
ter
Acquisit
nal
ions
Asset
Purchase

Restru
cturin
g Scheme
of Merger
Arrange and
ment Demerg
er

Transfer of Intangible property
rights to a central entity

Conversion of full-fledged
Int distributor to limited risk
er distributor
na
l

Conversion of full-fledged
manufacturer to limited risk
manufacturer

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

4.3.7 To determine whether any kind of compensation is payable at
the time of restructuring, it is important to –
• Understand the FAR of the restructured entity before and after
restructuring (including any loss of future expected profits on account
of the business restructuring)
• Understand the business reasons for and expected benefits from the
change
• Evaluate what other options/ alternatives are available to the parties
involved
• Consider whether an independent party would be willing to enter into
a contract for such restructuring. Independent parties would not enter
into a transaction that makes them worse off than their next best
option.
Note: The fact that a re-deployment of functions/assets/risks is based on
sound commercial reasons does not necessarily mean that its at arm's length
4.3.8 Arm’s length Compensation in business restructuring: OECD
Guidelines 2022 in Chapter IX (Part I and Part II) discusses Business
Restructuring and remuneration of post-restructuring controlled transaction.
This, inter alia, provides the following steps and process:
Step 1: Characterize the transactions entered into by the associated
enterprises, taking into account the business environment in which the
multinational enterprises (MNE) group is operating. This entails carrying out
the following activities:
• identification of the scope of arrangements between the associated
enterprises involved in the business restructuring.
• Performance of a functional analysis of the pre- and post-business
restructuring activities of associated enterprises affected by the
restructuring.
• reference to any relevant contract, including those entered to
implement the business restructuring as well as an examination of
risks assumed, and functions performed by the associated
enterprises.
• Examination of the consistency of the contractual terms with the
outcome of the functional analysis of the associated enterprises
taking part in the business restructuring, to determine the true nature
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of the transactions, including the legal, economic and tax effects
thereof.
Step 2: Select the most appropriate transfer pricing methodology or
methodologies
• Provided the pricing of the business restructuring itself and of the
post-restructuring arrangements are consistent with what would occur
under an agreement between independent parties in comparable
circumstances the arm’s length principle and its requirements are
met.
• The consideration may be determined by considering the following:
o an arm’s length outcome is one that makes business sense taking
into account the options realistically available for the taxpayer
involved in the business restructuring.
o an independent party dealing at arm’s length would seek to protect
its economic interest involved in the arrangements or be
appropriately remunerated for foregoing such interest.
Step 3: Apply the most appropriate method and determine an arm’s
length outcome
• A benefit expected at the MNE level from a business restructuring
may be any form of economic or commercial advantage. If the
examination show that the pricing of the business restructuring does
not make commercial sense, then arm’s length outcome can be
achieved by either –
o pricing adjustment by reference to the arrangement as entered
by the parties.
o using an arrangement reasonably expected to exist between
independent parties dealing at arm’s length in comparable
circumstances.
o application of transfer pricing provisions adjusting the
consideration receivable or payable by the Commissioner by
reference to the arrangement between independent parties
dealing in arm’s length in comparable circumstances.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

4.3.9 Selection and Application of TP Methods to Post-restructuring
Transactions with Related Parties
• Post-restructuring-controlled transactions require a robust FAR
analysis. Essential to perform pre- and post-restructuring
comparability analysis.
• The analysis should go beyond the construed characterisation of the
entity.
o Situation A: an entity characterized as a LRD can sometimes be
found to own valuable intangibles
o Situation B: an entity characterized as a contract manufacturer
can sometimes be found to pursue significant R&D activities or to
own/ use unique intangibles
• In some cases, pre-restructuring transactions may serve as an
internal CUP for post-restructuring-controlled transactions
4.4 Any transaction between an enterprise and a person other than an
AE will be deemed to be an international transaction with an AE as per sub-
section (2) of section 92B under certain situations.This deeming provision is
intended to cover cases where an independent third party (irrespective of
whether it is a resident or non-resident) can be interposed by two AEs to
remain out of the transfer pricing provisions of the Act.
Deemed International Transaction
4.5 According to sub-section (2) of section 92B, a transaction between an
enterprise and an unrelated person shall be deemed to be a transaction
between AEs if in relation to that transaction -
(i) there exists a prior agreement between such other person and the
AE; or
(ii) the terms of the relevant transaction are determined in substance
between such unrelated person and the AE.
4.6 For example, enterprise X of India and enterprise Y of Australia are
AEs. Enterprise Z of Singapore is not an AE of enterprise X. Enterprise Y
and enterprise Z enter into an agreement for determining the terms of
transactions between enterprise X and enterprise Z. The transaction as may
be entered between enterprise X and enterprise Z which is governed by such
an agreement existing between Y and Z shall be deemed to be a transaction

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 International Transaction

between two AEs. In this example the transaction could still be a deemed
international transaction if Enterprise Z was an Indian resident.

Independent Party Prior Agreement Associated Enterprise
(Z ) between Y and X (Y)

Australia
Singapore

India
Transaction between A Inc. and
Indian Company

Indian Company
(X Co.)

4.7 Finance Act (No.2) 2014 has amended the said section w.e.f
1-4-2015 to provide that even where the unrelated third party is located in
India, the transaction between the Indian entity and the unrelated third party
will be deemed as an international transaction between the Indian entity and
its AE located overseas. In the above case even if Z is an Indian resident,
the transaction between X Co. and Z would be treated as deemed
International Transaction.
The amended provisions would certainly cover within its ambit a three party
scenario under the provisions of section 92B(2). However, a four party
situation would need a detailed analysis / evaluation by the accountant. The
same is explained in the form of example below:

XYZ Plc. (AE of
ABC Plc. (AE) Unrelated Party)

Outside India

India

ABC Ltd. Local Agreement XYZ Ltd.
(Assessee) (Unrelated Party)

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

In the said case, ABC Plc. which is based outside India enters into an
agreement with XYZ Plc. (an unrelated party) to procure (raw material) from
XYZ Plc and all its subsidiaries on a global basis.
Pursuant to the said agreement, ABC Ltd. which is a subsidiary of ABC Plc.
procures raw material from XYZ Ltd which is a subsidiary of XYZ Plc.
In light of the facts provided above, whether the arrangement between ABC
Ltd. and XYZ Ltd. will be deemed to be an international transaction under
Section 92B(2) of the Act for ABC Ltd.? Such cases should be analysed in
detail by the accountant (having regard to the underlying facts and
circumstances) before reaching to a conclusion.

Impact of Amendment
• The tax authorities may evaluate whether the profits earned in India
is lower because of the influence of a non-resident AE on that
transaction.
• As per the amendment, domestic transactions which are influenced
by a Non-resident AE would also be covered within the scope of TP
provisions.
• Care should be taken to properly report and disclose such
transactions to avoid levy of penalty under Section 271AA.
• Amendment may not cover transaction between two resident parties
in India who are AEs. (Meaning of an AE and the scenarios where 2
persons can be regarded as AEs has been defined under section
92A(1) and 92A(2), respectively)

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 International Transaction

Example of Deemed International Transaction:
Case 1
Foreign Co

Understanding for transfer of
business unit of Indian Co 1

Outside India

India

India Co 1 India Co 2
(AE of FCo) (AE of FCo)

Business unit
of ICo 1

Foreign Co has two subsidiaries in India (I Co 1 and I Co 2). I Co 1 proposed
to transfer one of its business undertakings to I Co 2. There is an
understanding that I Co 1 has with F Co regarding transfer of this business
as well as the terms and conditions of transfer.
Since I Co 1 and I Co 2 are AEs, provisions of section 92B(2) should not
apply to the transaction of sale of business unit.
However, sale of a business undertaking can involve termination/
renegotiation of an existing contract, which can be based on an
understanding between I Co1 and F Co. In such case, an international
transaction of ‘business restructuring’ can exist between I Co 1 and F Co as
per the provisions of section. 92B(1) read with section 92F(v) of the Act.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Case 2:
Foreign Co

Unrelated
Vendor
Outside
India

India
India Co Unrelated
(AE of FCo) Vendor

Foreign Co. has a global procurement organization that identifies, appoints,
and negotiates with global vendors to supply to Foreign Co’s affiliates
(including India Co) at terms agreed by Foreign Co and the vendors.
Such transaction would be covered under the amended provision.

Case 3:
Foreign Co

Terms/ Conditions
determined by F Co

Outside India

India

India Co Contract
(AE of FCo) Manufacturer

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 International Transaction

Indian Co. enters into an arrangement with a third party contract
manufacturer for manufacture & purchase of goods. The terms are
determined in substance by Foreign Co.
Such transaction would be covered under the amended provision

Tangible and intangible property
4.8 Tangible property has an existence in physical form. Any property
other than tangible is intangible property. OECD Guidelines 2022 defines
intangible as something which is not a physical asset or a financial asset 1,
which is capable of being owned or controlled for use in commercial
activities, and whose use or transfer would be compensated had it occurred
in a transaction between independent parties in comparable circumstances.
OECD guidelines illustratively lists patents, know-how, trademarks, names
and brands, rights under contracts and government licenses, goodwill, group
synergies as intangible items.
4.9 Finance Act, 2012 inserted an explanation to Section 92B of the Act
w..e.f 1-4-2012, which clarifies the expression “intangible property” for
purposes of the Indian transfer pricing regulations to include-
(i) marketing related intangibles assets, such as, trademarks, trade
names, brand names, logos; or
(ii) technology related intangibles assets, such as, process patents,
patent applications, technical documentation such as laboratory
notebooks, technical know-how; or
(iii) artistic related intangible assets, such as, literary works and
copyrights, musical compositions, copyrights, maps, engravings ; or
(iv) data processing related intangible assets, such as proprietary
computer software, software copyrights, automated databases, and
integrated circuit masks and masters; or
(v) engineering related intangible assets, such as industrial design,

1 According to the OECD Guidelines 2022, a financial asset is any asset that is cash, an

equity instrument, a contractual right or obligation to receive cash or another financial
asset or to exchange financial assets or liabilities, or a derivative. Examples include
bonds, bank deposits, stocks, shares, forward contracts, futures contracts and swaps.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

product patents, trade secrets, engineering drawing and schema-tics,
blueprints, proprietary documentation; or
(vi) customer related intangible assets, such as, customer lists, customer
contracts, customer relationship, open purchase orders; or
(vii) contract related intangible assets, such as, favourable supplier,
contracts, licence agreements, franchise agreements, non-compete
agreements; or
(viii) human capital related intangible assets, such as, trained and
organised workforce, employment agreements, union contracts; or
(ix) location related intangible assets, such as leasehold interest, mineral
exploration rights, easements, air rights, water rights; or
(x) goodwill related intangible assets, such as, institutional goodwill,
professional practice goodwill, personal goodwill of professional,
celebrity goodwill, general business going concern value; or
(xi) methods, programmes, systems, procedures, campaigns, surveys,
studies, forecasts, estimates, customer lists, or technical data; or
(xii) any other similar item that derives its value from its intellectual
content rather than its physical attributes.
Given the wide scope of the phrase ‘international transaction’ and more
particularly as regards ‘intangible property’ the accountant will need to
exercise due diligence that all relevant transactions are considered and
included in the report, whether these are included in the books of accounts or
records of the assessee or not. 2 The accountant should also review the
record of any pending or past transfer pricing assessments or appeals of the
assessee to identify any transaction not otherwise apparent from the books
of accounts or records of the assessee. Where the accountant is unable to
verify all such transactions due to any reason, and/ or relies upon
explanations/ representations made to it by the assessee, and/ or there is a
difference of opinion between the accountant and the assessee, such aspect

2 It may be mentioned that there may not be exact similarity between the definitions as

per transfer pricing principles and accounting principles. In the Indian context ‘Intangible’
for transfer pricing purposes may be in variation with ‘intangible assets’ in accounting
terms as per AS 26 and/or Ind AS 38.

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 International Transaction

should be included in the accountant’s report as a note or qualification, as
appropriate.
4.10 One of the most important aspects is to identify the intangibles, which
are owned by the Group and the Indian entity. While, the above explanation
provides detailed insights into the kind of intangibles, identification of
intangibles, is an intensive process and requires detailed understanding of
the industry and business model of the group and the Indian entity. The
accountant can refer to the value driver analysis performed in the Master
File, key customer contracts, customer relationships, vendor lists, etc. as
reference points to identify intangibles, apart from the legally owned
intangibles.
4.10.1 An intangible, for transfer pricing purposes, is something which:
• Is not a physical asset or a financial asset
• Is capable of being owned or controlled for use in commercial
activities; and
• Whose use or transfer would be compensated had it occurred in a
transaction between independent parties in comparable
circumstances
• Legal, contractual, and other forms of protection may affect the value
of an item and the returns that should be attributed to it – but the
existence of such protection is not a necessary condition for an item
to be characterised as an intangible for transfer pricing purposes.
4.10.2 Methods for valuing intangibles in Transfer Pricing
(i) Market Approach:
• Estimates value based on actual market transactions
• Requires the collection of market data from comparable transactions
and analysis of the data to estimate the value of the intangible
through comparison and correlation.
(ii) Income Approach:
• Considers income and expense data relating to the intangible and
based on cash flow projections and discount rates computes a fair
market value.
• Includes the discounted cash flow method and the relief from royalty
approach, two commonly used valuation methods.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

(iii) Cost Approach:
• Values intangible assets based on their ‘cost to create’ or what it
might cost to recreate a similar asset
• The OECD Guidelines note that the use of methods that seek to
estimate the value of intangibles based on the cost of intangible
development is generally discouraged.
4.10.3 Valuation is an important consideration in the transfer/migration
of intangibles
Substance/commercial reasons for transferring intangibles is also critical.
Since the ownership of intangibles can represent a major profit driver for a
business, the valuation, pricing and supporting reasons for the transfer is
paramount, particularly if intangibles ownership is being transferred from a
high tax jurisdiction to a low tax jurisdiction.
For the purpose of 92E report, part B of clause 12 in form 3CEB, the
disclosure required is pertaining to amount paid/received or
payable/receivable for purchase/ sale/transfer/lease/use of each category of
intangible property
(i) as per books of account;
(ii) as computed by the assessee having regard to the arm’s length price.
Professionals would base their independent opinions based on the valuation
reports of other professionals. However, reasonable independent scrutiny
and assessment on the following aspects is to be done:
• Existence of such intangible, IP Structuring and Group Policies
• Documentation being maintained
• Prior history and cost base or Capitalisations/ accruals of the
company
• Any patents, trademarks or registrations acquired
• Valuation Methodologies, workings, assumptions, and the
base/benchmark ratios/ calculations as compared to independent
companies in similar industry
Further, As all the intangibles referred to Explanation (ii) to Section 92B may
not be separately accounted in the books of accounts (such as customer
lists, human capital related intangibles, customer relationship, goodwill, etc),
the accountant may need to rely on the transfer pricing documentation
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 International Transaction

maintained by the assessee under Rule 10D as well as obtain adequate
representations from the management stating that all the international
transactions relating to intangibles have been disclosed to the accountant.
4.11 There may be outright sale transaction for a consideration between the
Associate Enterprises or there may be a License agreement between AEs for
use of above intangibles. Intangibles are generally created by the
manufacturing activities or Research & Development activities undertaken by
the AEs, or there may be a case of marketing intangibles created by
marketing, distribution and after sale-service by any AE.
Chapter VI of the Transfer Price Guidelines by OECD (2017) provides
guidance specifically tailored to determine ALP for transactions that involve
the use/ transfer of intangibles. The BEPS Action Plan 8 of OECD suggests
that profits associated with the transfer and use of intangibles is
appropriately allocated in accordance with the value creation.
Benchmarking of the use/ transfer of above intangibles between AEs needs
to be properly made by the management based on generally accepted
approaches for valuation like the Cost Approach, The Market Approach and
the Earning Approach. The TP auditor needs to certify the ALP calculated by
the assessee by applying any of the TP methods.
4.12 With respect to marketing intangible and particularly advertisement,
marketing and promotional (‘AMP') expenses, the accountant will need to
exercise due diligence to establish whether the AMP expenses are incurred
by AE in India to cater to the needs of the customers in the local market and
not incurred at the instance or behest of overseas AE nor there was any
mutual understanding or arrangement or allocation or contribution by the AE
towards reimbursement of any part of AMP expenditure incurred by it for the
purpose of its business. For carrying out this exercise cases decided on this
should be kept in mind.

Services, finances, and costs etc.
4.13 “Provision of services” refers to trade related services like intellectual
property rights and trade related investments. According to the OECD
guidelines, there are two main issues while analysing intra-group services:
(i) whether an intra-group service that should be charged for has been
provided; and
(ii) what the charge should be in accordance with the arm’s length
principle.
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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

In this regard, the accountant may refer to the following aspects while
determining whether the intra-group services have been rendered:
(a) Benefits test – The basis to decide whether a service has been
provided is set out in the guidelines as ‘whether an independent enterprise in
comparable circumstances would have been willing to pay for the activity if
performed for it by an independent enterprise or would have performed the
activity in-house for itself. If the activity is not one for which the independent
enterprise would have been willing to pay or perform for itself, the activity
ordinarily should not be considered as an intra-group service under the arm’s
length principle’. Services benefiting a group of enterprises as a whole
should be allocated amongst the group in a way that matches the benefit
received.
(b) Shareholder activities – An activity that a group member (usually the
parent company or a regional holding company) performs solely because of
its ownership interest in one or more other group members i.e in its capacity
as shareholder. This type of activity would not be considered to be an intra-
group service, and thus would not justify a charge to other group members.
This type of activity may be referred to as a “shareholder activity”.
Certain illustrative examples for Shareholder activities can be:
(i) juridical structure of the parent company itself such as meetings of
shareholders of the parent, issuing of shares in the parent company,
stock exchange listing of parent company and cost of supervisory
board;
(ii) reporting requirements of parent company including consolidation of
reports, parent company’s audit of subsidiary’s accounts carried out
exclusively in the interest of parent company, preparation of
consolidated financial statements of the MNE;
(iii) raising funds for the acquisition of its participations and costs relating
to the parent company’s investor relations such as communication
strategy;
(iv) raising funds for the acquisition of its participations and costs relating
to the parent company’s investor relations such as communication
strategy;
(v) ancillary to the corporate governance of the MNE as a whole.
(c) Duplicative activities – An activity which is undertaken by one group
member that merely duplicate(s) a service that another group member is
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 International Transaction

performing for itself, or that is being performed for such other group member
by a third party(s) are considered to duplicative activities. An exception may
be where the duplication of services is only temporary, for example, where
an MNE group is reorganising to centralise its management functions.
Another exception would be where the duplication is undertaken to reduce
the risk of a wrong business decision (e.g. by getting a second legal opinion
on a subject). Furthermore, the fact that a company performs, for example,
marketing services in-house and also is charged for marketing services from
a group company does not of itself determine duplication, since marketing is
a broad term covering many levels of activity. The Accountant shall examine
the information provided by the taxpayer to determine whether the intra-
group services are different, additional, or complementary to the activities
performed in-house. The benefits test would then apply to those non-
duplicative elements of the intra-group services.
(d) Incidental Benefits – There can be some cases where an intra-group
services performed by a group member such as a shareholder or
coordinating centre relates only to some group members but incidentally
provides benefits to other group members. Examples could be analysing the
question whether to reorganize the group, to acquire new members, or to
terminate a division. These activities could constitute intra-group services to
the particular group members involved, for example those members who may
make the acquisition or terminate one of their divisions, but they may also
produce economic benefits for other group members not directly involved in
the potential decision since the analysis could provide useful information
about their own business operations. The incidental follow-on benefits that
ordinarily would not cause these other group members to be treated as
receiving an intra-group service because the activities producing the benefits
would not be ones for which an independent enterprise ordinarily would be
willing to pay.
Similarly, an associated enterprise should not be considered to receive an
intra-group service when it obtains incidental benefits attributable solely to it
being part of a larger concern, and not to any specific activity being
performed. For example, no service would be received where an associated
enterprise by reason of its affiliation alone has a credit-rating higher than it
would if it were unaffiliated, but an intra-group service would usually exist
where the higher credit rating were due to a guarantee by another group
member, or where the enterprise benefitted from deliberate concerted action
involving global marketing and public relations campaigns.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Capital financing transactions
4.14 The AEs often enter into transactions of capital financing including
borrowing, lending, guarantee arrangements, etc. The pricing of these
arrangements will have a bearing on the profits or losses of the AEs and
hence are included as part of the definition of ‘international transaction’.
These transactions of capital financing including any type of long-term or
short-term borrowing, lending or guarantee, purchase or sale of marketable
securities or any type of advance, payments or deferred payment or
receivable or any other debt arising during the course of business are
expressly covered as international transactions vide Finance Act 2012.The
accountant will need to carefully identify and report such transactions and
particularly equity and preference capital, debentures, guarantees provided
or received, etc. Advance payments received or made and debts arising
during the course of business shall need to be carefully considered and
reported by the accountant however ensuring that there is no duplication or
overlap with reporting of the principal transactions to which such advances or
debts relate to, unless the accountant identifies factors which cause such
advances or debts as separate transactions.
The OECD has released “OECD Transfer Pricing Guidelines for Multinational
Enterprises and Tax Administrations” in January 2022 incorporating
discussion on transfer aspects of financial transactions in Chapter X. It seeks
to provide guidance for determining whether the conditions of certain
financial transactions between associated enterprises are consistent with the
arm’s length principle. This may be referred to while analysing financial
transactions for the purposes of the certificate under section 92E of the Act.
The accountant shall consider disclosing the transactions in relation to
advance, payments or deferred payment or receivable or any other debt
arising during the course of business either by way of a note in the ‘detailed
observation/remarks’ section of the respective underlying primary transaction
to which such balances pertain to or make a separate disclosure of such
balances along with a description of the underlying primary transaction to
which it is closely linked.

Cost contribution arrangement
4.15 Agreement or arrangement represents understanding, and not a
transaction as ordinarily understood as being some business or dealing,
which is carried on or transacted between two or more persons. It is

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 International Transaction

reciprocal to contribute to the cost or incur expenditure for the mutual
advantage or to share according to the agreement or the arrangement. Such
agreement or arrangement is not in the nature of conveying any property or
provision of services or lending or borrowing and is known as ‘cost
contribution arrangement’.
4.16 The cost contribution arrangements, as aforesaid, are arrangements
between business enterprises to share the costs and risks of jointly
developing, producing, or obtaining assets, services or rights. Its conditions
should be in conformity with arm’s length principle and therefore, a
participant's contributions must be consistent with what an independent
enterprise would have agreed to contribute under comparable circumstances
given the benefits it reasonably expects to derive from the arrangement. The
accountant should gain an understanding of the transaction and make
appropriate reporting for the same.

Free of cost transfer of goods or services
4.17 When determining whether or not international transaction exist in the
books of accounts or records of the Assessee, the Accountant also need to
consider the free of cost goods / services rendered / availed by the
Assessee. A reference can also be placed on the positions adopted by the
taxpayer under for GST for such free of cost goods / services by the
Assessee.
4.18 The Accountant will need to carefully examine the necessary facts/
conditions to assess and identify such transactions not otherwise apparent
from books of accounts or records of the Assessee and make appropriate
reporting for the same. Where amounts are recognized on a notional basis in
the books of accounts due to applicable accounting standards or otherwise,
the same should be in conformity with arm’s length principle. Examples of
such transactions may include free of cost employee stock option plans, free
of cost software / software related services, free of cost management
services, etc.
4.19 To the extent there is an intentional set-off or where the pricing of the
principal transaction is determined (basis functions performed, assets
employed and risks assumed) after considering the free of cost transfers, a
separate disclosure of such free of cost transfers may not be necessary.
However, the fact of such set-off could be included in the accountant’s report
as a note. Same is the case with ‘shareholder activities’ and ‘incidental
benefits’ that are not compensable.
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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Example:
F Co.

Outside India

IT Service agreement India

India Co
(AE of F Co.)

F Co. has entered into a service agreement with India Co. for provision of IT
services. As per the inter-company agreement, F Co. provides the necessary
software/ tools, provides management oversight, and supervises the work
carried out by India Co. The compensation to India Co. is agreed having
regard to the roles and responsibilities of both the parties, including the free
of cost software/ management services received by India Co. In such a case,
a separate disclosure of such free of cost transfers may not be necessary.
4.20 The primary responsibility for the disclosing of such transactions rests
with the taxpayer and the Accountant is entitled to place reliance on the
representations provided by the taxpayer as to the details / completeness of
such transactions.

Cross-border transactions- Interplay of section 9
and section 92A
4.21 For a transaction to be an international transaction, it should satisfy
the following two conditions cumulatively:
(a) it must be a transaction between two AEs; and
(b) at least one of the two enterprises must be a non-resident.
4.22 A transaction is considered to be a cross-border transaction if it
originates in one country and gets concluded in another country. A cross-
border transaction may or may not be an international transaction within the
meaning of Chapter X of the Act. Similarly, a transaction which is not a
cross-border transaction may still be an international transaction for the

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 International Transaction

purpose of the said chapter if it falls within the ambit of the definition of
“international transaction”.
4.23 For example, it may be assumed that there are two US companies
which are AEs. If the Indian subsidiary of one such US (holding) company
enters into a transaction with the Indian branch or the permanent
establishment in India of the other US company, this transaction, even
through it has originated, executed and concluded within India, shall be an
international transaction as it is between two AEs and one of the party is a
non-resident.
4.24 In alternative, assume that there is an Indian company which is the
holding company of two Indian (subsidiary) companies. The two Indian
companies are AEs since they are subsidiaries of a common holding
company. If one such Indian subsidiary company enters into a transaction
with the foreign branch of the other Indian subsidiary company, such
transaction shall not be regarded as an international transaction. In this case,
even though the transaction is between two AEs, both the parties to the
transaction are residents. For a transaction to be regarded an international
transaction, either or both the parties must be non-residents. An important
aspect to be noted here is that even though the above mentioned transaction
is not an international transaction but it may be covered under domestic
transfer pricing, subject to fulfilment of conditions prescribed under section
92BA, as per the amendements made vide Finance Act 2012 and the ALP
would have to be determined having regard to transfer pricing provisions.
4.25 Even where a transaction is between two non-resident AEs, the
provisions of chapter X of the Act shall apply so long as the income arising
therefrom is assessable within the perview of the Act. It is possible that an
international transaction between two AEs, both of whom are non-residents,
may not attract the provisions of chapter X of the Act if the income from such
transction is not taxable in India and falls outside the scope of total income
assessable under the Act.

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 Chapter 4A
Specified Domestic Transactions
4A.1 Transfer pricing regulations have been extended vide Finance Act
2012 to include transactions entered into with domestic related parties or by
an undertaking with other undertakings of the same entity for the purposes of
section 40A (now omitted), Chapter VI-A and section 10AA. Domestic
transfer pricing provisions are applicable from Assessment Year 2013-14
onwards.
4A.2 All of the compliance requirements relating to transfer pricing
documentation, accountant’s report, etc shall equally apply to specified
domestic transactions as they do for international transactions amongst
associated enterprises.

Definition
4A.3 The definition of section 92BA which defines Specified Domestic
Transaction (SDT) has been amended vide Finance Act, 2017 to omit
transactions in the nature of expenditure for which payment has been made
or would be made to persons specified in section 40A(2)(b). The said
amendment is applicable for assessment year 2017-18 i.e. previous year
2016-17.
Section 92BA defines SDT which is covered by TP regulationsas under:
“For the purposes of this section and sections 92, 92C, 92D and 92E,
“specified domestic transaction” in case of an assessee means any of the
following transactions, not being an international transaction, namely:—
⎯ any transaction referred to in section 80A;
⎯ any transfer of goods or services referred to in sub-section (8) of
section 80-IA;
⎯ any business transacted between the assessee and other person as
referred to in sub-section (10) of section 80-IA;
⎯ any transaction, referred to in any other section under Chapter VI-A
or section 10AA, to which provisions of sub-section (8) or sub-section
(10) of section 80-IA are applicable; or
 Specified Domestic Transactions

⎯ any business transacted between the persons referred to in sub-
section (6) of section 115BAB;
⎯ any other transaction as may be prescribed,
and where the aggregate of such transactions entered into by the assessee
in the previous year exceeds a sum of Rupees Twenty Crores.

Threshold Limit
4A.4 The above referred transactions will be regarded as SDT only if the
aggregate value of all the above specified transactions exceeds the threshold
limit of Rupees 20 Crores (w.e.f 1st April 2016 onwards). If the threshold limit
is crossed, the taxpayer will be required to comply with TP requirements with
reference to all the transactions regardless of the fact that that the value of
transactions under one of the limbs may be very small or nominal. Thus,
there is no internal threshold for each limb of the definition.
4A.5 The threshold limit for SDT can be computed either on net basis (i.e.
without including indirect tax levies like service tax, VAT, etc.) if the
assessee is availing credit of those indirect taxes or on gross basis if the
assessee is not availing credit, depending upon the method of accounting
regularly followed. A useful reference may be made to the paragraph relating
to Sales, Turnover, Gross Receipts under Guidance Note on Tax Audit u/s.
44AB issued by the Institute for the purpose of determining the threshold
limit.
4A.6 Transactions covered under section 80A, 80-IA and 10AA
Section 92BA extends to:
(i) any transaction referred to in section 80A;
(ii) any transfer of goods or services referred to in sub-section (8) of
section 80-IA;
(iii) any business transacted between the assessee and other person as
referred to in sub-section (10) of section 80-IA;
(iv) any transaction, referred to in any other section under Chapter VI-A
or section 10AA, to which provisions of sub-section (8) or sub-section
(10) of section 80-IA are applicable
4A.7 Transactions covered under section 80A
Section 80A applies to deductions to be made in computing total income
under Chapter VI-A. Though the reference in section 92BA is to section 80A

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

in general, on a closer examination, it becomes clear that the reference is
merely to sub-section (6) of section 80A and not to any other sub-section
since other sub-section of section 80A merely regulates the quantum of
deduction and does not involve fair pricing of any transaction. This is also
supported by corresponding amendment made to section 80A(6) by Finance
Act 2012 to amend the meaning of expression ‘market value’ referred to in
that sub-section and to provide that in case of specified domestic
transactions, the market value shall be computed at arm’s length price.
4A.8 Section 80A (6) of the Act provides that
“Notwithstanding anything to the contrary contained in section 10A or section
10AA or section 10B or section 10BA or in any provisions of this Chapter
under the heading “C— Deductions in respect of certain incomes”, where any
goods or services held for the purposes of the undertaking or unit or
enterprise or eligible business are transferred to any other business carried
on by the assessee or where any goods or services held for the purposes of
any other business carried on by the assessee are transferred to the
undertaking or unit or enterprise or eligible business and, the consideration,
if any, for such transfer as recorded in the accounts of the undertaking or unit
or enterprise or eligible business does not correspond to the market value of
such goods or services as on the date of the transfer, then, for the purposes
of any deduction under this Chapter, the profits and gains of such
undertaking or unit or enterprise or eligible business shall be computed as if
the transfer, in either case, had been made at the market value of such
goods or services as on that date.
Explanation — For the purposes of this sub-section, the expression “market
value”,—
(i) in relation to any goods or services sold or supplied, means the price
that such goods or services would fetch if these were sold by the
undertaking or unit or enterprise or eligible business in the open
market, subject to statutory or regulatory restrictions, if any;
(ii) in relation to any goods or services acquired, means the price that
such goods or services would cost if these were acquired by the
undertaking or unit or enterprise or eligible business from the open
market, subject to statutory or regulatory restrictions, if any;
(iii) in relation to any goods or services sold, supplied or acquired
means the arm’s length price as defined in clause (ii) of section

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 Specified Domestic Transactions

92F of such goods or services, if it is a specified domestic
transaction referred to in section 92BA.
4A.9 This provision requires that the inter unit transfer of goods or services
between eligible and other units of the same taxpayer should be recognized
at market value of such goods or services as on the date of transfer for the
purpose of computing deduction admissible to the taxpayer under specified
sections of Chapter VI-A. The provision covers income as well as
expenditure of the eligible unit. Further, if threshold of INR 20 crore is not
crossed the same will continue to be governed by un-amended provisions of
section 80A(6) of the Act and FMV will be computed on general principles
4A.10 The provisions currently in force which grant profit linked tax holiday
deductions and which are regulated by section 80A(6) and, consequently,
subject to Domestic transfer pricing are as follows:-
• 80-IA – Infrastructure development, etc
• 80-IAB – SEZ development
• 80-IAC – Startup business
• 80-IB – Industrial undertakings
• 80-IBA – Development and building house projects
• 80-IC – Industrial undertakings or enterprises in special category
states
• 80-ID – Hotels and convention centres in specified area
• 80-IE – Undertakings in North-Eastern states
• 80JJA – Collection and processing of bio-degradable waste
• 80JJAA – Employment of new workmen
• 80LA – Offshore Banking units and International Financial Services
Centre
• 80P – Co-operative societies
4A.11 Transfers referred to in section 80-IA(8)
The second limb of section 92BA refers to any transfer of goods or services
referred to in sub-section (8) of section 80-IA. Section 80-IA (8) covers inter-
unit transfer of goods and services.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Section 80-IA(8) reads as under:
“Where any goods or services held for the purposes of the eligible business
are transferred to any other business carried on by the assessee, or where
any goods or services held for the purposes of any other business carried on
by the assessee are transferred to the eligible business and, in either case ,
the consideration, if any, for such transfer as recorded in the accounts of the
eligible business does not correspond to the market value of such goods or
services as on the date of the transfer, then, for the purposes of the
deduction under this section, the profits and gains of such eligible business
shall be computed as if the transfer, in either case, had been made at the
market value of such goods or services as on that date”
Provided that where, in the opinion of the Assessing Officer, the computati on
of the profits and gains of the eligible business in the manner hereinbefore
specified presents exceptional difficulties, the Assessing Officer may
compute such profits and gains on such reasonable basis as he may deem
fit.
Explanation.—For the purposes of this sub-section, "market value", in
relation to any goods or services, means—
(i) the price that such goods or services would ordinarily fetch in the
open market; or
(ii) the arm's length price as defined in clause (ii) of section 92F,
where the transfer of such goods or services is a specified
domestic transaction referred to in section 92BA.
4A.12 The above provision entitles the assessing officer to compute profits
and gains of eligible business based on market value of goods and services
transferred between an eligible and a non-eligible business only if the
consideration for such transfer (if any) as recorded in the books of accounts
of the eligible business does not correspond to the market value of the goods
or services. By virtue of the amendment made to the above explanation vide
Finance Act 2012, on lines of extension of Explanation to section 80A(6)
defining market value, the Explanation under this provision has also been
expanded to provide that the market value shall be computed at arm’s length
price if the inter unit transfer constitutes specified domestic transaction.
4A.13 Transfers referred to in section 80-IA(10)
The third limb of section 92BA refers to business transacted between the
assessee and any other person as referred to in sub-section (10) of section
80-IA.

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 Specified Domestic Transactions

4A.14 Section 80-IA(10) reads as under:
“Where it appears to the Assessing Officer that, owing to the close
connection between the assessee carrying on the eligible business to which
this section applies and any other person, or for any other reason, the course
of business between them is so arranged that the business transacted
between them produces to the assessee more than the ordinary profits which
might be expected to arise in such eligible business, the Assessing Officer
shall, in computing the profits and gains of such eligible business for the
purposes of the deduction under this section, take the amount of profits as
may be reasonably deemed to have been derived therefrom.”
“Provided that in case the aforesaid arrangement involves a specified
domestic transaction referred to in section 92BA, the amount of profits
from such transaction shall be determined having regard to arm’s
length price as defined in clause (ii) of section 92F”
4A.15 Section 80-IA (10) applies to transactions between the assessee and
any other person which results in excessive profits in the hands of the
assessee:
(a) either owing to close connection with other person; or
(b) for any other reason.
The dealings between taxpayer and other person get covered by section 80-
IA(10) provided the course of business between them is so arranged that the
transaction produces more than ordinary profits in the eligible business.
4A.16 Transactions in other provisions to which section 80-IA(8)/(10)
apply
Specified domestic transactions as defined in section 92BA also refer to any
transaction, referred to in any other section under Chapter VI-A or section
10AA, to which provisions of section 80-IA(8) and section 80-IA(10) are
applicable.
The following profit linked incentive provisions under Chapter VI-A are also
governed by provisions of section 80-IA(8) and section 80-IA(10) and hence
will be subject to Domestic TP:-
• 80-IAB- Deductions in respect of profits and gains by an undertaking
or enterprise engaged in development of Special Economic Zone.
• 80-IAC- Special provisions in respect of specified business

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

• 80-IB- Deduction in respect of profits and gains from certain industrial
undertakings other than infrastructure development undertakings
• 80-IBA- Deduction in respect of profits and gains from housing
projects
• 80-IC- Special provisions in respect of certain undertakings or
enterprises in certain special category States
• 80-ID- Deduction in respect of profits and gains from business of
hotels and convention centres in specified area
• 80-IE- Special provisions in respect of certain undertakings in North-
Eastern States
4A.17 Transactions between the persons referred to in sub-section (6)
of section 115BAB
Section 115BAB was introduced by the Taxation Laws (Amendment) Act,
2019 providing for a concessional tax rate of 15% to a domestic company if
specified conditions are satisfied. Sub-section (6) of this section reads as
follows:
(6) Where it appears to the Assessing Officer that, owing to the
close connection between the person to which this section applies
and any other person, or for any other reason, the course of
business between them is so arranged that the business transacted
between them produces to the person more than the ordinary profits
which might be expected to arise in such business, the Assessing
Officer shall, in computing the profits and gains of such business for
the purposes of this section, take the amount of profits as may be
reasonably deemed to have been derived therefrom:
Provided that in case the aforesaid arrangement involves a
specified domestic transaction referred to in section 92BA, the
amount of profits from such transaction shall be determined having
regard to arm's length price as defined in clause (ii) of section 92F:
Provided further that the amount, being profits in excess of the
amount of the profits determined by the Assessing Officer, shall be
deemed to be the income of the person.
Hence, if a company is seeking benefits of lower rate of tax under section
115BAB then the auditor should examine whether transaction would be
covered under the first proviso to sub-section (6) as mentioned above and
take action accordingly.

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 Chapter 5
Arm’s Length Price
Meaning and determination
5.1 In commercial parlance, an arm’s length price is the price at which
independent enterprises deal with each other, where the conditions of their
commercial and financial relations ordinarily are determined by market
forces. Section 92F(ii) of the Act, defines the arm’s length price as a price
which is applied or proposed to be applied in a transaction between persons
other than associated enterprises (‘AE’), in uncontrolled conditions.
5.2 The steps involved in the determination of the arm’s length price can
be summarised as follows:
(i) identification of the “international transaction/(s)” or specified
domestic transaction/(s);
(ii) identification of the functions performed, assets employed, and risks
assumed (‘FAR’) by the taxpayer and the AE being parties to the
transaction(s);
(iii) deciding the characterisation of the entities who are party to the
transaction based on the analysis of functions performed, assets
employed and risks assumed;
(iv) deciding if the international transactions or specified domestic
transactions are closely linked or not [Rule 10A(d)] and accordingly
functional analysis to be done using aggregation of transaction or
transaction by transaction approach;
(v) identification / selection of the tested party (for application of resale
price method, cost plus method and transactional net margin
method);
(vi) identification of the most appropriate method which will, inter-alia,
include:
a) identification of an “uncontrolled transaction” - Rule 10A (ab);
⎯ Review of existing internal uncontrolled transaction, if any;
⎯ Determination of available sources of information on external
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

comparables where such external comparables are needed
taking into account their relative reliability.
Identification and comparison of specific characteristics
embodied in international transactions or specified domestic
transactions and uncontrolled transactions-Rule 10B(2);
b) finding out whether uncontrolled transactions and international
transactions or specified domestic transactions can be compared
by reconciling/resolving differences, if any - Rule 10B(3);
(vii) ascertaining the most appropriate method by applying the tests laid
down - Rule 10C;
(viii) determination of the arm’s length price by applying the method
chosen - Rule 10B(1).
Please note that step (vi) is a repetitive exercise (in respect of each of the
prescribed methods) until a satisfactory conclusion is reached thereby
leading to selection of the most appropriate method out of the methods
prescribed under Section 92C(1) of the Act. Further, no particular method
has been accorded any priority under the Indian Transfer Pricing legislation.
The most appropriate method is to be selected having regard to the nature of
the transaction(s), functions performed by the parties involved in the
transaction(s) and other relevant factors.
Example – ABC India is engaged in distribution of XYZ brand printers in the
Indian market, which are manufactured by ABC Inc. (a US based group
entity). Apart from the distribution of printers, ABC India also imports printer
cartridges and other spares from its group entity ABC Inc, which are used in
the after-sales business. The international transactions in this case are
import of printers and import of cartridges & spares.
The typical steps involved in determination of the arm’s length price in the
above example could be as follows:
Identify international transactions
1. Import of printers; and
2. Import of cartridges and spares.

Decide if the transactions are closely linked
In the present case, if ABC India follows a business strategy where it targets
to sell the printers to penetrate the market and thereafter get recurring

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 Arm’s Length Price

business through sale of cartridges, then the transaction of import of printers
and import of cartridges and spares could be said to be closely linked, and
may be evaluated using aggregation approach.

FAR analysis
Undertake an in-depth FAR analysis of ABC India and ABC Inc. For instance,
ABC India performs functions in the nature of procurement, quality control,
inventory management, marketing and sales promotion (limited) etc., employs
assets in the nature of office premises, warehouses etc. and assumes limited
market and inventory risks amongst others. On the other hand, ABC Inc.
performs functions in the nature of corporate strategy formulation, product
research and development, manufacturing, pricing etc., employs assets in the
nature of manufacturing know-how, brand, manufacturing facilities,
warehouses etc. and assumes product liability, research and development,
market risks amongst others.

Characterization of the parties involved in the aforementioned transactions
and accordingly selecting the tested party
If after an in-depth FAR analysis of ABC India and ABC Inc, ABC India is
characterised as a limited risk distributor and ABC Inc. is characterised as a
full-fledged manufacturer and further reliable comparable data for ABC India
can be found, then typically ABC India being the entity with the least complex
FAR shall be selected as the tested party.

Ascertaining the most appropriate method and determination of the arm’s
length price
After a careful examination of the facts and circumstances of the case and
further after applying the tests laid down in Rule 10C, in the instant case, the
resale price method could be selected as the most appropriate method.
Further, in case where no internal comparable data is available, external
comparable data could be identified through available sources of information
and accordingly the arm’s length price can be ascertained.

5.3 Section 92C(1) stipulates that the arm’s length price is to be
determined by adopting any one of the following methods, being the most
appropriate method:
• Comparable Uncontrolled Price method (CUP method)

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

• Resale Price Method (RPM)
• Cost Plus Method (CPM)
• Profit Split Method (PSM)
• Transactional Net Margin Method (TNMM)
• Other Method (OM) as prescribed by the Board and provided in Rule
10AB1.
5.4 Rule 10C(1) lays down the general guidelines in the selection of the
most appropriate method. The Rule states that the method to be selected
shall be the one best suited to the facts and circumstances of each
international transaction or specified domestic transaction and that provides
the most reliable measure of the arm’s length price.
5.5 Rule 10C(2) lists the specific factors that should be taken into
account in the process of selecting the most appropriate method. These
factors are as under:
(i) nature and class of international transactions or specified domestic
transactions;
(ii) class or classes of AEs entering into the transaction and the functions
performed by them taking into account the assets employed or to be
employed and risks assumed by such enterprises;
(iii) availability, coverage and reliability of data necessary for application
of the method. For instance, data relating to transactions entered into
by the enterprise itself would be more reliable than the data relating
to transactions entered into by third parties;
(iv) the degree of comparability existing between the international
transaction or specified domestic transaction and uncontrolled
transaction and between enterprises entering into such transactions
(v) the extent to which reliable and accurate adjustments can be made to
account for the difference between the transactions.
(vi) the nature, the extent and reliability of assumptions required to be
made in application of a method.

1 Rule 10AB vide Notification No. 18/2012 [F. NO. 142/5/2012-TPL] dated 23 May

2012, applicable for assessment year 2012-13 and onwards

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 Arm’s Length Price

5.6 Rule 10C, inter alia, specifies that the availability, coverage and
reliability of data and whether reasonably accurate and reliable adjustments
could be made as the relevant considerations in selecting the most
appropriate method. In actual practice, the choice of most appropriate
method depends not only on the nature and character of international
transaction or specified domestic transaction but also on the availability of
comparable transactions and data. Hence, the selection of most appropriate
method is a process of applying both the criteria. It may happen that what
appears to be most appropriate method on the basis of nature of
international transaction or specified domestic transaction may not be
eventually selected because of non-availability of comparable data. The
following example would clarify. An enterprise may buy from its AE and resell
in India. The transaction itself suggests that the most appropriate method is
Resale Price Method (RPM). There may not be any internal comparable
transaction available. Even an external comparable may not be available.
Even if an external comparable is available, the available data may not be
sufficient to determine the Arm’s length Gross Profit. Therefore, RPM may
not be most appropriate method and some other method is to be chosen.
The selection of most appropriate method is a process of continuously
evaluating the nature and characteristics of international transactions or
specified domestic transactions and the comparable transactions.
5.7 The factors referred to above are to be applied cumulatively in
selecting the most appropriate method. The reference therein to the terms
‘best suited’ and ‘most reliable measure’ indicates that the most appropriate
method will have to be selected after a meticulous appraisal of the facts and
circumstances of the international transaction or specified domestic
transaction. Further, the selection of the most appropriate method shall be
for each particular international transaction or specified domestic transaction.
The term ‘transaction’ itself is defined in rule 10A(d) to include a number of
closely linked transactions. Therefore, though the reference is to apply the
most appropriate method to each particular transaction, keeping in view, the
definition of the term ‘transaction’, the most appropriate method may be
chosen for a group of closely linked transactions. Two or more transactions
can be said to be linked when these transactions emanate from a common
source being an order or a contract or an agreement or an arrangement and
the nature, characteristics and terms of these transactions are substantially
flowing from the said common source. For example, a master purchase order
is issued stating the various terms and conditions and subsequently,

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

individuals orders are released for specific quantities. The various purchase
transactions are closely linked transactions.
5.8 It may be noted that in order to be closely linked transactions, it is not
necessary that these transactions need to be identical or even similar. For
example, a collaboration agreement may provide for import of raw materials,
sale of finished goods, provision of technical services and payment of
royalty. Different methods may be chosen as the most appropriate methods
for each of the above transactions when considered on a standalone basis.
However, under particular circumstances, one single method may be chosen
as the most appropriate method covering all the above transactions as the
same are closely linked.
5.9 There is yet another category of transactions which may be identical
or similar though not closely linked. For example, independent purchase
transactions having identical or similar nature, characteristics, terms and
conditions are not closely linked transactions because these transactions do
not emanate from a common source. However, under particular
circumstances, one single method may still be chosen as the most
appropriate method covering all the above transactions.
The following examples, [referred in the OECD Transfer Pricing Guidelines
(2017)], may be useful in this regard:
“Examples may include 1. Some long-term contracts for the supply of
commodities or services, 2. rights to use intangible property, and 3.
pricing a range of closely-linked products(e.g. in a product line) when
it is impractical to determine pricing for each individual product or
transaction.” (Para 3.9)
“Another example where a taxpayer’s transactions may be combined
is related to portfolio approaches. A portfolio approach is a business
strategy consisting of a taxpayer bundling certain transactions for the
purpose of earning an appropriate return across the portfolio rather
than necessarily on any single product within the portfolio. For
instance, some products may be marketed by a taxpayer with a low
profit or even at a loss, because they create a demand for other
products and/or related services of the same taxpayer that are then
sold or provided with high profits (e.g. equipment and captive
aftermarket consumables, such as vending coffee machines and
coffee capsules, or printers and cartridges). Similar approaches can
be observed in various industries. Portfolio approaches arean

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example of a business strategy that may need to be taken into
account in the comparability analysis and when examining the
reliability of comparables.” (Para 3.10)
5.10 It is not uncommon to notice transactions which are not only
dissimilar or unidentical but are also not linked .For example, there may be
transactions of purchase, sale and provision of technical service. In such
case, wherever internal comparables are available, appropriate method
should be used if the circumstances so justify.
5.11 Section 92C(2) provides that most appropriate method referred to in
section 92C(1) shall be applied, for determination of arm’s length price, in the
manner as prescribed in Rule 10B. The first proviso to section 92C(2)
provides 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.
The second proviso to section 92C(2) provides that if the variation between
the arm’s length price, so determined and price at which the transaction has
actually been undertaken does not exceed such percentage as may be
notified2 by the Central Government in the Official Gazette, the price at which
the international transaction [ or the specified domestic transaction] has been
undertaken will be deemed to be the arm’s length price. The variation is to be
computed with reference to the actual price at which the international
transaction [or the specified domestic transaction] has been undertaken. This
proviso shall be applicable for assessment or reassessment proceedings
pending before an Assessing Officer as on 1 October 2009.
5.12 The aforesaid amended second proviso refers to arm’s length price
(and not ‘arithmetic mean’ – as was the case in Finance Act 2002), and a
view can be adopted that it is applicable to any ‘arm’s length price’

2 Notification dated 13 September 2019, the rate of 1 percent for wholesale trading

transaction and 3 percent in all other cases for financial year 2018-19
CBDT has also defined the term “wholesale trading” as “an International Transaction or a
Specified Domestic Transaction of trading in goods, which fulfills the following conditions,
namely:
a) purchase cost of finished goods is 80% or more of the total cost pertaining to such
trading activities; and
b) average monthly closing inventory of such goods is 10% or less of sales pertaining
to such trading activities.

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determined (whether as a single comparable price, or as arithmetic mean of
multiple comparable prices). Notably, only one method out of the 6 methods
can be identified as the most appropriate method for a given transaction.
Such most appropriate method may lead to a single comparable price or
multiple prices. The arm’s length price is the single comparable price or
arithmetic mean of multiple comparable prices arrived at by application of the
most appropriate method.
5.13 The proviso provides that the arithmetical mean of such prices shall
be the arm’s length price
A. ALP determined by assesse `
CUT1 ALP1 INR 7,600
CUT2 ALP2 INR 7,380
CUT3 ALP3 INR 7,320

Arithmetic mean as per proviso INR 7,433
ALP determined INR 7,433
Assuming that the Indian taxpayer sells a product to its AE, in the above
example, if the transfer price is equal to or above INR 7,433, it would be
treated as being arm’s length from an Indian transfer pricing perspective.
However, if the transfer price was less than INR 7,433, then it could vary
from ALP only to the extent of the notified percent (not exceeding 3 percent)
of the actual value of international transaction. An example to illustrate this is
as follows:
Scenario 1: Transfer Price is INR 7,000 and ALP is INR 7,433
Difference between the transaction price and arm’s length
price INR 433
3% of the transaction value INR 210
Since the difference between the transaction price and the
arm’s length price is more than 3% of the transaction price,
the transaction will be considered not to be at arm’s length
In case of a wholesale distributor, instead of 3%, 1% of the transaction price
will be considered.

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Scenario 2: Transfer Price is INR 7,250 and ALP is INR 7,433
Difference between the transaction price and arm’s length
price INR 183
3% of the transaction value INR 218
Since the difference between the transaction price and the
arm’s length price is less than 3% of the transaction price, the
transaction will be considered to be at arm’s length
In case of a wholesale distributor, instead of 3%, 1% of the transaction price
will be considered.
5.14 A third proviso to this section has been inserted vide Finance (No. 2)
Act 2014 stating 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". With the
introduction of the new mechanism, the provisions of first and second proviso
(i.e. arithmetic mean and tolerable range) shall not apply.
CBDT vide Notification No. 83/2015 has introduced the use of the range
concept as well as the use of multiple year data. Detailed discussion on the
same in provided in Chapter 1 of this publication.

Uncontrolled transaction
5.15 Rule 10A(ab) defines an “uncontrolled transaction” to mean “a
transaction between enterprises other than associated enterprises, whether
resident or non-resident”. When an uncontrolled transaction has been
entered into, it could be said that it has been contracted under “uncontrolled
conditions”.
5.16 An uncontrolled transaction can be between:
• a resident and a non-resident; or
• a resident and a resident; or
• a non-resident and a non-resident.
5.17 While selecting, uncontrolled transaction / companies, due care
should be taken to identify / make appropriate adjustment for the differences
between the international transaction [or specified domestic transaction]

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being evaluated and the comparable transaction so selected to ensure an
appropriate comparison.

Comparable uncontrolled transactions
5.18 Rule 10B(2), lays down the criteria for comparability between
international transactions [or specified domestic transactions] and
uncontrolled transactions. This process is not quantitative but qualitative and
involves exercise of judgment. The criteria listed in Rule 10B(2) are:
• distinctive nature of the property transferred or services provided;
• functions performed taking into account the assets employed or to be
employed;
• risks assumed by the respective parties;
• contractual terms of the transaction;
• market conditions.

Distinctive nature of the property and services
5.19 The following are some of the characteristics to be assessed vis-à-vis
the property transferred or service provided:
In the case of transfer of tangible property:
• the physical features of the property;
• its quality and reliability; and
• the availability and volume of supply.
In the case of provision of services:
• the nature and extent of the services.
More specifically for financing services in the nature of intra-group funding/
loan transactions, corporate guarantee loan arrangements, etc., the following
characteristics needs to be assessed:
• the nature/ type of the financial transaction;
• the purpose of the transaction; and
• the duration and covenants of the financial transaction; etc
In the case of intangibles:
• the form of the transaction (eg. licensing or sale);

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• the terms of the transaction;
• the type of property (eg. patent, trademark or know-how);
• the duration and extent of protection;
• anticipated benefits from the use of the property etc.
The following examples, taken from New Zealand transfer pricing guidelines,
may be referred to
• An alkaline battery would sell at a premium to a standard (zinc
carbon) battery, because the superior quality alkaline battery would
be expected to last significantly longer than the standard battery.
• A battery with a known brand would sell for more than an unknown
brand, even if the quality of the two batteries were identical. Other
things being equal, consumers would be expected to prefer the
battery with an established reputation for reliability.
• A multi coloured battery may sell for more than an equivalent black
battery, depending on the extent to which consumer’s preference is
influenced by packaging.
Whether the transactions as illustrated in the aforesaid examples can be
taken as comparable transactions or not would depend on the availability of
data for making the reasonably accurate adjustments for the differences that
affect prices / profits in the open market.
5.20 Further, the following guidance, from the OECD Transfer Pricing
Guidelines (2017), may also be referred to:
“Para 1.108Depending on the transfer pricing method, this factor
must be given more or less weight. Among the methods described at
Chapter II of these Guidelines, the requirement for comparability of
property or services is the strictest for the comparable uncontrolled
price method. Under the comparable uncontrolled price method, any
material difference in the characteristics of property or services can
have an effect on the price and would require an appropriate
adjustment to be considered. Under the resale price method and cost
plus method, some differences in the characteristics of property or
services are less likely to have a material effect on the gross profit
margin or mark-up on costs. Differences in the characteristics of
property or services are also less sensitive in the case of the
transactional profit methods than in the case of traditional transaction
methods. This however does not mean that the question of

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comparability in characteristics of property or services can be ignored
when applying these methods, because it may be that product
differences entail or reflect different functions performed, assets used
and/or risks assumed bythe tested party.
Para 1.109 In practice, it has been observed that comparability
analyses for methods based on gross or net profit indicators often put
more emphasis on functional similarities than on product similarities.
Depending on the facts and circumstances of the case, it may be
acceptable to broaden the scope of the comparability analysis to
include uncontrolled transactions involving products that are different,
but where similar functions are undertaken. However, the acceptance
of such an approach depends on the effects that the product
differences have on the reliability of the comparison and on whether
or not more reliable data are available. Before broadening the search
to include a larger number of potentially comparable uncontrolled
transactions based on similar functions being undertaken, thought
should be given to whether such transactions are likely to offer
reliable comparables for the controlled transaction.”
Analysis of functions performed
5.21 Functions are defined as the activities that each of the entities
engaged in a particular transaction perform as a part of its operations This
functional analysis seeks to identify the economically significant activities
and responsibilities undertaken, assets used or contributed, and risks
assumed by the parties to the transactions. To illustrate, provided below are
some typical functions undertaken in the context of manufacturing, research
& development and distribution:
• raw material procurement
• production scheduling
• manufacturing of the products
• inventory management of raw materials and finished goods
• product research, design and development
• developing and administering budgets
• production planning and scheduling
• quality control
• packaging and labelling of products

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• warehousing
• sales and marketing
• technical services
• shipping of products to customers
• administrative services
• after sales support
Analysis of assets employed
5.22 Transactions that are proposed to be compared should be analysed
for the assets employed. In this context, some of the following points may be
noted;
a) Whether assets are owned or leased
b) Whether activity is capital or labour intensive
c) Presence or absence of intangibles
d) Are the assets unique in nature (like an Intellectual Property)
Typical intangible assets could be as follows:
• Patents
• Unpatented technical know-how
• Formulae
• Trademarks and brand names
• Trade names
• Copyrights
• Technical information
• Customer list
• Franchises
• Marketing channel
• Highly qualified personnel
5.23 Intangibles can be ordinarily divided into two categories:
manufacturing and marketing. Manufacturing intangibles are characterised
as one of the two types – patents or non-patented technical know-how – and
arise out of either research and development activity or the production
engineering activities of the manufacturing plant.

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5.24 Marketing intangibles include trademarks, corporate reputation, the
distribution network and the ability to provide services to customers before
and / or after the sale.
5.25 While carrying out the above analysis, it is necessary to assess
whether the assets employed in the respective transactions significantly
affect their comparability.
5.26 Further, it is not necessary that the assets are recorded in the
balance sheet for it to have significant value for transfer pricing purposes.
Even in cases where the assets (say intangibles) are not recorded in the
balance sheet, due consideration should be given to the same while
undertaking the functional analysis.
Analysis of risks assumed
5.27 An entity’s return is usually reflective of the risks assumed by it –
higher the risks, higher are the returns.
5.28 Transactions that are proposed to be compared should be analysed
for the risk-content. Some of the significant risks present in a normal
transaction are:
Nature of risks Particulars
1. Financial risk a. Capital contribution
b. Method of funding
c. Funding of losses
2. Product risk a. Design and development ofproduct
b. Up-gradation of product
c. After Sales Service
d. Risks associated with R & D
e. Product liability risk
f. Intellectual property risk if any
3. Market risk a. Development of market including
advertisement and product promotion etc.
b. Business volume risk
c. Assured sales risk
d. Fluctuations in demand and prices.
4. Credit risk a. Risk of bad debts

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Nature of risks Particulars
5. Foreign a. Risk on account of fluctuation of foreign
exchange risk currency exchange rates
6. Capacity a. Risks on account of under-utilisation of
utilisation risk capacity
5.29 It is important to align the ability to control and manage risk based on
the actual activities. One cannot bear the risk contractually if there is no
ability to control and manage such a risk. For example: A Co cannot be
considered to be assuming risks in a scenario where it does not have the
ability to control the decisions that lead to arising of such risks or it does not
have financial wherewithal to withstand the loss arising from such risks.
5.30 Further, sometimes the risk profile within the AEs may be contractual
and also backed by substance and it might be difficult to identify third parties
with identical risk profile. For example: Capacity utilisation risk might not be
borne by the customer in a third party scenario which might be the case in
the transaction with the AE. In such a situation, adjustment for difference in
risks should be considered for comparability and arm’s length price
computation purposes.

Characterisation
5.31 Characterisation is the process of assessing and determining the
nature of the transacting entity (in a given international transaction or
specified domestic transaction) as a licensed manufacturer / contract
manufacturer / entrepreneur distributor / low risk distributor etc., based on
the functional analysis which facilitates the process of selection of the tested
party which in turn assists in the choice of the most appropriate method and
also in the identification of the uncontrolled transactions for comparability
purposes.
5.32 Characterisation of the related parties is an important component to a
transfer pricing analysis and is used as the foundation in conducting the
economic analysis. Characterisation of an entity (for transfer pricing
purposes) refers to the process by which an entity is classified in a particular
category based on the analysis of the functions, assets and risks of the said
entity. For eg. based on an analysis of the functions, assets and risks of a
given entity it could be classified as a manufacturer (entrepreneur, contract,
toll etc.) or as a distributor (entrepreneur, normal risk, low risk etc.) or as a
service provider.

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5.33 In a typical scenario, a manufacturer and a distributor can be
characterised as follows:-
a) Manufacturing set-up
Having regard to illustrative functions / risk / asset, the manufacturer could
be characterized as follows:
Parameters Full Fledge Licensed Contract Toll
Manufacturer Manufacturer Manufacturer Manufacturer

Produces Own behalf Own behalf Principal Principal
on

Intellectual Owns the IP Does not own Does not own Does not own
Property the IP but
uses the IP
owned by
Principal on
license basis

Materials Owns Owns Owns Does not own

Production Does for own Does for own Done by Done by
scheduling Principal Principal

Selling and Performs Performs Does not Does not
distribution perform perform
function

Bears Yes Yes Limited Limited
market risk

Bears Yes Yes Limited No
inventory
risk

Bears Yes Yes No No
capacity
utilisation
risk

Bears Yes Yes No No
credit risk

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b) Distribution set-up
Having regard to illustrative functions / risk / asset, the distributor could be
characterized as follows:
Parameters Commission Limited risk Normal risk Entrepreneur
agent distributor distributor distributor
Takes title No Yes Yes Yes
Credit risk No Limited Yes Yes
Inventory risk No Limited Yes Yes
Marketing No Limited Limited Yes
responsibilities
Foreign No No Yes Yes
exchange risks

Tested party
5.34 Comparable Uncontrolled Price Method is a two sided method i.e.,
either of the parties to the international transaction [or the specified domestic
transaction] can be selected as the tested party. However, for the application
of Cost plus Method, Resale Price Method or Transactional Net Margin
Method, it is necessary to choose one of the parties to the transaction as the
tested party whose profitability needs to be tested (i.e. mark-up on costs,
gross margin, or net profit margins) and compare the profitability of the
tested party’s transactions with uncontrolled internal or external
comparables, as the case may be. On the other hand, profit split method,
may require combination of one sided or two-sided method depending upon
methodology used.
5.35 The choice of the tested party should be consistent with the
functional analysis of the transaction, and the characterisation of the entities.
5.36 The tested party generally would be the less complex party to the
controlled transaction and should be the party in respect of which most
reliable data for comparability is available. It may be possible that the tested
party could be the group entity (AE) which is party to the transaction. To
illustrate, say in a transaction pertaining to the sale of goods by a US
company (an entrepreneur and owner of significant Intellectual Property) to
its India subsidiary (a limited risk distributor), the Indian entity should be
selected as the tested party since its functions are less complex as
compared to the US company and data of comparable distributors will be
more easily available for the purpose of benchmarking.

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5.37 While making such an analysis, even the foreign entity could also be
selected as the tested party. For instance where an Indian entrepreneur
sells goods to its US subsidiary which acts as a low risk distributor, the US
entity should be selected as the tested party. In such scenarios, the
members should check if detailed information / analysis is maintained by the
Company.

Contractual terms
5.38 The important contractual terms of the transactions should be
ascertained to determine whether transactions as well as the transaction
pricing / margin are comparable or not. Some of the contractual terms that
need to be examined are:
• terms of delivery
• CIF, C&F, FOB
• terms of payment
• discount, if any
• credit period
• warranty period
• installation services
5.39 An example of how contractual terms may affect transfer pricing may
be seen in the following example, which has been taken from Para B.2.3.2.7
of the United Nations Practical Manual on Transfer Pricing for Developing
Countries (2017).
“Consider Company A in one country, an agricultural exporter, which
regularly buys transportation services from Company B (its foreign
subsidiary) to ship its product, cocoa beans, from Company A’s country to
overseas markets. Company B occasionally provides transportation services
to Company C, an unrelated domestic corporation in the same country as
Company B. However, the provision of such services to Company C
accounts for only 10 per cent of the gross revenues of Company B and the
remaining 90 per cent of Company B’s revenues are attributable to the
provision of transportation services for cocoa beans to Company A. In
determining the degree of comparability between Company B’s uncontrolled
transaction with Company C and its controlled transaction with Company A,
the difference in volumes involved in the two transactions, volume discount if
any, and the regularity with which these services are provided must be taken

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into account where such factors would have a material effect on the price
charged.”
5.40 It should be noted that in practice, information concerning the
contractual terms of potentially comparable uncontrolled transactions may
not be available, particularly where external comparables are used for the
analysis. The effect of deficiencies in the information in establishing
comparability will differ depending on the type of transaction being examined
and the transfer pricing method applied.
5.41 Further, the revised OECD Transfer pricing guidelines, 2017 provides
for a vigilant approach for testing the arm’s length nature of an international
transaction by not just evaluating the on-paper agreement or the contractual
terms, but also by scrutinizing the actual business conduct of the transacting
parties, the commercial viability of the transaction, the practical feasibility
considered by geographical locations, employment of assets, assumption of
risks, etc.
5.42 The following example from Para 1.44 of the OECD Transfer Pricing
Guidelines (2017) illustrates the concept of clarifying and supplementing the
written contractual terms based on the identification of the actual commercial
or financial relations. “Company P is the parent company of an MNE group
situated in Country P. Company S, situated in Country S, is a wholly-owned
subsidiary of Company P and acts as an agent for Company P’s branded
products in the Country S market. The agency contract between Company P
and Company S is silent about any marketing and advertising activities in
Country S that the parties should perform. Analysis of other economically
relevant characteristics and in particular the functions performed, determines
that Company S launched an intensive media campaign in Country S in order
to develop brand awareness. This campaign represents a significant
investment for Company S. Based on evidence provided by the conduct of
the parties, it could be concluded that the written contract may not reflect the
full extent of the commercial or financial relations between the parties.
Accordingly, the analysis should not be limited by the terms recorded in the
written contract, but further evidence should be sought as to the conduct of
the parties, including as to the basis upon which Company S undertook the
media campaign.”
5.43 To the extent possible, adjustments should be attempted to even out
the difference between the comparables and the tested party. In the event
such adjustments are not possible or where the situation requires too many
adjustments, the reliability of the method used as well as the analysis

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performed may require a revisit and probably it would be relevant to use an
alternate method.

Market conditions
5.44 The market conditions in which uncontrolled transactions and
international transactions [or the specified domestic transaction] are
conducted must be evaluated to judge their comparability. Some of the
different market conditions are:
• geographical location and size
• regulatory laws and government orders
• cost of labour and capital
• level of competition
• nature of market whether wholesale/retail
• overall economic development
5.45 Many of the above conditions are not amenable to reasonably
accurate adjustments. The market conditions would be more relevant in
determining the comparability only and therefore, unless transactions take
place in the same market conditions, they will not be comparable.
5.46 An example of impact of the aforesaid differences is provided below:
The taxpayer is engaged in the manufacturing and trading of pharmaceutical
products. The taxpayer has sold Product A to its AE in Thailand and also to a
third party in Vietnam. The details are provided below:
Particulars Sale to an AE Sale to a third party
Country Thailand Vietnam
Quantity exported 30,000 1,000
Average selling price per unit 10 20
(in USD)
Usage Wholesale Trading Retail Trading

Prima facie, one may say that the sale of Product A to the AE in Thailand is
not at arm’s length since the same product has been sold to a third party in
Vietnam at a much higher price. However, one has to analyse the following
factors before arriving at a conclusion:

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a) Geographical differences, market conditions and size of the
markets
The price at which a product is sold in one country cannot be compared with
the price at which the same product is sold in another country because of the
impact on account of geographical differences i.e. country specific demand/
supply factors, market conditions, regulations and government orders in
force, level of competition, availability of substitute products, consumer
purchasing power, etc. which could have a bearing on the price.
b) Volume
It is essential to evaluate the impact of the difference in volumes transacted
with an AE and an independent third party respectively and accordingly make
a suitable adjustment to eliminate the difference. For instance, in the above
example, the quantity exported to the AE is 30,000 units vis-à-vis 1,000 to
the third party. In an arm’s length scenario, any third party would ideally ask
for a volume discount. Therefore, unless it is demonstrated that the volume
has no impact on the pricing of the transaction under consideration, an
appropriate adjustment should be made.
c) Laws and government orders in force
The Government orders which are prevalent in Thailand and Vietnam would
also be relevant and may need to be examined.
d) Level of market
Export prices of the same product sold to an AE and a third party
respectively are bound to be different if the AE and the third party are at
different levels of market in the entire value chain. In other words, in the
above example, the AE operates as a wholesale trader which is the second
level in the entire value chain whereas the third party operates as a retail
trader which is the third level in the entire value chain.
As stated above, it would be critical to evaluate if reliably accurate
adjustment on account of the aforesaid differences could be made to
eliminate the differences, and in the absence of such an adjustment the
transaction cannot be considered as comparable.
Business strategies, commercial considerations and
economic principles
5.47 Economic principles and prevailing business conditions are
fundamental to any transfer pricing evaluation. Therefore, business

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strategies adopted by enterprises and market conditions faced by taxpayers
are relevant factors for determining comparability with uncontrolled
transactions/margins, and must be carefully considered during the
comparability analysis. While the Indian TP regulations do not specifically
recognize / provide for analysis of the business strategies, the OECD
Guidelines duly recognize the need to analyse the business strategies while
undertaking the comparability analysis. Some examples where business
strategies/ economic realities could be relevant are:
• market strategies such as entry strategies, market penetration, loss
leadership etc. followed by some companies may result in losses in
the initial /interim years, as a part of a bigger strategy of building
market share and reaping subsequent benefits therefrom.
• In case of start up operations, enterprises are generally not able to
recover their initial set-up costs etc. during the initial few years of
operations. It is not appropriate in such cases to compare the
taxpayers profit/ margins with the margins earned by established
comparables that are at a different stage of operations.
5.48 It is not necessary that all the criteria specified in Rule 10B(2) should
be cumulatively applied while selecting comparable transactions. The
relevance of these criteria depends on the method chosen as most
appropriate method. For instance, when CUP is chosen as the most
appropriate method, the nature of the property and service, the functions
performed, risk undertaken and the terms of contract become critical in
choosing the comparable transaction. It can generally be stated that cr iteria
mentioned in rule 10B(2) need to be applied with more rigour when
comparability is done at transactional level. But when the comparability is
done at enterprise level, it becomes difficult to apply the criteria like
contractual terms, nature of products or services etc. In other words, a
rigorous analysis of functions performed, assets used and risk taken (FAR) is
difficult when enterprise level comparisons are made in CPM, RPM, TNMM
or PSM.
5.49 The above analysis is carried out to determine whether the
uncontrolled transactions and international transactions or specified domestic
transaction are comparable. Rule 10B(3) states that an uncontrolled
transaction shall be comparable to an international transaction or specified
domestic transaction if:

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(i) none of the differences between transactions or enterprises are likely
to materially affect the price or cost charged or paid in or profit arising
from, such transactions in the open market; or
(ii) reasonably accurate adjustments can be made to eliminate material
effects of differences.
5.50 If there are no differences, the transactions are comparable straight
away. If the differences can be adjusted with reasonable accuracy, then the
transactions are comparable, subject to adjustments. If, however, the
differences cannot be adjusted with reasonable accuracy, the transactions
are to be ignored and the search for comparable transactions would need to
commence all over again. For instance, under TNMM where margins are to
be compared, the margin of a 1,000crore company cannot be compared with
that of a 10 crore company. The two most obvious reasons are the size of
the two companies and the relative economies of scale under which they
operate. The fact that they operate in the same market on a “level playing
field” may not make them comparable enterprises. Some of the other factors/
criteria which could be considered for the purpose of comparability analysis,
in order to identify the uncontrolled transactions are:
• level of fixed assets as a percentage of total sales, level of operating
expenses as a percentage of sales;
• level of investment in intangible assets; and
• differences in the level of risks assumed by the parties viz. market
risk, human resources, quality, contract risk, credit/ collection risks
etc.
5.51 It is important to note that the transactions entered into by AEs with
unrelated party (“internal comparables”) would provide more reliable and
accurate data as compared to transactions by and between third parties
(“external comparables”).OECD’s Guidelines on Transfer Pricing recognize
the fact that external comparables are difficult to obtain and, also, it may be
incomplete and difficult to interpret. Hence for these reasons, internal
comparables are preferred to external comparables.
5.52 To illustrate say, the controlled transaction involves the sale of
watches by AE1, a watch manufacturer in Country1, to AE2, a watch importer
in Country 2, which purchases, imports and resells the watches to unrelated
watch dealers in Country 2.

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In the above example, one can identify the following comparable transactions
(assuming the characteristics of the products are same in all the scenarios)
(a) Internal comparables
The price charged for watches sold in a comparable uncontrolled
transaction between AE 1and Unrelated Party C (i.e. transaction #1);
The price charged for watches sold in a comparable uncontrolled
transaction between AE 2and Unrelated Party A (i.e. transaction #2)
(b) External comparables
The price paid for watches sold in a comparable uncontrolled
transaction between Unrelated Party A and Unrelated Party B (i.e.
transaction #3)
5.53 The analysis of the uncontrolled transactions is made to assess their
comparability with the international transaction or specified domestic
transaction.
5.54 A question arises as to what should be the number of comparable
uncontrolled transactions to be selected. In other words, is it sufficient to
have just one CUT or is it necessary that a reasonable number of CUTs
should be selected? Both the Act and the Rules do not prescribe the number
of CUTs to be chosen. An analysis of section 92C(2) read with the proviso
thereto and Rule 10B(1) would show that selection of even one CUT is
permissible. The proviso to section 92C(2) uses the expression “provided

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that where more than one price is determined by the most appropriate
method.....”. This indicates that selection of multiple CUTs is not required as
a rule and if an assessee adopts multiple CUTs the proviso would be
applicable. This is further strengthened by the language adopted in Rule
10B(1) which clearly permits adoption of even a single CUT. For example,
Rule 10B(1)(a)(i) uses the expression “......in a comparable uncontrolled
transaction, or a number of such transactions...” (emphasis supplied). Similar
expression is used in other clauses of Rule 10B(1). It is possible to have a
single most appropriate CUT. Therefore, it may be said that if one most
appropriate CUT is selected, such CUT would represent ALP. However, if
more than one CUT is available the proviso to section 92C(2) would be
applicable.
5.55 Rule 10B(4) provides that the data to be used in analysing the
comparability of an uncontrolled transaction with an international
transaction [or a specified domestic transaction] shall be the data relating to
the financial year in which the international transaction [or the specified
domestic transaction] has been entered into. Within the same financial year,
the CUT may precede or succeed an international transaction.
5.56 The proviso to Rule 10B(4), further states that data relating to a
period of not more than 2 years preceding such financial year may also be
considered, if such data reveals facts which could have an influence on the
determination of the transfer prices in relation to transactions being
compared. Multiple year data has been permitted to be used vide Finance
(No. 2) Act 2014.CBDT vide Notification No. 83/2015 has issued detailed
guidance on the use of the multiple year data for the purpose of
comparability analysis. Discussion on the same is detailed in Chapter 1 of
this publication.
5.57 Further, the OECD in its Transfer Pricing Guidelines (2017) in Para
3.76 to 3.79 also supports the use of multiple year data. It states that in order
to obtain a complete understanding of the facts and circumstances
surrounding the controlled transaction, it generally might be useful to
examine data from both the year under examination and prior years. The
analysis of such information might disclose facts that may have influenced
(or should have influenced) the determination of the transfer price. For
example, the use of data from past years will show whether a taxpayer's
reported loss on a transaction is part of a history of losses on similar
transactions, the result of particular economic conditions in a prior year that
increased costs in the subsequent year, or a reflection of the fact that a

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

product is at the end of its life cycle. Such an analysis may be particularly
useful where a transactional profit method is applied. Multiple year data can
also improve the understanding of long-term arrangements. Multiple year
data will also be useful in providing information about the relevant business
and product life cycles of the comparables. Differences in business or
product life cycles may have a material effect on transfer pricing conditions
that needs to be assessed in determining comparability. The data from
earlier years may show whether the independent enterprise engaged in a
comparable transaction was affected by comparable economic conditions in
a comparable manner, or whether different conditions in an earlier year
materially affected its price or profit so that it should not be used as a
comparable. Multiple year data can also improve the process of selecting
third party comparables for example by identifying results that may indicate a
significant variance from the underlying comparability characteristics of the
controlled transaction being reviewed, in some cases leading to the rejection
of the comparable, or to detect anomalies in third party information.
5.58 The Other Method (OM) offers more flexibility and permits
comparison by use of a “price which has been charged or paid, or would
have been charged or paid” thereby allowing use of bonafide quotations,
bids, proposals as comparable transactions or prices, and also economic and
commercially justifiable models and similar approaches.

Power of Assessing Officer
5.59 According to section 92C(3), the Assessing Officer may himself
proceed to determine the arm’s length price if any of the following conditions
are satisfied:
(i) the price charged or paid in an international transaction or specified
domestic transaction has not been determined on the basis of the
most appropriate method.
(ii) any information and document relating to an international transaction
or specified domestic transaction has not been kept and maintained
as mandated.
(iii) the information or data used in computation of the arm’s length price
is not reliable or correct.
(iv) the assessee had failed to furnish, within the specified time, any
information or document which he was required to furnish.

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5.60 If any of the above conditions are satisfied, the power to determine
the arm’s length price may be exercised in any proceeding for the
assessment of income. The Assessing Officer also, is required to determine
the arm’s length price in accordance with section 92C(1) and (2) only, which
states that the arm’s length price will have to be arrived at on the basis of the
most appropriate method. The Assessing Officer may determine the arm’s
length price on the basis of the material or information or document available
with him. Even where such determination is made by the Assessing Officer, if
more than one price may be determined by the most appropriate methods,
the arm’s length price shall be taken to be arithmetical mean of such pr ices.
5.61 The information, which the assessee may be called upon to furnish,
in the absence of which the Assessing Officer would have power to substitute
the arm’s length price, should be that which the assessee has in his
possession and is capable of being furnished.
5.62 The substitution of the arm’s length price by the Assessing Officer
shall be preceded by an opportunity of hearing being given to the assessee
to show cause why such substitution of the arm’s length price should not be
made.
5.63 When the Assessing Officer substitutes the arm’s length price on the
basis of material or information or document in his possession, he may
accordingly re-compute the total income of the assesse .No deduction under
section 10A or 10B or Chapter VIA shall be allowed in respect of the amount
of income by which the total income of the assessee is enhanced. The
restriction on the admissibility of an exemption / deduction is only under
sections 10A or 10AA or 10B or Chapter VI-A. It appears that deduction
under section 10C may be available on the enhanced income.
5.64 The income of one of the AEs may be recomputed by substituting the
actual price paid/charged to another AE for any property or service with the
arm’s length price. When this substitution takes place it results in a re-
computation of the total income of such AE. This re-computation would,
however, not entitle the other AE to demand a re-computation of its total
income. Consequently, it would not be entitled to a refund of any tax. For
example, if XYZ Ltd. has paid royalty of INR 100 to its AE ABC Ltd., it would
have deducted INR 20 as tax under section 115A read with section 195 and
remitted the balance of INR 80 to ABC Ltd. If the Assessing Officer computes
the arm’s length price of royalty to be INR 75 and substitutes it for the actual
amount paid, i.e. INR 100, ABC Ltd., will not able to demand either a re-

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

computation of the royalty income received by it or a refund of tax in excess
of what is due on the basis of the arm’s length price.
5.65 Section 92CA(2A) inserted by Finance Act 2011 with effect from 1
June 2011 provides that where an international transaction not referred to
the Transfer Pricing Officer by the Assessing Officer comes to the notice of
the Transfer Pricing Officer, then such international transaction can be
examined by the Transfer Pricing Officer as if it was referred to him. Further,
section 92CA(2B) inserted by Finance Act 2012 with retrospective effect from
1stJune 2002 provides that where an assessee has not furnished an
accountant’s report under section 92E and an international transaction
comes to the notice of the Transfer Pricing Officer, then such international
transaction can be examined by the Transfer Pricing Officer as if it was
referred to him.

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 Chapter 6
Methods of Computation of Arm’s
Length Price
Meaning of relevant terms
6.1 The various methods of computation of arm’s length price are
prescribed in Rule 10B.For this purpose, certain terms are defined in Rule
10A as under:
Rule 10A - Meaning of expressions used in computation of arm’s length
price.
For the purposes of this rule and rules 10AB to 10E-
(a) ‘uncontrolled transaction’ means a transaction between
enterprises other than AEs, whether resident or non-resident;
(b) ‘property’ includes goods, articles or things, and intangible
property;
(c) ‘service’ includes financial services; and
(d) ‘transaction’ includes a number of closely linked transactions.
Further, Section 92F(v) of the Act defines the term ‘transaction’ as below:
‘Transaction’ includes an arrangement, understanding or action in
concert -
(A) whether or not such arrangement, understanding or action is
formal or in writing; or
(B) whether or not such arrangement, understanding or action is
intended to be enforceable by legal proceeding.
6.2 Rule 10B stipulates the methods of determination of arm’s length
price. The relevant portion of the rule dealing with each of the methods
prescribed is extracted here below and suitable explanations thereof are
given along with illustrations encompassing several adjustments for enabling
better understanding of the principles involved and the type of working called
for.
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Comparable Uncontrolled Price Method (CUP
Method)
6.3 Rule 10B(1)(a) - Comparable uncontrolled price method, by
which,-
(i) the price charged or paid for property transferred or services
provided in a comparable uncontrolled transaction, or a number
of such transactions, is identified;
(ii) such price is adjusted to account for differences, if any, between
the international transaction [or the specified domestic
transaction] and the comparable uncontrolled transactions or
between the enterprises entering into such transactions, which
could materially affect the price in the open market;
(iii) the adjusted price arrived at under sub-clause (ii) is taken to be
an arm’s length price in respect of the property transferred or
services provided in the international transaction [or the
specified domestic transaction].
6.4 The comparable uncontrolled price method is considered as one of
the traditional transaction methods of determining the arm’s length price. Two
other traditional transaction methods are the Resale Price Method and the
Cost Plus Method.
6.5 Typical transactions in respect of which the comparable uncontrolled
price method may be adopted are:
(a) Transfer of goods;
(b) Provision of services;
(c) Royalty for use of Intangibles;
(d) Interest on loans.
6.6 The OECD in its Transfer Pricing Guidelines (2022) observes as
under:
Para 2.14 “The CUP method compares the price charged for property
or services transferred in a controlled transaction to the price charged
for property or services transferred in a comparable uncontrolled
transaction in comparable circumstances. If there is any difference
between the two prices, this may indicate that the condition of the

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commercial and financial relations of the AEs are not at arm's length,
and that the price in the uncontrolled transaction may need to be
substituted for the price in the controlled transaction.”
6.7 Comparable uncontrolled transactions which involve a transaction
between one of the enterprises and an uncontrolled party, are referred to as
internal comparables. Comparable uncontrolled transactions which involve a
transaction between two parties, neither of which is an associated enterprise,
are called external comparables.
6.8 Further, OECD Transfer Pricing Guidelines (2022) has additionally
incorporated the application of quoted prices under the CUP methodology
while establishing arm’s length nature of commodities’ transfer between AEs.
The guidelines have broadened the applicability of the CUP method and
have alleviated the arm’s length determination for commodity transactions.
Para 2.19 of the guidelines asserts, “Under the CUP method, the
arm’s length price for commodity transactions may be determined by
reference to comparable uncontrolled transactions and by reference
to comparable uncontrolled arrangements represented by the quoted
price”.
The following para are also relevant:
Para 2.20: For the CUP method to be reliably applied to commodity
transactions, the economically relevant characteristics of the
controlled transaction and the uncontrolled transactions or the
uncontrolled arrangements represented by the quoted price need to
be comparable. For commodities, the economically relevant
characteristics include, among others, the physical features and
quality of the commodity; the contractual terms of the controlled
transaction, such as volumes traded, period of the arrangements, the
timing and terms of delivery, transportation, insurance, and foreign
currency terms. For some commodities, certain economically relevant
characteristics (e.g. prompt delivery) may lead to a premium or a
discount. If the quoted price is used as a reference for determining
the arm’s length price or price range, the standardised contracts
which stipulate specifications on the basis of which commodities are
traded on the exchange and which result in a quoted price for the
commodity may be relevant. Where there are differences between the
conditions of the controlled transaction and the conditions of the
uncontrolled transactions or the conditions determining the quoted

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price for the commodity that materially affect the price of the
commodity transactions being examined, reasonably accurate
adjustments should be made to ensure that the economically relevant
characteristics of the transactions are comparable.
2.23: A particularly relevant factor for commodity transactions
determined by reference to the quoted price is the pricing date, which
refers to the specific time, date or time period (e.g. a specified range
of dates over which an average price is determined) selected by the
parties to determine the price for commodity transactions.
6.9 The steps involved in the application of this method are:
(i) Identify the price charged or paid in comparable uncontrolled
transactions;
(ii) The above price should be adjusted for transaction level differences
on the basis of functions performed, assets used and risks taken
(FAR) analysis and enterprise level differences if any;
(iii) The adjusted price is the arm’s length price;
6.10 On the aspect of comparability for application of the CUP method, the
United Nations (‘UN’) in its Practical Manual on Transfer Pricing for
Developing Countries (2021) has observed as under:
“B.4.2.2.3. Product comparability should be closely examined in
applying the CUP Method. A price may be materially influenced by
differences between the goods or services transferred in the
controlled and uncontrolled transactions. The CUP Method is
appropriate especially in cases where an independent enterprise
buys or sells products that are identical or very similar to those sold
in the controlled transaction or in situations where services are
rendered that are identical or very similar to those rendered in the
controlled transaction.
B.4.2.2.4. Although product comparability is important in applying the
CUP Method, the other comparability factors should not be
disregarded. Contractual terms and economic conditions are also
important comparability factors. Where there are differences between
controlled and uncontrolled transactions, adjustments should be
made to enhance reliability”.

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6.11 Given that the CUP Method compares the prices of the products, it is
warranted that high degree of similarity on all aspects (such as products /
services, terms of the transaction etc.) be established between the products
being compared.
The UN in the Practical Manual on Transfer Pricing for Developing Countries
(2021) observes as under:
B.4.2.2.5 Reasonably accurate adjustment may be made for differences in:
• The type and quality of the products. (E.g. unbranded Kenyan coffee
beans as compared with unbranded Brazilian coffee beans);
• Delivery terms. (e.g.AE 1 sells similar bicycles to AE 2 and Unrelated
Party C. All relevant information on the controlled and uncontrolled
transactions is available to AE1, and hence it is probable that all
material differences between the transactions can be recognized. The
uncontrolled price can be adjusted for the difference in delivery terms
to eliminate the effect of this difference on the price);
• Volume of sales and related discounts. (E.g.AE 1 sells 5000 bicycles
to AE 2 for US$90 per bicycle, while it sells 1000 similar bicycles to
Unrelated Party C. The effect of the differences in volume on price
should be analysed, and if the effect is material, adjustments should
be made perhaps based on volume discounts in similar markets);
• Product characteristics. (E.g. the uncontrolled transactions to an
unrelated party involve bicycles on which modifications have been
made. However, the bicycles sold in the controlled transactions do
not include these modifications. If the product modifications have a
material effect on price, then the uncontrolled price should be
adjusted to take into account this difference in price);
• Contractual terms. (E.g. AE 1 sells the bicycles to AE 2 offering a 90
day credit term but the contract terms dictate that all sales to
Unrelated Party C are Cash On Delivery);
• Risk incurred. (E.g. AE 1 is exposed to inventory risk related to sales
by AE 2 and the risk that customers of AE 2 will default on their
bicycle purchase loans; whereas in the transaction between AE 1 and
Unrelated Party C, the latter is exposed to the inventory risk and the
risk of its customers’ default. This difference in risk allocation must be
analysed and its effect on price quantified before AE 2’s prices and
Unrelated Party C’s prices can be considered comparable); and

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• Geographical factors. (E.g. AE 1 sells bicycles to AE 2 located in
South Africa, while Unrelated Party C, to which it also sells the same
bicycles, is located in Egypt. The only material difference that could
be identified between the controlled and uncontrolled transactions
concerns the locale. To perform adjustments to account for this
difference one might have to consider, for example, differences in
inflation rates between South Africa and Egypt, the competitiveness
of the bicycle market in the two countries and differences in
government regulations if relevant).
B.4.2.2.6. Reasonably accurate adjustments may not be possible for:
• Unique and valuable trademarks. (E.g. assuming AE 1 is engaged in
manufacturing high value branded goods, and attaches its valuable
trademark to the goods transferred in the controlled transaction, while
uncontrolled transaction concerns the transfer of goods that are not
branded. The effect of the trademark on the price of a watch may be
material. However, it will be difficult, if not impossible, to adjust for
effect of the trademark on price since the trademark is an intangible
asset that is unique. If reasonably accurate adjustments cannot be
made to account for a material product difference the CUP Method
may not be the appropriate method for the transaction); and
• Fundamental differences in the products. (E.g. if the products being
sold are significantly different from the products sold in the proposed
comparable transaction it may not be possible to adjust for the
product differences).
In such events, CUP method should not be used for the purpose of
the analysis.
B.4.2.2.7. Notwithstanding the difficulties often associated with adjustments
to address the sources of non-comparability described above, the need to
make adjustments should not automatically prevent the use of the CUP
Method. It is often possible to perform reasonably accurate adjustments. If
reasonable adjustments cannot be performed the reliability of the CUP
Method is decreased. In these circumstances another transfer pricing method
may be more appropriate.
Examples where it may not be possible to make reasonably accurate
adjustments are given below:

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• Difference in the position of the entity in the value chain: (E.g.AE 1
sells bicycles to AE 2 as also to Unrelated Party C. Further, AE 2,
after purchasing the bicycles from AE 1 sells the same bicycles to
Unrelated Party D.
When the bicycles are sold by AE 1 to Unrelated Party C, they are
sold to the final customers for their own use, whereas the bicycles
sold to AE 2, are not for the use of AE 2, but for further sales to
Unrelated Party D.
From the above, it can be seen that there is an added level in the
entire value chain, when the sales are to AE 2 vis-a-vis the sales
made by AE 1 to Unrelated Party C. The position of an entity in the
value chain impacts the price at which a product is sold due to the
additional functions that may be performed by the said entity.
In such a case, it may not be possible to compare the transaction of
sale of bicycles by AE 1 to Unrelated Party C with the transaction of
sale by AE 2 to Unrelated Party D, due to the unavailability of
accurate and reliable data pertaining to the margin earned by AE 1
from the sales to Unrelated Enterprise C.
• Difference in the characterization of the entity: (E.g. AE 1 is a captive
manufacturer engaged in the manufacturing of bicycles for AE 2. AE
2 is a full fledge distributor engaged in the distribution of the bicycles
to the customers. The pricing for the sale made by AE 2 to the
customers is governed by the prevailing market conditions.
In such a case, it may not be possible to compare the transaction of
sale of bicycles by AE 1 to AE 2 with the transaction of sale of
bicycles by AE 2 to the customers, due to the differences in the
functions performed, assets employed and the risks undertaken by
AE1 and AE 2 and the consequent difference in their characterisation
and position in the value chain with respect to the transaction of sale
of bicycles.)

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AE 1
(Captive Manufacturer)

Sale

AE 2
(Full fledge Distributor)

Sale

Customer

6.12 The application of the CUP method can be understood with the
following example:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as
follows:

Shareholder’s name Status % holding
AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30
Financial Institutions Indian Company 10
Public 30

AE1 Ltd., is a manufacturer of compact disc (CD) writers and its customers,
inter alia, include AE2 Ltd, and M Ltd, an unrelated party.
AE1 Ltd., during the year has supplied 10,000 nos. of the product to AE2 Ltd.
at a price of INR 2,000 per unit and 200 nos. of the same product to AE3
Ltd., at a price of INR 2,750 per unit. AE1 Ltd., has sold 100 units of the
same product to M Ltd.at INR 3,000 per unit.

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Comparison of the international transaction vis-a-vis comparable
uncontrolled transaction
Particulars International Comparable Remarks
transaction uncontrolled
(with AE2 Ltd.) transaction
(with M Ltd.)
Terms Freight on Cost Insurance Freight and insurance
Board (‘FOB’) and Freight INR 550
(‘CIF’)
Quantity Yes No Quantity discount of
discount INR 10 per product
and a free gift (CD) of
INR 20
Credit One month Cash and carry Cost of credit 1.25%
per month
Warranty No warranty Six months Cost of warranty is
warranty INR 250 per unit
Factors to be considered while determining ALP:
(a) In the CUP method, one has to start from the price charged in the
case of the comparable uncontrolled transaction.
(b) In this illustration one has to start with the price charged by AE1 Ltd.,
to M Ltd.
(c) The price charged to M Ltd., will have to be increased by the value of
credit which is at the rate at 1.25% p.m. (i.e. 15% p.a.).If the similar
credit were offered to M Ltd., the price charged to M Ltd. would have
been higher, after factoring this cost.
(d) The price charged to M Ltd., will have to be reduced by the following;
(i) INR 550 representing the freight and insurance –This is for
the reason that if the price to M Ltd., had been on FOB
basis, it would have been less by INR 550.
(ii) INR 250 per unit representing the estimated cost of warranty
execution for a period of six months on the basis of a
technical analysis and past experience - This is for the
reason that if the warranty was not given, the price to M Ltd.
would have been lower, without factoring this cost.

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(iii) INR 10 representing the cost of each CD – This is for the
reason that if similar gift had been offered to M Ltd., the
effective price to M Ltd., would have been less.
(iv) INR 20 representing a quantity discount - This is for the
reason that if similar discount had been offered to M Ltd., the
effective price to M Ltd., would have been less.
Computation of arm’s length price under the comparable uncontrolled
price method
The following points are to be noticed:
(i) All adjustments in the course of applying this method are to be made
to the price charged in the uncontrolled transaction. The presence or
absence of any specific features in the uncontrolled transaction as
compared to the international transaction [or the specified domestic
transaction] is to be adjusted for. These features are to be evaluated
in monetary terms. This is a subjective process based on objective
facts.
(ii) Only differences that would materially affect the price in the open
market are required to be adjusted. Two points may be noted. Firstly,
materiality would have to be judged in the light of various
circumstances. If there are numerous adjustments, which are
individually not material but collectively material, the necessary
adjustments are required to be made. Secondly, the term ‘open
market’, though not defined, would mean a transaction between a
knowledgeable and a willing purchaser and a knowledgeable and
willing seller where neither of them is influenced or compelled to act
in a particular manner.

Resale Price Method (RPM)
6.13 Rule 10B(1)(b) resale price method, by which,-
(i) The price at which property purchased or services obtained by
the enterprise from an AE is resold or are provided to an
unrelated enterprise, is identified;
(ii) such resale price is reduced by the amount of a normal gross
profit margin accruing to the enterprise or to an unrelated
enterprise from the purchase and resale of the same or similar
property or from obtaining and providing the same or similar

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services, in a comparable uncontrolled transaction, or a number
of such transactions;
(iii) the price so arrived at is further reduced by the expenses
incurred by the enterprise in connection with the purchase of
property or obtaining of services;
(iv) the price so arrived at is adjusted to take into account the
functional and other differences, including differences in
accounting practices, if any, between the international
transaction or the specified domestic transaction and the
comparable uncontrolled transactions, or between the
enterprises entering into such transactions, which could
materially affect the amount of gross profit margin in the open
market;
(v) the adjusted price arrived at under sub-clause (iv) is taken to be
an arm’s length price in respect of the purchase of the property
or obtaining of the services by the enterprise from the AE.
6.14 Typical transactions where RPM may be adopted are distribution of
goods involving little or no value addition. Also, it is pertinent to note that
while CUP method is a two sided method (wherein the said method can be
applied using details / data of either of the transacting parties), RPM is a one
sided method wherein only the margins earned by one of the transacting
party i.e., the distributor, can be analysed / evaluated.
6.15 The OECD in its Transfer Pricing Guidelines (2022) has observed as
under:
Para 2.35 - An appropriate resale price margin is easiest to determine
where the reseller does not add substantially to the value of the
product. In contrast, it may be more difficult to use the resale price
method to arrive at an arm’s length price where, before resale, the
goods are further processed or incorporated into a more complicated
product so that their identity is lost or transformed (e.g. where
components are joined together in finished or semi-finished goods).
Another example where the resale price margin requires particular
care is where the reseller contributes substantially to the creation or
maintenance of intangible property associated with the product (e.g.
trademarks or trade names) which are owned by an AE. In such
cases, the contribution of the goods originally transferred to the value
of the final product cannot be easily evaluated.

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Para 2.36 - A resale price margin is more accurate where it is
realised within a short time of the reseller’s purchase of the goods.
The more time that elapses between the original purchase and resale
the more likely it is that other factors – changes in the market, in
rates of exchange, in costs, etc. – will need to be taken into account
in any comparison.”
6.16 On application of RPM, the UN in the Practical Manual on Transfer
Pricing has observed as under:
“4.3.4.3 While product differences may be more acceptable in
applying the Resale Price Method as compared to the CUP Method,
the property transferred should still be broadly similar in the
controlled and uncontrolled transactions. Broad differences are likely
to reflect differences in functions performed, and therefore gross
margins earned, at arm’s length.
4.3.4.4 Example:
The compensation for a distribution company should be the same
whether it sells washing machines or dryers, because the functions
performed (including risks assumed and assets used) are similar for
the two activities. It should be noted, however, that distributers
engaged in the sale of markedly different products cannot be
compared. The price of a washing machine will, of course, differ from
the price of a dryer, as the two products are not substitutes for each
other. Although product comparability is less important under the
resale price method, greater product similarity is likely to provide
more reliable transfer pricing results. It is not always necessary to
conduct a resale price analysis for each individual product line
distributed by the sales company. Instead, the resale price method
can be applied more broadly, for example based on the gross margin
a sales company should earn over its full range of broadly similar
products.”
From the above, it can be observed that RPM is more tolerant as compared
to CUP toward product differences. RPM thus focuses on functional
comparability. A similar level of compensation is expected for performing
similar functions across different activities.

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6.17 The UN in the Practical Manual on Transfer Pricing has explained
that RPM can be used even for a commission agent:
4.3.1.5 Other approaches are possible. For example, if the
associated enterprise acts as a sales agent that does not take title to
the goods, it is possible to use the commission earned by the sales
agent (represented as a percentage of the uncontrolled sales price of
the goods concerned) as the comparable gross profit margin.
6.18 The steps involved in the application of this method are:
(i) identify the international transaction [or specified domestic
transaction] of purchase of property or services;
(ii) identify the price at which such property or services are resold or
provided to an unrelated party (resale price);
(iii) identify the normal gross profit margin in a comparable uncontrolled
transaction whether internal or external. The normal gross profit
margin is that margin which an enterprise would earn from purchase
of the similar product from an unrelated party and the resale of the
same to another unrelated party;
(iv) deduct the normal gross profit from the resale price;
(v) deduct expenses incurred in connection with the purchase of goods;
(vi) adjust the resultant amount for the differences between the
uncontrolled transaction and the international transaction [or the
specified domestic transaction]. These differences could be functional
and other differences including differences in accounting practices.
Further these differences should be such as would materially affect
the amount of gross profit margin in the open market;
(vii) the price arrived at is the arm’s length price of the international
transaction [or the specified domestic transaction];
6.19 The application of RPM can be understood with the following
example:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as
follows;
Shareholder’s name Status % holding
AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30

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Shareholder’s name Status % holding
Financial Institutions Indian Company 10
Public 30
AE1 Ltd., trades in compact disc (CD) writers. AE1 Ltd., procures CD writers
both locally and in the international market. Its imports consist of CD writers
purchased from AE2 Ltd. as well as other manufacturers (Non AEs).
AE1 Ltd., during the year purchased 100 CD writers from AE2 Ltd. at INR
2,900 per unit. These are resold to A Ltd., an unrelated party, at a price of
INR 3,000 per unit.
AE1 Ltd., has also purchased similar products from an unrelated supplier,
viz. K Ltd., and has resold the same to M Ltd., who is also an unrelated party
and has earned a gross profit of 15% on sales.

Analysis of the sales transactions
Particulars Sales to A Ltd. Sales to M Ltd. Impact on GP
Price Ex shop FOB Destination Impact of Freight
with cost of freight and insurance on
and insurance GP is 2% as the
estimated at 2% of sale price
GP increases but
corresponding
expenses are not
debited to trading
account but to
profit and loss
account

Quantity Yes - the cost No Impact of quantity
discount of the same is discount on GP is
estimated at 1% 1%
of GP

Free gifts No One CD pack for As cost of gift is
every CD writer not debited to
with no change in trading account but
sale price to P &L Account,
there is no impact

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Particulars Sales to A Ltd. Sales to M Ltd. Impact on GP
on GP
Warranty No 6 months warranty As cost of warranty
(without change in is not debited to
sale price) - cost trading account but
of warranty is to P&L Account,
estimated at INR there is no impact
250 per unit on GP

Analysis of the purchase transactions
Particulars Purchase from Purchase from K Impact
AE2 Ltd. Ltd.
(International
transaction)
Customs INR 25 per unit INR25 per unit No impact
duty
Freight INR 10 per unit Nil Cost of purchase
inwards from K Ltd., is
lower
Quantity INR 15 per unit Nil Cost of purchase
discount from K Ltd., is
higher
Warranty Nil 6 months warranty No impact
purchase price
remaining
unchanged

Factors to be considered while determining ALP:
(a) In the above example, the international transaction is the purchase
transaction entered into by AE1 Ltd., with AE2 Ltd. which should be
determined on the basis of arm’s length price;

Purchase from AE2 Ltd. Sales to A Ltd.
AE1
Ltd

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(b) The comparable uncontrolled transaction is the purchase transaction
entered into by AE1 Ltd., with K Ltd.

Purchase from K Ltd. Sales to M Ltd.
AE 1 Ltd

(c) The starting point for arriving at the ALP of such purchase transaction
is the resale price charged to A Ltd. viz. INR3,000 [Rule 10B(1)(b)(i)].
(d) From the said resale price, the normal gross profit margin which AE1
Ltd., would earn in a comparable uncontrolled transaction should be
reduced. In this example, the actual gross profit margin earned by AE
1 Ltd., in respect of its purchase from K Ltd, and its resale to M Ltd, is
15%.
(e) The following adjustments are made to arrive at the normal GP;
Actual gross profit margin with M Ltd. 15%
Less:
1. Difference between Ex-shop and FOR prices 2%
2. Difference due to quantity discount 1%
Normal gross profit margin with M Ltd. 12%
Note: While arriving at normal gross profits from the actual gross
profits, only the differences in the sale transactions of AE1 Ltd., with
A Ltd., and M Ltd., have been taken. The differences in the purchase
transactions of AE 1 Ltd., with AE2 Ltd. and K Ltd., affecting the
gross profits are taken separately as provided in sub rule (iv).
(f) The resale price of INR3000. to M Ltd., is reduced by the normal
gross profit margin of 12%. The resultant cost of sales is INR2640
(i.e. 3000-360) [Rule 10B(1)(b)(ii)].
(g) The cost of sales so arrived at is reduced by the expenses incurred in
connection with the purchase (international transaction) i.e. freight of
INR 10 and customs duty of INR25. The resultant amount is INR 2605
(i.e. 2640-25-10) [Rule 10B(1)(b)(iii)].
(h) The above amount is further adjusted to take into account functional
and accounting differences between the international transaction and
the comparable uncontrolled transaction with AE2 Ltd the purchase

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transaction with K Ltd., which will affect the amount of gross profit
margin as explained below.
(i) The aforesaid amount of INR 2605 should be increased by INR10
being the freight incurred by AE1Ltd., in the case of purchase from
AE2Ltd., but not incurred in case of purchase from K Ltd., This is for
the reason that if a similar freight had been paid in respect of
transaction with K Ltd, the gross profit margin from K Ltd., would have
been lower and the resultant price would have been higher.
(j) A decrease by INR15 representing the quantity discount allowed by
AE2 Ltd., is to be made. This is for the reason that if a similar
discount had been allowed in respect of transaction with K Ltd, the
gross profit margin from K Ltd., would have been higher and the
resultant price would have been lower.
Determination of arm’s length price under RPM
1. AEs : AE1 Ltd. and AE2 Ltd.
2. Other enterprises : K Ltd. and M Ltd.
3. International transaction : AE1 Ltd. and AE2 Ltd.
4. Bought from AE2Ltd. and resold to : A Ltd.
5. CUT is purchase from K Ltd. and sales
to M Ltd.

Details INR /unit
Price paid to AE2 Ltd.(FOB) 2,900
Quantity 100
Purchases cost (actual) (A) 2,90,000
Actual GP Margin on sales to M Ltd.(%) 15
Normal GP Margin on sales to M Ltd.(%) 12
Price charged to A Ltd. 3,000
Less: Normal GP margin 360
Balance 2640
Less: Expenses connected with purchase (freight & customs 35
duty paid)
Price before adjustment 2,605

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Add:
Freight incurred in case of purchase from AE2 Ltd. 10
Sub total 10
Less :
Quantity discount allowed by AE2 Ltd. 15
Sub total 15
Arm’s length price 2,600
Adjusted purchase cost (B) 2,60,000
Income increases by (A-B) 30,000
The following points are to be noticed:
(i) RPM is to be adopted only when goods purchased from an AE are
resold to unrelated parties.
(ii) In contrast to the CUP Method, the reliability of RPM is influenced by
factors that have less effect on the price of a product than on the
costs of performing functions. Such differences could affect gross
margins [e.g. the composition of Cost of Goods Sold (‘COGS’)].
These factors could include cost structures (e.g. accounting
practices), business experience (e.g. start‐up phase or mature
business) or management efficiency.
(iii) As provided in Rule 10B(1)(b)(iii), the expenses incurred in
connection with the purchase from AE are to be reduced from cost of
sales. In RPM, the arm’s length purchase price is arrived at reducing
the normal gross profit margin from the resale price as the first step.
If the computation is stopped at this step itself, the derived purchase
amount would be inclusive of such expenses. It is therefore
necessary to reduce such expenses in arriving at the arm’s length
purchase price.
(iv) Adjustments have to be made also for accounting practices apart
from functional and other differences. Differences in accounting
practices may be because:
(a) sales and purchases have been accounted for inclusive of taxes
or exclusive of taxes;
(b) method of pricing the goods namely, FOB or CIF;
(c) fluctuations in foreign exchange.

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(v) The comparability analysis should try to take into account whether the
reseller has the exclusive right to resell the goods, because exclusive
rights may affect the resale price margin.
(vi) In actual practice, the resale in any financial year may be also out of
opening stock. Similarly, the goods purchased during the said year
may remain in closing stock. Under the RPM, the arm’s length price
of purchases from AE during the financial year should be determined.
The process of determination under Rule 10B(1)(b) culminates in the
cost of sales rather than value of purchase during the year. This ‘cost
of sales’ should be converted into ‘value of purchase’. For this
purpose, the closing stock of goods purchased from AE should be
added and the opening stock of purchases from AE should be
deducted. The focus here is to identify cost of goods sold and make
adjustment therein rather than amount of purchases only.
(vii) Further, it may not possible to reliably compute the gross margin of
the comparables since in India at this point of time there is no uniform
accounting convention which is applicable for computing the gross
margin. The companies could follow different accounting principles
while recording a particular expense item. Hence, it is not possible to
ensure that all the expense items have been uniformly accounted by
all comparables while computing the gross margin. For example –
Reporting of discounts, transportation cost, insurance and warranty
cost, valuations of the inventory, etc. As a result, application of RPM
using external comparable transaction could be a challenge
considering the availability of the reliable data.
6.20 It is important to understand the characterization of the AEs (based
on the detailed functional analysis) before one selects RPM as the most
appropriate method. This can be explained by way of an example provided
below:
ABC Inc. owns valuable patents to manufacture the bicycles and has a
valuable trade name. ABC Inc.’s subsidiary i.e. ABC Ltd purchases the
bicycles from ABC Inc. and resells the bicycles to unrelated dealers in India.
The bicycle is new in the Indian market and is not known to the Indian
consumers. Further, it is assumed that comparable uncontrolled transactions
are not available. The financial data under two scenarios is provided below:

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Particulars Case 1 Case 2
Sales to third parties 1,000 1,000
Cost of goods sold 700 700
Gross Profit 300 300
Gross Profit / Sales ratio 30% 30%
Value added expenses 50 250
(‘VAE’)
VAE / Sales 5% 25%
In this case, it is important to analyse the following aspects before selecting
the most appropriate method:
Case 1
• It is important to analyse the functions performed, assets employed
and the risks undertaken by ABC Inc. as well as ABC Ltd. with
respect to the transaction of purchase of bicycles by ABC Ltd. from
ABC Inc., to determine the characterisation of the above entities and
identify the tested party.
• ABC Inc. owns valuable intangibles, performs R&D activities and
generally has operations that are more complex than those of the
sales company (i.e. ABC Ltd).
• On the other hand, ABC Ltd is engaged in purchase of bicycles and
selling it to the third parties without undertaking any significant value
addition on its own.
• VAE/Sales maybe an important factor to evaluate the intensity of
functions as advocated in Sony Ericsson Mobile Communications
India Pvt. Ltd (ITA No 16/2014) Ruling by the High Court.
• Since the VAE in case 1 is only 5% of the sales, it can be said that
the marketing spend needed create customer awareness to facilitate
sale of product in the Indian market is borne by ABC Inc. and the
VAE incurred by ABC Ltd is with respect to normal selling function.
• It should be noted that a foreign entity may be selected as the tested
party if it is the less complex entity and if reliable data in respect of
the international transaction under consideration is available.
• From the above functional analysis, ABC Ltd can be characterised as
a normal risk bearing distributor and ABC Inc. is the entrepreneurial

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entity. As seen from the characterisation, ABC Inc. is more complex
entity and therefore, it cannot be considered as a tested party. As
result, ABC Ltd has been selected as a tested party in this case.
• Since comparable uncontrolled transactions are not available, the
CUP Method cannot be applied as the most appropriate method.
• ABC Ltd is engaged in purchase of bicycles from ABC Inc. are further
selling it to a third party without any significant value addition. The
gross profit realised by ABC Ltd can be compared using RPM as the
most appropriate method in this case.
Case 2
• The VAE in case 2 is significant i.e. 25% of the sales. It can be said
that ABC Ltd is engaged in developing the marketing intangible in the
Indian market for ABC Inc.
• This is the case where the reseller contributes substantially to the
creation or maintenance of intangible property associated with the
product (e.g. trademarks or trade names) which are owned by an AE.
In such cases, the contribution of the goods originally transferred to
the value of the final product cannot be easily evaluated.
• Further, this activity of brand building may require to be separately
evaluated for testing the arm’s length nature. In case the activity of
reselling and brand building are inextricably inter linked and cannot
be separately evaluated, there may arise a need to evaluate a
different method for testing the arm’s length nature of the
aforementioned closely linked transactions.
• In such cases, RPM may not be the most appropriate method and
one has to take recourse to other methods prescribed under the Act.
6.21 Further, one should also evaluate the pricing mechanism, contractual
terms, roles and obligations as well as the functional profile of the parties to
a transaction, before the determination of the most appropriate method to
benchmark the international transaction [or the specified domestic
transaction].
For example – A distributor could be awarded a net profit on sales for
performing the routine distribution functions. However, in such a scenario
RPM may not be the most appropriate method since RPM takes into account

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the gross margin earned by the distributor. In such a situation, TNMM could
be considered as the most appropriate method.
Typically, RPM may be the most appropriate method in case of a normal risk
distributor, who is awarded a reasonable level of gross margin for the
functions performed.

Cost Plus Method (CPM)
6.22 Rule 10B(1)(c)cost plus method, by which,-
(i) the direct and indirect costs of production incurred by the
enterprise in respect of property transferred or services
provided to an AE, are determined;
(ii) the amount of a normal gross profit mark-up to such costs
(computed according to the same accounting norms) arising
from the transfer or provision of the same or similar property or
services by the enterprise, or by an unrelated enterprise, in a
comparable uncontrolled transaction, or a number of such
transactions, is determined;
(iii) the normal gross profit mark-up referred to in sub-clause (ii) is
adjusted to take into account the functional and other
differences, if any, between the international transaction [or the
specified domestic transaction] and the comparable
uncontrolled transactions, or between the enterprises entering
into such transactions, which could materially affect such profit
mark-up in the open market;
(iv) the costs referred to in sub-clause (i) are increased by the
adjusted profit mark-up arrived at under sub-clause (iii);
(v) the sum so arrived at is taken to be an arm’s length price in
relation to the supply of the property or provision of services by
the enterprise.
6.23 Typical transactions where CPM may be adopted are:
(a) provision of services;
(b) joint facility arrangements;
(c) transfer of semi finished goods;
(d) long term buying and selling arrangements.

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6.24 The OECD in its Transfer Pricing Guidelines (2022) states as follows:
Para 2.45 “This method probably is most useful where semi finished
goods are sold between associated parties, where associated parties
have concluded joint facility agreements or long-term buy-and-supply
arrangements, or where the controlled transaction is the provision of
services.”
2.46 The cost plus mark-up of the supplier in the controlled
transaction should ideally be established by reference to the cost plus
mark-up that the same supplier earns in comparable uncontrolled
transactions (“internal comparable”). In addition, the cost plus mark-
up that would have been earned in comparable transactions by an
independent enterprise may serve as a guide (“external
comparable”).
UN Practical Manual on Transfer Pricing for Developing Countries
(2021) states as under:
4.4.8.1 The CPM is typically applied in cases involving the intragroup
sale of tangible property where the related party manufacturer
performs limited manufacturing functions or in the case of intragroup
provision of services.
The method usually assumes the manufacturer or service provider
has low risks, because the level of the costs will then better reflect
the value being added and hence the market price.
4.4.8.2 The CPM is also generally used in transactions involving a
contract manufacturer, a toll manufacturer or a low risk assembler
which does not own product intangibles and assumes little risk. The
related customer involved in the controlled transaction will generally
be much more complex than the manufacturer (or service provider) in
terms of functions performed (e.g. conducting marketing and selling
functions, coordination of production and sales, giving instructions to
the contract manufacturer about the quantity and quality of
production, and purchasing raw materials in some cases), risks
assumed (e.g. market risk, credit risk and inventory risk) and assets
used or contributed (e.g. product or other intangibles). The contract
manufacturer is thus the less complex and as such should be the
tested party in the transfer pricing analysis.

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4.4.8.3 The CPM is usually not a suitable method to use in
transactions involving a fully-fledged manufacturer which owns or
develops unique and valuable product intangibles as it will be very
difficult to locate independent manufacturers with comparable product
intangibles. That is, it will be hard to establish a profit mark-up that is
required to remunerate the fully-fledged manufacturer for its unique
and valuable intangibles. In a typical transaction structure involving a
fully-fledged manufacturer and related sales companies (e.g.
commissionaires), the sales companies will normally be the less
complex entities involved in the controlled transactions and will
therefore be the tested party in the analysis. The RPM is typically
more easily applied in such cases
Also, it is pertinent to note that similar to RPM, CPM is also a one sided
method wherein the margins earned by the manufacturer / service provider
can be tested under this method.
6.25 The steps involved in the application of this method are:
(i) Determine the direct and indirect cost of production in respect of
property transferred or service provided to an AE.
(ii) Identify one or more comparable uncontrolled transactions for same
or similar property or service.
(iii) Determine normal gross profit mark-up on costs in the comparable
uncontrolled transaction. Such costs should be computed according
to the same accounting norms. In other words, the components of
costs of comparable uncontrolled transaction should be the same as
those of international transaction [or the specified domestic
transaction].
(iv) Adjust the gross profit mark-up to account for functional and other
differences between the international transaction [or the specified
domestic transaction] and the comparable uncontrolled transaction.
Such adjustments should also be made for enterprise level
differences.
(v) The direct and indirect cost of production in the international
transaction [or the specified domestic transaction] is increased by
such adjusted gross profit mark-up.
(vi) The resultant figure is the arm’s length price.

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6.26 With respect to CPM, The UN in the Practical Manual on Transfer
Pricing states as below:
“As with the RPM, and for the same reasons, close similarity of
products in the controlled and uncontrolled transactions is less
important under the Cost Plus Method than under the CUP Method,
while functional comparability (including comparability of risks
assumed and assets used) is more important. However, because
significant differences in products may necessarily result in significant
differences in the functions, the controlled and uncontrolled
transactions should ideally involve the manufacturing of products
within the same product family. (para 4.4.5.2 )
6.27 An example on importance of functional similarity is provided below:
A Limited is engaged in manufacturing of pet bottles and sales to third party
customers in the Indian market. It is also engaged in selling the
manufactured pet bottles to the AE outside India. The AE further sells the pet
bottles to third party customers in their respective markets.
The functional profile of A Limited with respect to sales to third parties in
domestic market and AE is provided below:
Functions performed Domestic Export
business business
(Unrelated) (AE)
Manufacturing function √ √
Marketing and distribution function √ X
After sales support √ X
Inventory management √ X

Risks assumed Domestic Export
business business
Market risk √ X
Credit risk √ X
Foreign exchange risk X √
Inventory risk- √ X
From the above, one could see that there are differences in the functional
profile of A Limited with respect to sales made to third parties in the domestic
market and to AEs. Owing to such differences, while CPM can be used for

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analyzing the transaction pertaining to export to the AE (by A Limited),
however the gross margins earned by A Limited from such exports cannot be
compared with the gross margin earned by A Limited from sale to third party
customers in the Indian market.
6.28 The OECD in its Transfer Pricing Guidelines (2022) has stated the
following in relation to application of CPM:
2.51 For this purpose, it is particularly important to consider
differences in the level and types of expenses – operating expenses
and non-operating expenses including financing expenditures –
associated with functions performed and risks assumed by the parties
or transactions being compared. Consideration of these differences
may indicate the following:
a) If expenses reflect a functional difference (taking into account
assets used and risks assumed) which has not been taken into
account in applying the method, an adjustment to the cost plus mark-
up may be required.
b) If the expenses reflect additional functions that are distinct from
the activities tested by the method, separate compensation for those
functions may need to be determined. Such functions may for
example amount to the provision of services for which an appropriate
reward may be determined. Similarly, expenses that are the result of
capital structures reflecting non-arm's length arrangements may
require separate adjustment.
c) If differences in the expenses of the parties being compared
merely reflect efficiencies or inefficiencies of the enterprises, as
would normally be the case for supervisory, general, and
administrative expenses, then no adjustment to the gross margin may
be appropriate.
2.55 In principle historical costs should be attributed to individual
units of production, although admittedly the cost plus method may
overemphasize historical costs. Some costs, for example costs of
materials, labour, and transport will vary over a period and in such a
case it may be appropriate to average the costs over the period.
Averaging also may be appropriate across product groups or over a
particular line of production.

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Further, averaging may be appropriate with respect to the costs of
fixed assets where the production or processing of different products
is carried on simultaneously and the volume of activity fluctuates.
Costs such as replacement costs and marginal costs also may need
to be considered where these can be measured and they result in a
more accurate estimate of the appropriate profit.
6.29 The application of CPM can be understood with the following
example:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as
follows:
Shareholder’s name Status % holding
AE2 Ltd. Foreign Company 30
AE3 Ltd. Indian Company 30
Financial Institutions Indian Company 10
Public 30
AE1 Ltd., an unrelated party, develops software for various customers, who
include AE2 Ltd. and M Ltd.
AE1 Ltd., during the year billed AE2 Ltd. INR 2,00,000. The total cost (direct
and indirect) for executing this work was INR 1,75,000.
AE1 Ltd., provided similar services to M Ltd., and earned a gross profit (GP)
of 50% on costs.

Analysis of transactions
Particulars Transactions with AE2 Transactions with M
Ltd. Ltd.
Technology Yes No - value of technology
support received support incurred by AE1
Ltd., is INR 17,500
Discount offered Yes – Discount offered is No
INR 8,750
Expenses No Yes – expenses incurred
incurred by AE1 INR 13,125
towards marketing
Credit Yes – Cost of credit is No
estimated at INR 2,625

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Factors to be considered while determining ALP:
(a) In CPM, one has to start with the gross profit mark-up which the
enterprise earned in a comparable uncontrolled transaction. In this
example, the comparable uncontrolled transaction is between AE1
Ltd., and M Ltd.
(b) Such gross profit (GP) markup needs to be adjusted for the following:
➢ As AE1 Ltd., did not receive the technology support from M Ltd.,
it has priced its services higher resulting in it earning a higher
GP with M Ltd.. The value of technology support of INR17,500
received from AE2 Ltd. is 10% of cost. Therefore, the GP with M
Ltd., has to be reduced by 10%.
➢ AE1 Ltd. did not provide discount to M Ltd., as volume of
business from M Ltd., was not as high as that from AE2 Ltd.
Had AE1 Ltd., offered similar discount to M Ltd., the GP with M
Ltd., would have been lower. The discount of INR 8,750 offered
to AE2 Ltd. is 5% of cost. Therefore, the GP with M Ltd., has to
be decreased by 5%.
➢ AE1 Ltd., has incurred INR 13,125 towards marketing functions
in respect of its transactions with M Ltd., which is 7.5% of its
cost. However, in its transactions with AE2 Ltd. the said
functions are assumed by AE2 Ltd. Had AE1 Ltd., not incurred
similar expenses with M Ltd., it would have settled for a lower
GP. Therefore, the GP with M Ltd., has to be reduced by 7.5%.
➢ The cost of credit of INR 2,625 provided by AE1 Ltd., to AE2
Ltd. is 1.5% of its cost. However, in its transactions with M Ltd.,
such credit is not provided. Had AE1 Ltd., provided similar credit
to M Ltd., it would have increased its price resulting in a higher
GP. Therefore, the GP with M Ltd., has to be increased by
1.5%.
(c) The resultant gross profit mark-up is the arm’s length gross profit
mark up.
(d) The costs of AE1 Ltd., in its transactions with AE2 Ltd. should be
increased by the arm’s length gross profit mark up to arrive at the
arm’s length income.

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Determination of arm’s length price under costs plus
method
1. AE : AE2 Ltd.
2. Other unrelated enterprise : M Ltd
3. International transaction : AE1 Ltd and AE2 Ltd
4. Comparable uncontrolled transaction : AE1 Ltd. and M Ltd

Determination of arm’s length gross profit mark up
Details %
Gross profit mark up in case of M Ltd. 50.00%
Less :
1. Technology support from AE2 Ltd. 10.00%
2. Quantity discount to AE2 Ltd not to M Ltd. 5.00%
3. Marketing functions performed by AE1Ltd., in 7.50%
respect of M Ltd.
Sub total 22.50%
Add :
1. Cost of credit to AE2. Ltd. 1.50%
Sub total 1.50%
Arm’s length gross profit mark up 29.00%

Determination of arm’s length price

Details Amount/ %
Direct and indirect costs incurred by AE1 Ltd. in 1,75,000
respect of transactions with AE2 Ltd.
Arm’s length gross profit mark up 29.00%
Arm’s length income (A) 2,25,750
Actual price charged to AE2 Ltd. (B) 2,00,000
Income increases by (A-B) 25,750
6.30 It is also important to note that the cost plus pricing is different from
CPM. This could be explained by way of the following example:

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A Limited is a captive service provider working with an assured return of 10%
on the total cost incurred in connection with provision of such services to the
Group. In this case, one could see that though the pricing is based on the
cost plus mark-up, the same cannot itself lead to a conclusion that CPM is
the most appropriate method. The costs that A Limited would be recovering
from the Group may involve costs incurred below the gross profit level and
thus, CPM may not be applicable in such a scenario.
The following points are to be noticed:
(i) In this method, the direct and indirect costs of production are to be
determined. The terms ‘direct’ or ‘indirect’ costs are however not
defined. A reference may therefore be made to the industry practice
as well as the pronouncements of the ICAI.
OECD Transfer Pricing Guidelines (2022) mentions about direct and
indirect costs as under:
2.53: While precise accounting standards and terms may vary, in
general the costs and expenses of an enterprise are understood to be
divisible into three broad categories. First, there are the direct costs
of producing a product or service, such as the cost of raw materials.
Second, there are indirect costs of production, which although closely
related to the production process may be common to several
products or services (e.g. the costs of a repair department that
services equipment used to produce different products). Finally, there
are the operating expenses of the enterprise as a whole, such as
supervisory, general, and administrative expenses.
2.54: The distinction between gross and net profit analyses may be
understood in the following terms. In general, the cost plus method
will use mark ups computed after direct and indirect costs of
production, while a net profit method will use profits computed after
operating expenses of the enterprise as well. It must be recognised
that because of the variations in practice among countries, it is
difficult to draw any precise lines between the three categories
described above. Thus, for example, an application of the cost plus
method may in a particular case include the consideration of some
expenses that might be considered operating expenses, as discussed
in paragraph 2.52.

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2.59: Example of the application of cost plus method
A is a domestic manufacturer of timing mechanisms for mass- market
clocks. A sells this product to its foreign subsidiary B. A earns a 5%
gross profit mark up with respect to its manufacturing operation. X, Y,
and Z are independent domestic manufacturers of timing mechanisms
for mass- market watches. X, Y, and Z sell to independent foreign
purchasers. X, Y, and Z earn gross profit mark ups with respect to
their manufacturing operations that range from 3% to 5%. A accounts
for supervisory, general, and administrative costs as operating
expenses, and thus these costs are not reflected in cost of goods
sold. The gross profit mark ups of X, Y, and Z, however, reflect
supervisory, general, and administrative costs as part of costs of
goods sold. Therefore, the gross profit mark ups of X, Y, and Z must
be adjusted to provide accounting consistency.
It may also be noted that determination of direct and indirect cost of
manufacturing is not mandated under the mandatory format of
financials under the Companies Act. This results in difficulty in
applying CPM for the external comparables and therefore, CPM as
the most appropriate method may fail.
Further, in the Indian scenario, it is not possible to reliably compute
the gross margin of the comparables since there is no uniform
accounting convention which is applicable for computing the gross
margin. The companies could follow different accounting principles
while recording a particular expense item. Hence, it is not possible to
ensure that all the expense items have been uniformly accounted by
all comparables while computing the gross margin. For example –
Reporting of R&D costs, valuations of the inventory, etc. As a result,
application of CPM using external comparable transaction could be a
challenge considering the availability of the reliable data.
Further, reliability of CPM may also be adversely affected by factors
such as cost structures, business, management efficiency and lack of
reliable external comparable data etc.
(ii) In determining the direct and indirect cost, the following factors have
to be borne in mind:
(a) if the plant has been under utilised the costs may have to be
suitably adjusted;

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(b) absorption costing method is normally to be preferred.
(iii) This method is to be adopted only in cases of supply of property or
services to an AE. This method is not to be applied when the
enterprise is in receipt of property or services from an AE. However,
in such cases, one may still evaluate the applicability of CPM as the
most appropriate method by considering the AE as the tested party.

Profit Split Method (PSM)
6.31 Rule 10B(1)(d) profit split method, which may be applicable
mainly in international transactions [or specified domestic transactions]
involving transfer of unique intangibles or in multiple international
transactions [or specified domestic transactions] which are so inter-
related that they cannot be evaluated separately for the purpose of
determining the arm’s length price of any one transaction, by which-
(i) the combined net profit of the AEs arising from the international
transaction [or the specified domestic transaction] in which they
are engaged, is determined;
(ii) the relative contribution made by each of the AEs to the earning
of such combined net profit, is then evaluated on the basis of the
function performed, assets employed or to be employed and
risks assumed by each enterprise and on the basis of reliable
external market data which indicates how such contribution
would be evaluated by unrelated enterprises performing
comparable functions in similar circumstances;
(iii) the combined net profit is then split amongst the enterprises in
proportion to their relative contributions, as evaluated under
sub-clause (II);
(iv) the profit thus apportioned to the assessee is taken into account
to arrive at an arm’s length price in relation to the international
transaction [or specified domestic transaction]:
Provided that the combined net profit referred to in sub-clause (i) may,
in the first instance, be partially allocated to each enterprise so as to
provide it with a basic return appropriate for the type of international
transaction [or specified domestic transaction] in which it is engaged,
with reference to market returns achieved for similar types of
transactions by independent enterprises, and thereafter, the residual

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net profit remaining after such allocation may be split amongst the
enterprises in proportion to their relative contribution in the manner
specified under sub-clauses (ii) and (iii), and in such a case the
aggregate of the net profit allocated to the enterprise in the first
instance together with the residual net profit apportioned to that
enterprise on the basis of its relative contribution shall be taken to be
the net profit arising to that enterprise from the international
transaction [or specified domestic transaction].
6.32 Typical transactions where the profit-split method may be used are
transactions involving:
(a) integrated services provided by more than one enterprise for e.g., in
case of financial service sector, where the activities performed by
Indian company and foreign AEs in relation of a merger and
acquisition transaction are so interrelated that it may not possible to
segregate them;
(b) transfer of unique intangibles, for e.g. two AEs contribute their
respective intangibles to develop a new product or process and earn
income from such product or process.
6.33 The observations of the OECD, in its Transfer Pricing Guidelines
(2022), on this method are as follows:
2.114 The transactional profit split method seeks to establish arm’s
length outcomes or test reported outcomes for controlled transactions
in order to approximate the results that would have been achieved
between independent enterprises engaging in a comparable
transaction or transactions. The method first identifies the profits to
be split from the controlled transactions—the relevant profits—and
then splits them between the associated enterprises on an
economically valid basis that approximates the division of profits that
would have been agreed at arm’s length. As is the case with all
transfer pricing methods, the aim is to ensure that profits of the
associated enterprises are aligned with the value of their
contributions and the compensation which would have been agreed in
comparable transactions between independent enterprises for those
contributions. The transactional profit split method is particularly
useful when the compensation to the associated enterprises can be
more reliably valued by reference to the relative shares of their

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contributions to the profits arising in relation to the transaction(s) than
by a more direct estimation of the value of those contributions.
2.115 References to “profits” should be taken as applying equally to
losses.
6.34 Determining the combined profits to be split
In this regard, the OECD in its Transfer Pricing Guidelines (2022) observes
as under:
2.130 The combined profits to be split in a transactional profit split
method are the profits of the associated enterprises from the
controlled transactions in which the associated enterprises are
engaged. The combined profits to be split should only be those
arising from the controlled transaction(s) under review. In determining
those profits, it is essential to first identify the relevant transactions to
be covered by the transactional profit split. Where a taxpayer has
controlled transactions with more than one associated enterprise, it is
also necessary to identify the parties in relation to those transactions
and the profits to be split among them.
2.131 In order to determine the combined profits to be split, the
accounts of the parties to the transaction to which a transactional
profit split is applied need to be put on a common basis as to
accounting practice and currency and then combined. Because
accounting standards can have significant effects on the
determination of the profits to be split, accounting standards should
be selected in advance of applying the method and applied
consistently over the lifetime of the arrangement.
2.133 If the profit split method were to be used by associated
enterprises to set transfer pricing in controlled transactions (i.e. an ex
ante approach), then each associated enterprise would seek to
achieve the division of profits that independent enterprises would
have expected to realize from engaging in comparable transactions.
Depending on the facts and circumstances, profit splits using either
actual or projected profits are observed in practice.
6.35 There are two approaches to this method, namely, total profits split
and residual profit split.

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6.36 Total profits split: The steps involved are as follows:
(i) Determine the combined net profit of the AEs arising from the
international transactions [or the specified domestic transaction] in
which they are engaged. Such profits represent the profits earned
from third parties due to the combined efforts of the AEs. It may be
noted that the ‘combined net profit’ referred to in the rule is not the
aggregate of entire profits earned by the AEs. Example:AE1 may
earn profits from certain transactions wherein there is no contribution
by AE2and vice versa. Such profits do not enter into the
determination of combined net profit. Only those profits that are
earned as a result of joint efforts of AE1 and AE2 should be taken as
combined net profit.
(ii) Evaluate relative contribution made by each entity involved in the
transaction on the basis of:
(a) functions performed;
(b) assets employed;
(c) risks assumed;
(d) the reliable external market data indicating how such
contribution would be evaluated by unrelated enterprises
performing comparable functions in similar circumstances. It
may be noted that reference to ‘external market data’ indicates
comparable uncontrolled transactions. The use of word
‘external’ does not preclude use of internal CUT. In the process
of choosing CUTs, the function performed, assets used and
risks taken (FAR) of the uncontrolled transactions would have
been compared with the FAR of the international transactions
[or the specified domestic transaction].When the FAR of the
international transaction [or the specified domestic transaction]
and CUT are similar, the relative contribution adopted in the
CUT should be applied to the international transaction [or the
specified domestic transaction]. Any significant differences
between the two should be suitably adjusted.
(iii) Thereafter, split the combined net profit in proportion to the relative
contribution determined as above.
(iv) The profit so apportioned is taken to arrive at the arm’s length price in
relation to the international transaction [or the specified domestic
transaction]. The profits so apportioned to the AE when added to the

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costs incurred by it in relation to international transaction [or the
specified domestic transaction] would result in arm’s length price.
Residual profit split approach
6.37 In this approach, firstly, a basic return is determined for each of t he
enterprises and profits of each such enterprise is ascertained. This amount is
reduced from the combined net profits. Residual profits are allocated on the
basis of relative contribution.
Steps involved in this approach are as follows:
(i) Determine the combined net profit of the AEs arising from the
international transactions [or the specified domestic transaction] in
which they are engaged.
(ii) At the first stage, depending on functions performed, assets
employed and risks assumed, determine the basic return appropriate
to the respective activities. Allocate the combined net profit on the
basis of above. This step results in a partial allocation of the
combined net profit to each enterprise. For this purpose, the
allocation is undertaken with reference to margins of comparable
uncontrolled entities.
(iii) the balance of the combined net profit is allocated on the basis of the
evaluation of the relative contribution.
(iv) the total net profit from such two-tier allocation is taken to arrive at
the arm’s length price. The profits so apportioned to the AE when
added to the costs incurred by it in relation to international
transaction [or the specified domestic transaction] would result in
arm’s length price.
6.38 The application of PSM can be understood with the following
example:
AE1 Ltd., is an Indian company. The shareholding pattern of AE1 Ltd., is as
follows;
Shareholder’s name Status % holding
AE2 Ltd. Foreign Company 30
AE3 Ltd. Foreign Company 30
Financial Institutions Indian Company 10
Public 30

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AE1 Ltd., is an investment advisory company, which in association with AE2
Ltd. assists its clients with foreign acquisitions.
AE3 Ltd., which is based in U.S.A., has worldwide presence.AE1 Ltd. is
approached by M, an unrelated party for identifying potential target
companies for acquisitions in the USA. In order to serve M, AE1 Ltd. and
AE3 Ltd., have each contributed integrally to identification of potential target
and assisting M with the acquisition process. For the above, AE1 Ltd.,
received consideration of US$ 50,000.The financials are as follows;

Particulars AE1 Ltd. AE3 Ltd.
Revenue 30000 20000
Cost 20000 8000
Profit 10000 12000

Factors to be considered:
(a) The normal basic return is ordinarily calculated as a percentage of
the costs incurred or gross revenues or capital employed. In this
example, it is assumed as a percentage of the cost.
(b) Based on the FAR analysis, the basic return for AE1 Ltd., and AE3
Ltd., are determined to be 15% and 10% on cost respectively.
Accordingly, the normal basic return for AE1 Ltd. in India for the
aforesaid operation is US$ 3000.The similar returns for AE3 Ltd.,
US$ 800.The total basic return, thus, is US $ 3,800.
(c) On the basis of functions performed, risks assumed and assets
employed, the relative contribution may be taken at 70%, 30% for
AE1 Ltd. and AE3 Ltd., respectively.
Determination of arm’s length price under PSM:
First Approach: Total Profit Split Method

1. AEs : AE1Ltd. and AE3 Ltd.
2. Ultimate delivery of product is : By AE3 Ltd. to M Ltd.
3. International transaction : Between AE1 Ltd. and AE3
Ltd.

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Details US$
Price charged by AE1 Ltd from M Ltd 50,000
AE3 Ltd share of revenue 20,000
AE1 Ltd share of revenue 30,000
Combined total profits 22,000
Evaluation of relative contribution
AE1 Ltd : India return – 70% 15,400
AE3 Ltd : US return – 30% 6,600
Total 22,000
Total return for AE1 Ltd 15,400
Total cost of AE1 Ltd 20,000
Income of AE1 Ltd on arm’s length price (A) 35,400
Actual revenue (B) 30,000
Increased income (A-B) 5,400
Note: In this example, the basic return is not required to be taken into
account.
Second Approach: Residual profit split method

Details US$
Price charged by AE1 Ltd from M Ltd 50,000
AE3 Ltd share of revenue 20,000
AE1 Ltd share of revenue 30,000
Combined total profits 22,000
1. Basic return
AE1 Ltd : India return 3,000
AE3 Ltd : US return 800
Total 3,800
2. Residual net profit 18,200
AE1 Ltd: India return – 70% 12,740
AE3 Ltd: US return – 30% 5,460
Total 18,200
Total return for AE1 Ltd (12740 + 3000) 15,740

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Details US$
Total cost of AE1 Ltd. 20,000
Income of AE1 Ltd. on arm’s length price (A) 35,740
Actual revenue (B) 30,000
Increased income (A-B) 5,740
The following points are to be noticed:
(a) It is the profit from a transaction with the AE that needs to be
ascertained. If there are other transactions, which contribute to the
profits, then the profits from transactions with AE may have to be
arrived at on some approximation.
(b) The rule itself provides an alternative method to arrive at the arm’s
length price being the two-tier PSM;
(c) If in either of the alternatives, a range of figures is available, the
arithmetical mean of such figures may be adopted as the arm’s length
price. It may however not be possible to adopt the arithmetical mean
of the two alternatives.
(d) Under the two-tier split-method, the basic rate of return may have to
be adopted having regard to the profits compared to the net worth of
the enterprise. Such rate of return may not be uniform for all the
AEs involved in the transaction.
(e) This is the only method for which the Rule itself has prescribed the
types of transaction to which it may be applicable.
(f) Even though the computation proceeds with the profits from a
transaction, the purpose is only to arrive at the arm’s length price of a
transaction. It is only by substituting the arm’s length price for the
price in the international transaction [or the specified domestic
transaction] that an adjustment may be made to the income returned.

Transactional Net Margin Method (TNMM)
6.39 Rule 10B(1)(e) transactional net margin method, by which,-
(i) the net profit margin realised by the enterprise from an
international transaction or the specified domestic transaction
entered into with an AE is computed in relation to costs incurred

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or sales effected, or assets employed or to be employed by the
enterprise or having regard to any other relevant base;
(ii) the net profit margin realised by the enterprise or by an
unrelated enterprise from a comparable uncontrolled transaction
or a number of such transactions is computed having regard to
the same base;
(iii) the net profit margin referred to in sub-section (ii) arising in
comparable uncontrolled transactions is adjusted to take into
account the differences, if any, between the international
transaction [or the specified domestic transaction] and the
comparable uncontrolled transactions, or between the
enterprises entering into such transactions, which could
materially affect the amount of net profit margin in the open
market;
(iv) the net profit margin realised by the enterprise and referred to in
sub-clause (i) is established to be the same as the net profit
margin referred to in sub-clause (iii);
(v) the net profit margin thus established is then taken into account
to arrive at an arm’s length price in relation to the international
transaction or the specified domestic transaction.
6.40 Typical transactions where the transactional net margin method may
be adopted are:
(a) provision of services;
(b) distribution of finished products where RPM cannot be applied;
(c) transfer of semi-finished goods where CPM cannot be applied;
(d) transactions involving intangibles where PSM cannot be applied.
6.41 The steps involved in the application of this method are:
(i) Identify the net profit margin realised by the enterprise from an
international transaction [or the specified domestic transaction].
Where the assessee also has transactions, segments or businesses
where the international transactions [or the specified domestic
transaction] with AEs are not relevant, then the net profit margin to
be considered for the purposes of this TNMM method should be such
net profit margin as is derived only from the transactions, segments
or businesses related to the international transaction [or the specified

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domestic transaction]. The net profit margin may be computed in
relation to costs incurred or sales effected or assets employed or any
other relevant base.
For example,
• In case where the assessee acts as a distributor and the
transaction pertains to import, the revenue may be used as
base.
• In case the transaction involves export of services/goods,
costs may be taken as base provided the exporting entity acts
as a contract service provider / contract manufacturer.

• Return on capital employed or Return on assets are typically
used in case of a capital intensive manufacturing set-ups
where the tangible operating assets have a high correlation to
profitability. For example: Return on capital employed or
Return on assets could be used in case of a leasing company.
(ii) Identify the net profit margin from a comparable uncontrolled
transaction or a number of such transactions having regard to the
same base; In practice, net profit margin is ascertained at segment
level where segment data are available. The unallocated expenses
are allocated on a reasonable basis and the segmental net profit is
determined. Where segment data are not available, net profit is
normally determined at enterprise level. Where internal CUT is
available transaction level net profit may be determined.
(iii) In case internal CUT is not available, external CUT is taken. In such
case, as discussed above, net profit margin should be taken at
enterprise level (segmental or enterprise as a whole) of comparable
companies. A search should be carried out to identify comparable
companies on the basis of information and data available with the
assessee. Where such information and data are not available, search
may be carried out with reference to database in public domain.
(iv) The net profit margin so identified is adjusted to take into account the
transaction level and enterprise level differences if any. The
differences should be those that could materially affect the net profit
margin in the open market;

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(v) The adjusted net profit margin is taken into account to arrive at the
arm’s length price in relation to the international transaction [or the
specified domestic transaction].
6.42 The unavailability of reliable data for comparables in case of gross
profit based methods such as CPM and RPM may pose difficulties in
selecting them as the most appropriate method. In such circumstances,
TNMM may be considered as the most appropriate method, subject to other
parameters such as degree of comparability, comparability factors, functional
profile, etc.
6.43 However, this should not be construed as TNMM being a residual
method or method of last resort. Though, TNMM is more tolerant to
differences in the product comparability as compared to the traditional
methods, the comparability standard to be applied to the TNMM requires a
high degree of similarity in several factors between the tested party and the
independent enterprises that may adversely affect the net margins. For
example: contractual terms and conditions, functions performed, risks
assumed and assets employed, pricing mechanism, availability of the
comparable data, etc.
6.44 Net margins may be affected by factors that have no effect or less
significant effect on gross margins or prices due to the variation of operating
expenses between companies. These factors may be unrelated to transfer
pricing. For example – Difference in the capacity utilisation level of the tested
party vis-a-vis the comparables.
6.45 Specific factors that may affect net margins include, but are not
limited to:
• Barriers to entry in the industry;
• Competitive position;
• Management efficiency;
• Individual business strategies;
• Threat of substitute products;
• Varying cost structures;
• Difference in the working capital level;
• Difference in the import vs. domestic content;
• Difference in the capacity utilisation level;

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 Methods of Computation of Arm’s Length Price

• Difference in the business model: say outsourcing of some
manufacturing processes vs. in-house manufacturing of all the
processes;
• Difference in the functions: say undertaking own market / distribution
channels vs. distribution through individual distributors.
6.46 If material differences between the tested party and the independent
enterprises are affecting the net margins, reasonably accurate adjustments
should be made to account for such differences.
6.47 The application of the transactional net margin method may be
understood with the following example:
AE1 Ltd., is an Indian company
AE1 Ltd., manufactures compact disc (CD) writers and sells the same to AE2
Ltd., which is an AE of AE1 Ltd.
As AE1 Ltd., does not have similar transaction with a non AE, no internal
CUT is available. As AE1 Ltd., does not have information and data to identify
a comparable company, it has used the databases in public domain for
carrying out the search. The result of the search may be summarised as
follows:
No. of companies
Search on the basis of following keywords:
(a) Computer 800
(b) Computer hardware 250
(c) Computer peripherals 66
Sub total 1116
Elimination process :
Companies with different activities 800
Companies with duplication when multiple database
are used 75
Companies with no financials 90
Companies having significant operations like sales
or purchases with related party 100
Companies reporting no operations 50
Sub total 1115
Company/companies selected – Z Ltd. 1

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Note: The search criteria and filters adopted above should be taken as
illustrative only.
The comparison between AE1 Ltd., and Z Ltd., is carried out as follows:
Financials AE1 Ltd. Z Ltd.
INR (in crores) INR (in crores)
Sales 130 200
Other income 5 10
Total Income 135 210

Operating expenses 85 120
Interest 5 7
Depreciation 10 12
Loss on sale of undertaking 5 0
Expenses relating to non operating 1 3
income
Total expenditure 106 142
Net profits 24 58

Operating margin AE1 Ltd. Z Ltd.
INR (in crores) INR (in crores)
Sales 130 200
Gross revenue 130 200

Operating expenses 85 120
Interest 5 7
Depreciation 10 12
Total operating cost 100 139

Operating profit 30.00 61.00

Operating margin (before interest and 52.94 66.67
depreciation)
Operating margin (after depreciation 36.84 51.52
but before interest)

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 Methods of Computation of Arm’s Length Price

6.48 TNMM is less reliable when applied to the aggregate activities of a
complex enterprise engaged in various different transactions or functions.
The TNMM should thus generally not be applied on a company‐wide basis if
the company is involved in a number of different transactions or functions
which are not properly evaluated on an aggregate basis. However, it may be
possible to apply TNMM when the aggregate activities/transactions are
sufficiently interlinked, as for example when similar sales functions are
conducted for products in similar product lines.
6.49 The Delhi High Court in the case of Sony Ericsson Mobile
Communications India Pvt. Ltd (ITA No 16/2014) has upheld that TNMM
could be effective and reliable when applied to closely-linked or continuous
transactions. The following example explains that segregation of
advertisement, marketing and promotion (‘AMP’) expenses as an
independent transaction would lead to absurd results:
Particular Case 1 Case 2 Variation
Sales 1,000 1,000 1,000
Purchase price 600 500 500
Gross margin 400 500 500
AMP expense 50 150 50
Overhead expense 300 300 300
Net profit 50 50 150
TP adjustment 100
Add: Mark-up of 15% 15
Total profit 265
(115+150)
6.50 In case 2, a distributor having significant marketing functions incurred
substantial expenditure on AMP, three times more than in case 1, but the
purchase price being lower, the taxpayer got adequately compensated and
hence, no adjustment. If the AMP in case 2 was INR 50, i.e, identical to case
1, and AMP of INR 100 was incurred as a separate transaction, this would be
absurd if the TPO makes an adjustment, leading to a net profit of 26.5%,
which seems absurd.
Thus, it may be appropriate to aggregate the transaction of purchase and
marketing efforts leading to higher AMP expenses in the instant case.

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6.51 However, it is important to compute profit from the international
transaction [or the specified domestic transaction] if the activities are not
interlinked and are separate. This can be achieved by using the segmental
profitability based on appropriate assumptions and scientific allocation keys.
However, in cases where such segmental profitability is not possible,
differences in the profitability at the entity level cannot be loaded entirely on
the international transactions [or the specified domestic transaction] and this
would require application of the ‘principle of proportionality’.

Particular Taxpayer Third party
profitability profitability
Sales to AEs 40 150
Sales to Non AEs 60
Purchases 80 90
VAE 10.50 30
Net profit 9.50 30
Net profit / Cost 10.50% 25%

6.52 From the above, it can be seen that the profitability of the taxpayer is
lower by 14.50% (25%-10.50%). The entire difference cannot be attributable
to the sales since the sales to AEs accounts for only 40% of the total sales.
Therefore, adjustment may need to be restricted to 40% of the difference.
6.53 Rule 10B(e)(iii) requires that transaction level and enterprise level
differences should be adjusted if such differences materially affect the
amount of net profit margin.
In this example, following enterprise level differences could be visualised;
(a) Working capital – There may be differences in stock holding,
debtors and creditors. Appropriate adjustment to eliminate the impact of
above difference may be made by taking the prevailing interest rate. For this
purpose, useful reference may be made to the guidelines issued by Internal
Revenue Service of USA. However, in this example, it is assumed that the
difference in the working capital is not significant requiring any adjustment.
(b) Cost of capital – There may be difference in the manner of funding
such as equity, preference, debenture, inter corporate loans etc. In order that
such difference does not impact the net profit, the operating margin on
operating cost before interest is taken as profit level indicator.

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(c) Assets employed – There may be difference in assets employed and
the method of providing depreciation. In order that such difference does not
impact the net profit, the operating margin on operating cost before
depreciation is taken as profit level indicator.
(d) Assured or risk bearing business – There may be a difference in
the customer/ revenue model of the assessee vis-à-vis the comparables. For
example, the comparables identified may be entrepreneurs bearing the
market risks of business volume, customer continuity, etc and the assessee’s
international transaction [or the specified domestic transaction] is in the
nature of captive service provider or contract manufacturer with assured
volumes and/or assured compensation and/or assured business period, etc.
Such differences may be eliminated by making appropriate adjustment for
low-risk or risk free business.
(e) Difference in the capacity utilisation – There may be difference in
the utilisation of capacity by the tested party and the comparables. For
example: The taxpayer has utilized only 41.39% of its installed capacity (i.e.
58.61% of the fixed overheads remained unabsorbed), whereas the capacity
utilized by the comparables is 80.90%.As a result, the unabsorbed fixed
costs, debited to the profit and loss account due to existing accounting
practices, has, in fact skewed the profit level indicator of the taxpayer for the
period under consideration. As a result, it would be important to compute the
profitability from manufacturing activity after removing unabsorbed fixed
costs (to bring the capacity utilisation of the taxpayer in line with that of the
comparables) with a view to achieve meaningful comparison.
6.54 In the above table, the transaction level differences cannot be
noticed. However, some transaction level differences may exist and the same
may be adjusted if requisite information is available. Some of the common
transaction level differences may be as follows;
(a) Free gifts
(b) Extended warranty (in addition to the normal one-year)
(c) Marketing risks
(d) Pricing - Ex-Shop or FOR-destination.
(e) Quantity discount

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Table 5: Computation of arm’s length price under the transactional net
margin method
1. AE : AE2 Ltd.
2. International transaction : Between AE1Ltd. and AE2
Ltd.
3. Comparable uncontrolled company : Z Ltd.

%
Net profit margin of Z Ltd.- i.e. operating margin on cost before 51.52
interest and after depreciation
Adjustments for transaction level differences 0.00
Arm's length net profit margin 51.52

(INR in
crores)
Operating costs before interest and after depreciation 95.00
Arm's length sale revenue 143.94
Actual sales 130.00
Income increases by 13.94
The following points are to be noticed:
(a) Different bases of determining the net profit margin [i.e. profit level
indicators (PLI)] are recognised. The same basis of arriving at the net
profit margin is to be adopted year after year, unless circumstances
justify an alternate base;
(b) Whichever base is selected in determining the net profit margin in an
international transaction [or the specified domestic transaction], the
same basis is to be adopted for arriving at the net profit margin in the
comparable uncontrolled transaction;
(c) It is recommended that operating profit margin may be used instead
of net profit margin. Operating profit margin would eliminate the non-
operating items (the items of revenue and costs which do not result
from routine business operations such as profit on sale of assets,
dividend etc.).

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Further, the operating profit margins should be computed on the
basis of financial statements of the assessee and the comparable
company.
(d) The accounting treatment of expenses and depreciation is also a
critical factor in computing the arm’s length price. Unlike the
preceding methods, the rule does not explicitly provide for adjustment
on account of differing accounting practices. Nevertheless, such
differing practices should also be factored in;
(e) It is not uncommon to find purchase transaction being an internation al
transaction [or the specified domestic transaction] where TNMM is
used. TNMM requires the determination of the net profit margin from
an international transaction [or the specified domestic transaction]
and purchase transaction as such does not result in net profit.
However, as purchase is inextricably linked to earning net profit,
TNMM may be used for establishing arm’s length purchase value. In
such case, comparable operating margin should be appropriately
used to work back the arm’s length purchase cost. This may be
illustrated as follows:
Illustration 1:
1. Actual Profit and loss account of the assesse
INR in INR in
lakhs lakhs
Opening stock-AE purchases 100 Sales of AE purchases 800
Opening stock-Non AE 150 Sales of Non AE 1200
purchases purchases
Purchases from AE 500 Closing stock-AE 120
purchases
Purchases from Non AE 1000 Closing stock-Non AE 160
purchases
Gross profit 530
2280 2280
Expenses 200 Gross profit 530
Net profit 330
530 530

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

2. Comparable operating margin (PLI being operating profit 35%
on sale)

3. Profit and loss account - recast to compute arm’s length price of
purchase
(INR (INR
in in
lakhs) lakhs)
Opening stock-AE purchases 100 Sales of AE purchases 800
Purchases from 460 Closing stock-AE 120
AE(balancing figure) purchases
Gross profit (brought back) 360
920 920
Expenses-allocated 80 Gross profit 360
(in the ratio of sales) (worked back)
Net profits 280
(applying TNMM margin on AE sales)
360 360
4. Arm's length value of purchase is INR 460 as against actual value of
INR 500. Therefore, income increases by INR 40.

Illustration 2 :
1. Profit and loss account of the assessee – Actual
INR INR
in in
lakhs lakhs
Opening stock of raw material 100 Sale of finished goods 2500
(AE purchases)
Opening stock of raw material 150 Closing stock of raw 120
(Non-AE purchases) material (AE purchases)
Purchases of raw material from 500 Closing stock of raw 160
AE material (Non-AE
purchases)
Purchases of raw material from 1000 Closing stock of finished 500
Non-AE goods
Manufacturing costs 400

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 Methods of Computation of Arm’s Length Price

Admin, selling and finance 200
expenses
Net profit 930
3280 3280
2. Comparable operating margin (PLI being operating profit on sale) 45%
3. Profit and loss account - recast:
INR INR
in in
lakhs lakhs
Opening stock of raw material 150 Sale of finished goods 2500
(Non-AE purchases)
Cost of purchase from AE (net Closing stock of raw
of stock) 405 material 160
(balancing figure) (Non-AE purchases)
Purchases of raw material from Closing stock of finished
Non AE 1000 goods 500
Manufacturing costs 400
Admin, selling and finance
expenses 200
Net profit 1125
(arrived on basis of TNMM
margin)
3280 3280
Arm's length Purchase value :
Cost of purchase from AE (net of stock) 405
Add : Closing stock of Raw Material 120
Add : Closing stock of Raw Material in finished goods (see Note 1
below) 20
Less : Opening stock 100
Arm's length Purchase value 445
Actual purchase 500
Excess price paid 55

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Notes: 1. In the above example, the raw material cost (of purchases from
AE) built into closing stock of finished goods is assumed to be INR
20.
2. It is assumed that there is no opening stock of finished goods.

Other Method (OM) of determination of arm’s
length price
6.55 The CBDT has inserted a new Rule 10AB by notifying the “Other
Method” apart from the five methods already prescribed.
For the purposes of clause (f) of sub-section (1) of section 92C, the
Other Method for determination of the arms' length price in relation to
an international transaction [or the specified domestic transaction]
shall be any method which takes into account the price which has been
charged or paid, or would have been charged or paid, for the same or
similar uncontrolled transaction, with or between non-AEs, under
similar circumstances, considering all the relevant facts.
6.56 The introduction of the Other Method as the sixth method allows the
use of ‘any method’ which takes into account (i) the price which has been
charged or paid or (ii) would have been charged or paid for the same or
similar uncontrolled transactions, with or between non-associated
enterprises, under similar circumstances, considering all the relevant facts.
The various data which may possibly be used for comparability purposes
could be:
(a) Third party quotations/ invoices;
(b) Valuation reports;
(c) Tender/Bid documents;
(d) Documents relating to the negotiations;
(e) Standard rate cards;
(f) Commercial & economic business models; etc.
6.57 It is relevant to note that the text of Rule 10AB does not describe any
methodology but only provides an enabling provision to use any method that
has been used or may be used to arrive at price of a transaction undertaken
between non AEs. Hence, it provides flexibility to determine the price in
complex transactions where third party comparable prices or transactions

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may not exist. The wide coverage of the Other Method would provide
flexibility in establishing arm’s length prices, particularly in cases where the
application of the five specific methods is not possible due to reasons such
as difficulties in obtaining comparable data due to uniqueness of transactions
such as intangibles or business transfers, transfer of unlisted shares, sale of
fixed assets, revenue allocation/splitting, guarantees provided and received,
etc. However, it would be necessary to justify and document reasons for
rejection of all other five methods while selecting the ‘Other Method’ as the
most appropriate method. The OECD Guidelines also permit the use of any
other method and state that the taxpayer retain the freedom to apply
methods not described in OECD Guidelines to establish prices, provided
those prices satisfy the arm’s length principle.
6.58 The application of the sixth method may be understood with the
following examples:
Illustration A
AE1 Ltd. is an Indian Company.
AE1 Ltd. owns certain registered patents which it has developed by
undertaking research and development.
It is a subsidiary of AE2 Ltd., a foreign company.
AE1 Ltd. has sold its registered patents to AE2 Ltd., for `50 crores. The price
has been determined based on a valuation report obtained from an
independent valuer.
The sale of patents is a unique transaction and AE1 Ltd or AE2 Ltd. has not
entered into similar transactions with third parties and hence no internal or
external CUP is available.
AE1 Ltd. may select the Other Method as the most appropriate method and
use the independent valuation report for comparability purposes.
Illustration B
An Indian Company (I Co) buys back its equity shares issued to its foreign
AE (AE Co). I Co obtains a valuation report from an external firm identifying
the fair market value of these shares. I Co purchases the shares at the value
determined in the valuation report. This value denotes a price that would
have been charged if a third party would have bought the same shares.
Hence, I Co could use Rule 10AB and rely upon the valuation report to
demonstrate this transaction to be arm’s length.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Illustration C
An Indian Company (I Co) incurs hotel and travel expenses for the
employees of its foreign AE (AE Co) visiting India for a global seminar, These
expenses are paid by I Co directly to third party vendors on behalf of AE Co
and recovered on a cost-to-cost basis from AE Co. Further, such activity
does not entail a service element for I Co and hence does not necessitate a
mark-up. Hence, I Co may select the Other Method and rely upon such back-
to-back arrangement to demonstrate this recovery transaction to be arm’s
length.
Illustration D
An Indian Company (I Co) deputes some of its employees to its foreign AE
(AE Co) through secondment. AE Co takes these individuals onboard by
issuing letter of employments and is responsible for payment of the salary of
the employees. I Co frequently facilitates payment of salaries to the overseas
accounts of the seconded employees purely for administrative convenience.
In this case, salary costs are reimbursed by AE Co to I Co on a cost-to-cost
basis. Hence, I Co may select the Other Method and rely upon such back-to-
back arrangement to demonstrate transaction to be arm’s length.
Illustration E
Another example where this method could be used is in cases of cost
allocation arrangements where a taxpayer benefits from certain services
provided by a central entity of the group and has to pay a portion of the total
cost incurred by the service provider. These costs are generally allocated on
the basis of allocation keys like headcount, time spent, revenues etc. and a
third party outside the group may not have the capability to provide identical
services. Hence, in the absence of comparable prices or transactions, Rule
10AB may be applied and the cost allocation arrangement could be justified
appropriately.
Most appropriate method
6.59 (1) For the purposes of sub-section (1) of section 92C, the most
appropriate method shall be the method which is best suited to the
facts and circumstances of each particular international transaction [or
the specified domestic transaction], and which provides the most
reliable measure of an arm’s length price in relation to the international
transaction [or the specified domestic transaction].

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(2) In selecting the most appropriate method as specified in sub-
rule (1), the following factors shall be taken into account, namely:-
(a) the nature and class of the international transaction [or the
specified domestic transaction];
(b) the class or classes of AEs 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;
(c) the availability, coverage and reliability of data necessary for
application of the method;
(d) the degree of comparability existing between the international
transaction [or the specified domestic transaction] and the
uncontrolled transaction and between the enterprises entering
into such transactions;
(e) the extent to which reliable and accurate adjustments can be
made to account for differences, if any, between the international
transaction [or the specified domestic 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.[Rule 10C].
6.60 No particular method is suitable in every possible situation. It is not
possible to provide specific rules that will cover every case. While selecting
the most appropriate method, the factors prescribed in section 92C of the Act
and Rule 10C(2) should be considered.
Amongst these factors, the functions performed by AEs (including assets
employed and risks assumed) should be given due consideration. It is also
important to ascertain the extent and reliability of the uncontrolled data that is
available. The nature of the available data, and especially the amount and
reliability of detail on the factors entering into a comparability analysis, are
very important issues in the selection and application of a methodology.
Although it is difficult to prescribe general principles for choice of most
appropriate method, the following broad categorisation may be considered as
already indicated under each of the respective methods:

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

(i) CUP method may be used in case of loans, service fee, transfer of
tangibles, sale and purchase of goods/ commodities, etc;
(ii) RPM is most useful in case of marketing operations of finished
products, especially in case of distributors not performing significant
value addition to the product;
(iii) CPM is normally used where raw materials or semi-finished goods
are sold; where joint facility agreements or long-term buy-and-supply
arrangements, or the provision of services are involved;
(iv) PSM is normally used in cases where the transactions involve
provision of integrated services by more than one enterprise. For
example – One enterprise holds technology and the other enterprise
holds the distribution network and both are the key intangibles for the
overall success of the Group; freight forwarders and supply chain
specialists.
(v) Transactional net margin method could be used in case of
manufacturing operations, sale of raw materials or semi-finished
goods where CPM is not the most appropriate method, and marketing
operations of finished products where RPM is not the most
appropriate method.
(vi) Other method may be used in case of royalties, commodities, transfer
of intangibles and shares, etc.
6.61 For the purposes of sub-rule (1) of Rule 10B, the comparability of an
international transaction [or the specified domestic transaction] with an
uncontrolled transaction shall be judged with reference to the following
namely:-
(a) the specific characteristics of the property transferred or services
provided in either transaction;
(b) the functions performed, taking into account assets employed or to be
employed and the risks assumed, by the respective parties to the
transactions;
(c) the contractual terms (whether or not such terms are formal or in
writing) of the transactions which lay down explicitly or implicitly how
the responsibilities, risks and benefits are to be divided between the
respective parties to the transactions;

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(d) conditions prevailing in the markets in which the respective parties to
the transaction operate, including the geographical location and size
of the markets, the laws and government orders in force, costs of
labour and capital in the markets, overall economic development and
level of competition and whether the markets are wholesale or retail.
6.62 While evaluating each method the distinctive aspects of computation
should be borne in mind. For instance, RPM requires functional and other
differences including accounting practices to be adjusted to the price
whereas CPM and TNMM require such differences to be adjusted to the
margin.
6.63 Different methods may be chosen as most appropriate method for
different transactions of the assessee as long as the rationale for each of
such choices are adequately documented. Also, different methods may be
chosen for the same transaction in different years as long as the rationale for
each such choice made in each year is adequately documented.
Multiple Year Data and Range Concept
6.64 Appreciating that Transfer Pricing is not science but is influenced by
several factors the authorities decided to move away from single year
concept. At the same time, it was appreciated that with the data bases
becoming robust time has come to adopt range concept for the determination
of the arm’s length price. Consequently, as mentioned in para 1.26 of this
book, Central Board of Direct Taxes (CBDT) on October 20, 2015 issued the
final rules ie, Rule 10B(5) and Rule 10CA to give effect to the use of ‘multiple
year data’ and ‘range concept’. These rules are applicable to international
transactions and specified domestic transactions that are entered into by
taxpayers on or after 1 April 2014. Rule 10CA (which forms part of Annexure
II of this book) contains illustrations of application of the arm’s length range
concept. This is exhaustive and must be analysed to appreciate the approach
recommended.
Vide Notification No. 124/2021[F. No. 500/1/2014-APA-II] dated 29th
October, 2021 it was notified that where the variation between the arm’s
length price determined under section 92C and the price at which the
international transaction or specified domestic transaction has actually been
undertaken does not exceed one per cent. of the latter in respect of
wholesale trading and three per cent of the latter in all other cases, the price
at which the international transaction or specified domestic transaction has

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actually been undertaken shall be deemed to be the arm’s length price for
Assessment Year 2021-2022.
In essence, this extended the approach applied for the earlier years.
It was, further clarified that for the purposes of the notification, “wholesale
trading” means an international transaction or specified domestic transaction
of trading in goods, which fulfils the following conditions, namely:-
(a) purchase cost of finished goods is eighty per cent. or more of the
total cost pertaining to such trading activities; and
(b) average monthly closing inventory of such goods is ten per cent. or
less of sales pertaining to such trading activities.
6.65 Transfer Pricing Adjustments (Economic Adjustments) In terms of Rule
10B(3) appropriate comparability adjustments are required to be made while
computing the arm’s length Rule 10B(3) of the rules provides that:
“An uncontrolled transaction shall be comparable to an international
transaction if—
(i) none of the differences, if any, between the transactions being
compared, or between the enterprises entering into such transactions
are likely to materially affect the price or cost charged or paid in, or
the profit arising from, such transactions in the open market; or
(ii) reasonably accurate adjustments can be made to eliminate the
material effects of such differences.”
Arguably, the most common adjustments are working capital adjustment and
capacity utilization adjustment. These are discussed hereunder, in brief.
Further Statutory provisions suggest various adjustments under various
methods

Methods Adjustments suggested
CUP Method Price of uncontrolled transaction is adjusted to account for
[Rule differences, if any, between the international transaction
10B(1)(a)(ii)] and the comparable uncontrolled transactions or between
the enterprises entering into such transactions, which could
materially affect the price in the open market.
RPM [Rule The resale price arrived at is adjusted to take into account
10B(1)(b)(iv)] the functional and other differences, including
differences in accounting practices, if any, between the

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 Methods of Computation of Arm’s Length Price

Methods Adjustments suggested
international transaction and the comparable uncontrolled
transactions, or between the enterprises entering into such
transactions, which could materially affect the amount of
gross profit margin in the open market.
CPM [Rule The normal gross profit mark-up is adjusted to take into
10B(1)(c)(iii)] account the functional and other differences, if any,
between the international transaction and the comparable
uncontrolled transactions, or between the enterprises
entering into such transactions, which could materially
affect such profit mark-up in the open market.
TNM method The net profit margin arising in comparable uncontrolled
[Rule transactions have to be adjusted to take into account the
10B(1)(e)(iii)] differences, if any, between the international transaction
and the comparable uncontrolled transactions, or between
the enterprises entering into such transactions, which could
materially affect the amount of net profit margin in the open
market.
Thus, rule 10B prescribes two types of adjustments:
• Enterprise level differences
• Transactional differences
These adjustments have to be based on the specific characteristics of the
property transferred or services provided in relation to transaction and the
contractual terms (whether or not such terms are formal or in writing) of the
transactions which lay down explicitly or implicitly how the responsibilities,
risks and benefits are to be divided between the respective parties to the
transactions. Rule 10B suggests the following Enterprise level and
Transaction level adjustments:
• Functional differences
• Assets differences
• Risks differences
• Geographical location
• Size of the markets
• Wholesale or retail market

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

• The laws and Government orders in force
• Costs of labour
• Cost of capital in the markets
• Overall economic development
• Level of competition
• Accounting practices
These factors should be considered while searching for comparable.
However, it is not always possible to get the accurate comparables. Hence,
one has to choose the nearest possible comparable and adjust the
differences which materially affect the price of comparable.
There is no specific guidance, on numbers and amount of adjustments, either
in Indian Laws or in OECD and UN Guidelines. The OECD TPG 2022 [para
3.47 to 3.54] provides the following guidance:
• Comparability adjustments should be considered if (and only if) they
are expected to increase the reliability of the results and are expected
to improve comparability.
• Relevant considerations in this regard include the materiality of the
difference for which an adjustment is being considered, the quality of
the data subject to adjustment, the purpose of the adjustment and the
reliability of the approach used to make the adjustment.
• It bears emphasis that comparability adjustments are only appropriate
for differences that will have a material effect on the comparison.
• It should be noted that the need to perform numerous or substantial
adjustments to key comparability factors may indicate that the third-
party transactions are in fact not sufficiently comparable.
Therefore, it is provided that where there are numerous or substantial
adjustments to key comparability factors, it may indicate that the third-party
transactions are in fact not sufficiently comparable.
However, differences in the use of assets can sometimes be eliminated or
reduced to a significant extent by making comparability adjustments on
account of working capital or capacity utilization 1.

1 UNTPM 2021

174
 Methods of Computation of Arm’s Length Price

6.65. Working Capital Adjustments:
In a competitive environment 2, money has a time value. If a company
provided, say, 60 days trade terms for payment of accounts, the price of the
goods should equate to the price for immediate payment plus 60 days of
interest on the immediate payment price. By carrying high accounts
receivable a company is allowing its customers a relatively long period to pay
their accounts. It would need to borrow money to fund the credit terms and/or
suffer a reduction in the amount of cash surplus which it would otherwise
have available to invest. In a competitive environment, the price should
therefore include an element to reflect these payment terms and compensate
for the timing effect.
Working capital 3 is a financial metric which represents operating liquidity
available to a business. Along with fixed assets such as plant and equipment,
working capital is considered a part of operating capital. Net working capital
is calculated as current assets minus current liabilities. If current assets are
less than current liabilities, an entity has a working capital deficiency, also
called a working capital deficit. Current assets and current liabilities include
three accounts which are of special importance. They are: accounts
receivable (current asset)/inventory (current assets), and/accounts payable
(current liability). These accounts represent the areas of the business where
managers have the most direct impact.
Working capital adjustments are typically performed when applying the
TNMM, Cost-plus and Resale price methods. They account for the fact that
there is an opportunity cost and notional finance cost associated with the
holding of working capital.
Working Capital = [accounts receivable + inventory] - accounts payable
By performing working capital adjustments, operating profit that measures
profit before accounting for explicit interest expenses or income can be
corrected for the implicit interest embedded in sales and cost of goods sold
to increase the comparability of the transactions.

2 OECD TPG 2022 - Annex to Chapter III- Example of a Working Capital Adjustment

3 Demag Cranes & Components (India) (P.) Ltd. v Dy. CIT [2012] 17 taxmann.com

190 : [2012] 49 SOT 610 : [2012] 144 TTJ 320 (Pune) : (2012) 31 CCH 0486
PuneTrib.

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

OECD Guidance on WCA
If there are material differences between the controlled and uncontrolled
transactions, adjustments should be made if the effect of such differences on
prices or profits can be ascertained with sufficient accuracy to improve the
reliability of the results. The OECD re-iterates that working capital
adjustments should only be considered when the reliability of the
comparables will be improved, and reasonably accurate adjustments can be
made. (See OECD 2017 Annex to Chapter III para 1)
For instance, in the OECD’s 2017 Transfer Pricing Guidelines (TPG), its
states at 2.87 that "in those cases where there is a correlation between credit
terms and sales prices, it could be appropriate to reflect interest income in
respect of short-term working capital within the calculation of the net profit
indicator and/or to proceed with a working capital adjustment." Similarly, in
the case of the comparable uncontrolled price method, differences in
contractual terms e.g., sales or purchase volumes and credit terms, may
require working capital adjustments to the comparable prices.
Relevant market evidence of third-party behaviour that supports adjusting
prices or returns for the differences in working capital seems vital, as does
an analysis of the payment terms and practices used by the tested party and
comparables.
The reliability of a WCA should be considered in other ways as well. For
instance, a WCA involves adding or removing a notional cost of funds (which
could be represented as the cost of debt or equity) to/from a comparables
prices or financial results, but that notional cost could in fact be constrained
by commercial factors impacting the level and cost of debt that a company is
able to carry. In some cases, a comparable or tested party however may not
be able to access the level of funds that a WCA may imply. Further, the
arm’s length level and cost of debt, or equity of a firm would need to use that
source of funds, will need to be calculated as well, possibly impacting
interest expenses claimed if the tested party is being adjusted (say, to an
arm’s length level of working capital).
There may also be questions about whether the tested party or the
comparables are the entities whose prices or margins need to be adjusted.
For instance, it may be a concern that the tested party has adopted working
capital policies that aren’t arm’s length, due to the control of the parent over
the tested party in more ways than just pricing. Before adjusting the
comparables to meet the level of working capital reported by the tested party,
additional review would be necessary to understand the reasons for the

176
 Methods of Computation of Arm’s Length Price

tested party’s working capital. It may be appropriate, where non-arm's length
payable terms have been adopted, to adjust the tested party for that feature
and then consider anew the need for a WCA. A review of comparables from
the tested party’s industry and dealing in similar products might provide
insight both into arm’s length capital structures as well as insights into pricing
behaviour and the nature of competition in the tested party’s industry.
There are other issues that might impact on the reliability of working capital
adjustments including:
• Differences in seasonal vs non-seasonal capital needs of the tested
party and comparables, based on different economic circumstances,
markets, product or service offerings that impact prices reported;
• Differences in reported working capital balances due to different
reporting dates, which can be relevant when tested party and
comparables reporting periods don’t align; and
• Merger and acquisition or other events that suddenly shift tested
party’s or comparables’ working capital levels.
As noted above, an appropriate interest rate (preferably operational interest
rate of the tested party jurisdiction) to apply to a difference in working capital
must be chosen.
Working capital - type adjustments are also sometimes proposed to make an
adjustment for differences in functions, assets, and risks, in relation to
inventories; or in business strategies, particularly those relating to the
provision of finance to customers.
The following hypothetical illustration [UN TPM, 2021] is provided merely to
demonstrate how a working capital adjustment can be calculated. It should
not be construed as the only way in which such an adjustment may be
calculated.
Particulars Tested Party Comparable Party
Sales (A) 100 120
Earnings before interest and
taxes (EBIT) (B) 5 7
operating profit margin (PLI) (A/B
in %) (C) 5% 5.8%

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Net Working Capital (NWC)
Accounts receivable (D) 100 110
Inventory (E) 20 40
Accounts payable (F) 50 50
Net working capital (G) (D+E-F) 70 100
Net working capital to sales 70% 83.3%
Difference between net working
capital to sales of -13.3%
tested and comparable party (H)
Interest rate on NWC (I) 5%
Adjustment (J) (I*H) -0.7%
Working capital adjustment –
Re-computing the PLI for the
comparable (C-J) 5.1%

Various Tribunal and High Court judgements have held that there is need to
eliminate differences between the comparable companies and the Assessee
on account of economic circumstances by making working capital adjustment
and market risk and growth adjustment.
6.65. Capacity utilization adjustment
In the starting phase of any business, it is not easy to get business but
minimum infrastructure having regard to nature of business have to be
created. Some of the facilities are of fixed nature and some are of variable
nature. Building for office, factory and machineries have to be taken even the
production may not be possible at 100% of the capacity. Rent of the building
is generally of fixed nature even the production start at just 20% of the
capacity. Thus, 80% rent is relating to excess capacity. If the comparable is
operating at 80% or 100% capacity, then it would not be a proper comparable
unless some adjustments have been made.
In accounting terminology, fixed costs will broadly include almost all costs
(expenses) which are not included in cost of goods sold, and variable costs
are those captured in costs of goods. The implicit assumption required to
make the equivalence between the accounting and economics terminology is
that the accounting period is equal to the period in which fixed costs do not
vary in relation to production. In practice, this equivalence does not always

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 Methods of Computation of Arm’s Length Price

hold, and depending on the period under consideration by management,
some overhead expenses (eg, sales, general and administrative expenses)
can be adjusted by management, and the specific allocation of each expense
to each category will be decided under cost accounting.
The issue of capacity utilisation can arise in the following situations:
• Start-up phase
• Expansion phase
• Economic recession phase
• Under-utilisation or over utilisation of resources
Entities differ in size as well as in levels of activities so do the available
comparables for the purpose of transfer pricing determination. Extent of
capacity utilization is an accepted adjustment to improve comparability to
overcome the differences mentioned above. This adjustment finds support in
the OECD TP Guidelines and the United Nations TP Manual (including the
India chapter).
By definition, capacity utilization is the extent to which an enterprise actually
uses its installed productive capacity. It is the relationship between actual
output using the installed infrastructure, and the potential output which could
arise, if capacity was fully used. Typically expressed as a percentage, this
factor becomes an important comparability factor as it helps measure
productive efficiency and cost effectiveness, i.e., extent of output vis -à-vis
investment in or costs associated with the underlying infrastructure (the costs
are generally referred to as “fixed costs” in cost accounting terms). By virtue
of its definition, the concept of capacity utilization assumes most relevance in
the case of manufacturing concerns.
It is Important to address two critical questions in relation to this adjustment,
viz.,
(i) whether the adjustment should be made to the tested party or to
comparables?
(ii) how to compute the adjustment?
Further, particularly in light of the fact that there is no mechanism specified
under the Act or the Rules for computing the amount of capacity utilization
adjustment. Even the OECD TP Guidelines and the United Nations TP
Manual do not address the second question.

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The rationale to eliminate capacity under-utilization when applying the TNMM
is that the TNMM may be more acceptable than the other prescribed
methods under the Income-tax Act, 1961 (‘the Act’) as the differences in the
levels of absorption of indirect fixed costs would affect the net profit margin
and not the gross margin / gross mark-up on cost.
The OECD Transfer Pricing Guidelines for Multinational Enterprises and Tax
Administrations 2022, prescribe the making of adjustments to eliminate
differences in capacity utilization or idle capacity adjustments. Also, Rule
10B(1)(e)(iii) of the Income-tax Rules, 1962 (‘the Rules’) stipulates that an
adjustment to the net profit margin can be made for “capacity
underutilization”. Capacity under-utilization by enterprises is a factor affecting
net profit margin because lower capacity utilization results in higher per unit
costs, which, in turn, results in lower profits at a transactional or unit level.
There is no debate on the need for adjustments, however the issue is as to
the reasonable accuracy in the mechanism for such adjustments, so long as
a reasonable adjustment mechanism can be employed, objections to the
adjustment won’t hold.
In this context, it is useful to recall the observations of the Hon’ble Delhi High
Court in Sony Ericsson Mobile Communication India Pvt. Ltd. [March 2015]:
“It must be stated that transfer pricing is not an exact science but a method
of legitimate quantification which requires exercise of judgment on the part of
the administration and the taxpayer. It is method and formula based and
therefore is rational and scientific”. At present there is no authoritative
guidance relating to capacity utilization adjustments but the decision of the
Delhi Bench of the Income Tax Appellate Tribunal’s (‘the Tribunal’) in the
case of Claas India Private Limited [ITA No. 1783/Del/2011], has put forth
useful observations and guidelines on capacity utilization adjustment.
Since neither the Act nor the Rules provide the mechanism for computing
capacity utilization adjustment, but in this judgment the Tribunal has laid
down the following important principles:
• It is essential to ascertain the percentage of capacity utilization by the
taxpayer and the comparables when applying the TNMM.
• The difference in the percentage of capacity utilization of the taxpayer
vis-à-vis comparables should be given effect to in the operating profit
of comparables by adjusting their respective operating costs.
The Tribunal explained that operating costs can be either fixed, variable or
semi-variable:

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• Semi-variable costs need to be split into fixed and variable part.
• The variable costs and the variable portion of the semi-variable costs
remain unaffected due to any under or overutilization of capacity.
• The fixed operating costs and the fixed part of the semi-variable costs
are scaled up or down by considering the percentage of capacity
utilization by the taxpayer and such comparable.
In regard to capacity utilization re-emphasizes the need for maintaining
credible and accurate information for transfer pricing purposes. The decision
is indeed welcome and perhaps seminal, addressing the concerns of industry
and professionals alike and providing much needed guidance to the Revenue
and taxpayers when making capacity utilization adjustments.
However, in case there are some differences between the comparables and
the assessee, then the effect of such differences should be ironed out by
making suitable adjustment to the operating profit margin of comparables.
That is the way for bringing both the transactions, namely, the international
transaction and the comparable uncontrolled transactions, on the same
platform for making a meaningful and effective comparison. The above
analysis overtly transpires that the law provides for adjusting the profit
margin of comparables on account of the material differences between the
international transaction of the assessee and comparable uncontrolled
transactions. It is not the other way around to adjust the profit margin of the
assessee. In other words, the net operating profit margin realized by the
assessee from its international transaction is to be computed as such,
without adjusting it on account of differences with the comparable
uncontrolled transactions. The adjustment, if any, is required to be made only
in the profit margins of the comparables.
Importance and impact of capacity utilisation adjustment is also explained by
way of an example in Dy. CIT v Petro Araldite (P.) Ltd. [2013] 35
taxmann.com 590 (Mumbai - Trib.)4.

4 Dy. CIT v Petro Araldite (P.) Ltd. [2013] 35 taxmann.com 590 (Mumbai - Trib.),
upheld by Bombay HC wide CIT v Petro Araldite (P.) Ltd. [2018] 93 taxmann.com
438 (Bombay).

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Installed capacity in INR 10 crore INR 10 crore INR 10 crore
monetary terms
Capacity utilisation 50% 60% 80%
Sales Rs 5 crore Rs 6 crore Rs 8 crore
Variable overheads Rs 2.5 crore Rs 3 crore Rs 4 crore
at 50%
Fixed overheads Rs 2 crore Rs 2 crore Rs 2 crore
(40%) (33.33%) (25%)
Net profit Rs 0.5 crore Rs 1 crore Rs 2 crore
Profit margin 10% 16.67% 25%
(OP/Sales)

The above example shows that the profitability changes with the change in
the level of capacity utilization with higher profitability at higher utilization and
lower profitability at lower realization. This happens mainly because of higher
allocation or absorption of fixed overheads at lower capacity utilization which
comes down as the level of capacity utilization goes up. For instance, as
given in the above example, the rate of allocation or absorption of fixed
overheads to sales is 40% at 50% capacity utilization while it becomes
33.33% at 60% capacity utilization and 25% at 80% capacity utilization giving
more profit margin of 16.67% at 60% capacity utilization and 25% at 80%
capacity utilization as against profit margin of 10% at 50% capacity
utilization. The difference in capacity utilization thus materially affects the
profit margin and if there is a difference in the level of capacity utilization of
the assessee and the level of capacity utilization of the comparable
companies, adjustment is required to be made to the profit margin of the
comparables on account of difference in capacity utilization as per clause
(e)(iii) of sub-rule (1) of Rule 10-B of the Income Tax Rules, 1962.
The adjustment thus can be made to the profit margin of the comparables by
allocating fixed overheads at the same rate at which fixed overheads are
allocated in the case of the tested party.
For example, in the case of a comparable having 80% capacity utilization,
the rate of allocation of fixed expenses is 25% of the sales as against the
rate of allocation of fixed overheads of 40% in the case of the tested party
working at 50% capacity. Hence, adjustment needs to be made to make it
comparable. Therefore, margin of comparable need to be computed by
taking absorption rate of 40% instead of 25% rate of actual absorption.

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 Chapter 7
Documentation and Verification
Type of information and documents
7.1 Rule 10D(1) lays down thirteen different types of information and
documents that a person has to keep and maintain in relation to the
international transactions undertaken in a given financial year. Broadly, these
information and documents may be classified into three types:
(i) enterprise-wise documents – These are documents that describe the
enterprise, the relationships with other associated enterprise, the
nature of business carried out, etc. This information is, largely,
descriptive [clauses (a) to (c)].
(ii) transaction-specific documents – These are documents that explain
the international transaction in greater detail. It includes information
with regard to each transaction (nature and terms of the contract,
etc.), description of the functions performed, assets employed and
risks assumed by each party to the transaction, economic and market
analyses, etc. This information is both descriptive and quantitative in
nature [clauses (d) to (h)].
(iii) Computation related documents – These are documents which
describe and detail the methods considered, actual working
assumptions, policies etc., adjustments made to transfer prices and
any other relevant information, data, document relied for
determination of arm’s length price [clause (i) to (m)].
7.2 The documentation requirements prescribed in section 92D read with
Rule 10D applies not only to international transactions between associated
enterprises but also to the deemed international transactions covered under
Section 92B(2) of the Act as well as the specified domestic transactions
covered under Section 92BA of the Act.
7.3 It is pertinent to note that the list of documents provided under Rule
10D are prescriptive in nature and it is not essential that each of the
document be maintained in respect of each international transaction. While
the documents like the one mentioned in point (i) and (ii) above needs to be
maintained in respect of each international transaction/ specified domestic
Guidance Note on Report under Section 92E of the Income-tax Act, 1961

transaction, need for maintaining documents mentioned in point (iii) should
be critically analysed and maintained for each of the transaction and member
may exercise his professional judgement regarding the same.

Ownership, profile and business
7.4 A description of the ownership structure of the Assessee
enterprise with details of shares or other ownership interest held
therein by other enterprises.[clause (a), Rule 10D(1)].
7.5 It may be noted that the term “other enterprise” should refer to an
associated enterprise with which the taxpayer has undertaken an
international transaction undertaken in a given financial year. If this term
were to be given the meaning provided in section 92F(iii), then it would
virtually include every member in the register of members. No purpose would
then be served by duplicating the contents of that register. Where the person
is a company, the names of members who are associated enterprises, the
number of shares held by each of them and the percentage of their holding to
the total holding has to be stated.
7.6 However, where the number of members is very large, a generic
classification of the ownership structure may be given, namely, holdings by
Government (Central, State), Government companies, public financial
institutions, nationalised and other banks, mutual funds, venture capitalists,
foreign holdings, bodies corporate, directors and relatives, others. The
holdings of associated enterprises must, in any case, be shown separately.
7.7 Where the person is a firm or an association of persons, the names of
the partners of the firm or members of the association of persons and their
profit sharing ratios have to be stated. Similar details, to the extent
applicable, need to be furnished when the person is a body of individuals,
trust, Hindu undivided family, etc. The description of the ownership structure
should be stated as at the day on which one person became an associated
enterprise of another and as at every other day on which there was change
in the ownership interest of that other enterprise.
7.8 For example, assume that A Ltd., India and X Inc., USA, are
associated enterprises, and the holdings of X Inc. in A Ltd. were as under:
(a) Total number of 10, fully paid equity shares, issued by 100,000
and subscribed in A Ltd.
(b) Total number of shares of 10, fully paid up, held by X 50,000
Inc. on 1st April, 2001

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(c) Total number of shares of Rs.10, fully paid up, 10,000
acquired by X Inc. on 24 th November, 2001 (by private
purchase)
(d) Total number of shares of Rs. 10, fully paid up, 25,000
disposed of by X Inc. on 24 th February, 2002 (by
private sale)
Under this clause, A Ltd. will have to report the holdings of its Associated
Enterprise, as follows:
Details of ownership structure
Period Period Period
from1.4.2001 from24.11.200 from24.2.2002
Details
to23.11.2001 1to23.2.2002 to31.3.2002
No. of % No. of % No. of %
shares shares shares
(a) Directors, 50,000 50 40,000 40 65,000 65
relatives
and others
(b) X Inc., USA 50,000 50 60,000 60 35,000 35
(Associated
Enterprise)
Where the ownership structure is complicated, the above tabular statement
may be supplemented by a suitable diagrammatic representation of the
ownership interest held by associated enterprises in the Assessee.
7.9 The regulations require the Assessee to maintain information
regarding the shareholding pattern. Though there is no prescribed format for
this information, following is the format that the Accountant may suggest to
the Assessee.
S. No. List of shareholders Shareholding (%)

Further, ownership interest held by enterprises in the Assessee enterprise,
directly or indirectly through intermediaries, also needs to be maintained by
the Assessee. Accordingly, the identification of the ownership and the
relationship with the associated enterprises is the primary responsibility of
the Assessee.

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7.10 The Accountant shall verify that the Assessee maintains information
regarding enterprises having direct or indirect ownership interests, through
intermediaries, in the Assessee enterprise. The Accountant is required to
vouch the associated enterprises relationship as governed by Section
92A(1)(a); 92A(1)(b) and 92A(2) of the Income-tax Act, using his professional
judgement. The Accountant may rely on the financial statement including the
representation from the management with regard to the veracity of the same.
7.11 A profile of the multinational group of which the Assessee
enterprise is a part along with the name, address, legal status and
country of tax residence of each of the enterprises comprised in the
group with whom international transactions or specified domestic
transactions, as the case may be] have been entered into by the
Assessee, and ownership linkages among them. [clause (b), Rule
10D(1)].
7.12 As part of the profile of the multinational group, it may be advisable to
maintain, amongst other things, corporate brochures, catalogues and other
similar printed and / or electronic material that describe:
• The principal line(s) of business in which the group is engaged, such
as manufacturing of electronic goods, trading in chemicals, wholesale
trade in food grains, pharmaceuticals, etc.;
• Geographical areas in which the group one operates;
• Summarised global financials and other details such as capital
invested, assets employed, turnovers achieved, incomes earned,
profits made / losses incurred, etc.
7.13 With respect to each of the associated enterprises/ specified persons
in the group with whom the Assessee has entered into international
transaction / specified domestic transaction, the following specific details
must be maintained:
• Name;
• Address;
• Legal status (company, limited liability partnership, firm, etc.);
• Country of tax residence;
• Ownership linkages between the Assessee and the associated
enterprise.

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Sometimes, the establishment of ownership linkages between the Assessee
and other associated enterprises is a problem for the reason that sufficient
reportable information is not available. In such cases, the Assessee will have
to provide only the information that is available with him.
7.14 For example, A Ltd., India, is a 100% subsidiary of H Ltd., U.K., which
itself is a 100% subsidiary of R Inc., USA.R Inc, also, has another subsidiary,
C Ltd., Argentina. If, A Ltd. transacts with C Ltd., it will have to report the
ownership linkage between itself and C Ltd. However, this information may
not be available or even forthcoming from the ultimate holding company, R
Inc.
7.15 However, some of these details would also be required to be reported
by the ultimate holding company under the BEPS recommended three-tiered
approach to TP documentation, consisting of master file, local file and CbC
reporting. The assesse could source required data from such master file or
CbC report, wherever applicable.
7.16 The Assessee is required to maintain a document that describes the
profile of the multinational group. The member may exercise his professional
judgment to determine whether the profile prepared by the Assessee
provides sufficient information regarding the group, pertinent to transfer
pricing. Some of the information that may be contained in the profile are as
follows:
• the name and place of incorporation of the immediate parent
company;
• the name and place of incorporation of the ultimate parent company;
• the major product lines, services offered by the group;
• a brief description of the technology, brands or other intangibles
owned by the group;
• name(s) of major competitors.
Any other information regarding the group that may be pertinent to the
transfer pricing analysis.
7.17 The Accountant has to verify if such a profile has been prepared and
based on his understanding of the business of the Assessee and a test check
of the documents and records of the Assessee, he is required to determine
that the information contained in the profile is correct. In this regard, the

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Accountant may place reliance on the master file of the Assessee, if
applicable, to verify that the information contained in the report is correct.
7.18 The Assessee is also required to provide a list of associated
enterprises / specified persons from within the group, with whom the
Assessee has entered into international transactions / specified domestic
transactions. The following details are required to be maintained by the
Assessee:
• name of the group entity (associated enterprise / specified person)
• address of the group entity
• legal status
• nature of relationship
• country of tax residence.
7.19 The Accountant should obtain written representation from
management (of the taxpayer) providing him with name, address, legal status
and country of tax residence of each of the enterprises comprised in the
group with whom international transactions or specified domestic
transactions have been entered into by the Assessee, and ownership
linkages among them. He shall exercise his professional judgement and due
diligence to verify that the same is prima facie correct. The Accountant
should place reliance on the evidence/documents provided by the Assessee
to satisfy himself as to the accuracy of these facts. The Accountant could
verify the data from master file or CbC report, wherever applicable and
prepared by the Assessee.
7.20 The Accountant shall perform certain checks in regard to the various
categories and situations in which the two enterprises are associated
enterprises as provided in section 92A(1) and clause (a) and (b) of section
92A(2).A reference should be made to the tax audit report. He should also
check the register of members maintained by the Assessee under section 88
of the Companies Act, 2013and the voting rights corresponding to the shares
of the associated enterprise / specified persons.
7.21 A broad description of the business of the Assessee and the
industry in which the Assessee operates, and of the business of the
associated enterprises with whom the Assessee has transacted [Clause
(c), Rule 10D (1)].
7.22 Under this clause, a general explanation of the business carried out
by the Assessee and the associated enterprise/ specified person with whom

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it has transacted has to be stated. Where the Assessee/ associated
enterprise / specified person are engaged in more than one line of business,
the explanation will have to cover all businesses.
7.23 This explanation could typically cover areas such as:
• the business model used;
• technologies employed;
• products manufactured/traded;
• markets addressed and competition faced;
• geographic dispersion of manufacturing facilities etc.
7.24 The broad description of the industry in which the Assessee operates
will include reports about the industry, which are available in the public
domain. This could be material published in business newspapers, trade
journals and magazines, etc. all of which provide a macro-economic
perspective to the industry.

Associated Enterprises relationship with the
Assessee
7.25 The Assessee has to determine whether by virtue of clauses (c) to
(m) of section 92A(2) certain enterprises shall be deemed as associated
enterprises. The Accountant shall conduct the following checks to verify if the
Assessee has conducted due diligence in determining whether an entity is an
associated enterprise or not.
Clause (c): The Accountant should check the register of loans and
investments maintained by the Assessee under section 186 of the
Companies Act, 2013.
Clause (d): The Accountant shall obtain details of all the guarantees
pertaining to the borrowing from the management and representation for its
completeness thereof.
Clause (e): The Accountant shall obtain a representation from management
detailing composition and appointment of the members of board of directors
or governing board, Executive Directors and Executive Member of the
governing board. Further the member shall check the Register of Directors
maintained by the company under section 170 of the Companies Act, 2013

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Guidance Note on Report under Section 92E of the Income-tax Act, 1961

Clause (f): The Accountant shall obtain a representation from the
management detailing composition and appointment of the members of
board of directors or governing board, Executive Directors and Executive
Member of the governing board. Further the member shall check the Register
of Directors maintained by the both companies under section 170of the
Companies Act, 2013
Clause (g): The Accountant shall obtain a representation from the
management to the fact that enterprise is wholly dependent upon the
intangible assets such as know-how, patents, copyrights, trademarks,
licenses, franchises, or other commercial rights of similar nature, or any data,
documentation, drawing or specification relating to any patent, invention,
model, design, secret formula or process, of which the other enterprise is the
owner or has exclusive right.
Clause (h): The Accountant shall obtain the details of all the purchases of
raw material and consumable requirement made by the Assessee and
compute the party wise share of business i.e. party-wise purchases. He shall
obtain representation from the management to the fact that the information
provided is correct and complete.
Clause (I): The Accountant shall obtain a representation from the
management to the fact that enterprise sold the goods or articles
manufactured or processed by it, are sold to the other enterprise or to
persons specified by the other enterprise, and the prices and other
conditions relating thereto are influenced by such other enterprise
Clause (j) (Individual): The Accountant shall obtain a representation from
management providing details of controlling interests in all the affiliated
parties so as to determine the common controlling interest in two companies.
Clause (k) (HUF): The Accountant shall obtain a representation from
management providing details of controlling interests in all the affiliated
parties so as to determine the common controlling interest in two companies.
Clause (l): The Accountant shall obtain the partnership/AOP/BOI agreement
in order to determine whether any enterprise holds not less than ten per cent
interest in other firm, association of persons or body of individuals.
Clause (m): The Accountant shall obtain a representation from management
to the effect that there exists or does not exist between the two enterprises,
any relationship of mutual interest in case any such relationship is prescribed

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by CBDT. The Accountant shall exercise his professional judgement and due
diligence to verify that the same is prima facie correct.
7.26 The Accountant should obtain written representation by management
detailing the overview of the business of the Assessee and a description of
the business of the associated enterprises / specified persons with whom the
Assessee has transacted.
7.27 Following is the illustrative checklist to carry out business analysis of
the Assessee:
(a) year of establishment/incorporation;
(b) name and residence of the parent company (holding company);
(c) details of the place/s (units) from where services are rendered
(including area occupied, infrastructure, etc.);
(d) activity in brief (if there is more than one unit, details of activities in
each unit);
(e) stake-holding of the parent company;
(f) legal environment of the industry;
(g) key value drivers of the industry;
(h) major players in the industry;
(i) share of business in the industry;
(j) trends in profitability, turnover, market share etc;
(k) Intangibles of the business.
A similar description of the business of the associated enterprises with whom
the Assessee has undertaken international transactions, is also to be
prepared by the Assessee. The Accountant shall verify if such description is
also maintained.
Herein, it may be noted that transactions with parties under section 94A, will
also come within the purview of section 92A

Details of international transactions / specified
domestic transactions
7.28 The nature and terms (including prices) of international
transactions [or specified domestic transactions, as the case may

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be]entered into with each associated enterprise, details of property
transferred or services provided and the quantum and the value of each
such transaction or class of such transaction [clause (d), Rule 10D(1)].
7.29 The list of individual international transactions / specified domestic
transactions entered into by the Assessee with each of its associated
enterprises/ specified persons is required to be stated here. For ease in
comprehension and verification, the details may be compiled and presented
in a tabular form giving the details required.
7.30 While the data may be classified in any convenient manner, for the
purpose of facilitating the study of comparability, it is suggested that the
nature of the property transferred or service provided be used as the primary
key.
7.31 In addition to the standard inclusions such as name of associated
enterprise / specified person, product transferred or service provided,
quantity, price per unit of measurement etc., the data should, also, provide
information on matters such as:
• form and time of payment;
• discounts;
• shipment;
• purchase commitments;
• product returns by the customer;
• supportive services; etc.
The listing should, also, include transactions where the property has been
transferred or service has been provided “free of cost”. The Accountant may
also obtain written representation detailing the services provided / received
by associated enterprises.
7.32 The Accountant should examine the details of nature and terms
(including prices) of international transactions/ specified domestic
transactions entered into with each associated enterprise / specified person,
details of property transferred or services provided and the quantum and the
value of each such transaction or class of such transaction. The Accountant
should verify the information provided by the Assessee, by using standard
examination procedures from the books of accounts maintained by the
Assessee and information/explanations obtained during the course of such
examination.

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7.33 A description of the functions performed, risks assumed and
assets employed or to be employed by the Assessee and by the
associated enterprises involved in the international transaction[or
specified domestic transaction, as the case may be][clause (e), Rule
10D(1)].
7.34 The Assessee is required to undertake and describe the results of a
detailed functional analysis of the business process involved in the
transaction with the associated enterprise / specified person. In analysing of
the business process, the study should not only cover the activities of the
resident enterprise but, also, the activities of the non-resident enterprise. In
other words, it is the business process that it analysed and not the
enterprise.
7.35 The functional analysis should be made from the perspective of the
“functions performed”, “assets employed” and “risks assumed”. Simply put, a
‘functional analysis’ is a study to determine what economically significant
acts were performed in accomplishing the transactions in question and who
performed them.
7.36 The role of functional analysis is to:
(a) determine the facts with respect to a given transaction between the
related parties; and
(b) set the stage for the choice of tested party followed by the choice of
the pricing method by providing the framework within which
comparable transactions may be determined
7.37 The Assessee shall undertake a detailed functional analysis of the
company and its associated enterprise / specified person in order to
determine the functions performed, risks assumed and assets employed by
the Assessee and by the associated enterprises / specified persons involved
in the international transaction / specified domestic transaction. A functional
analysis is a method of finding and organizing facts about a business in
terms of its functions, risks and intangibles in order to identify how these are
divided up between the companies involved in the transaction under review.
The functions and risks are analyzed to determine the degree of risks
undertaken, the value of the intangibles provided and whether the profits (or
losses) earned by the entities are commensurate with the functions
performed. Functional analysis thus helps in assessing the correct
characterization of the parties to the transaction which in turn helps in