Key point and analysis of final rule on range concept and use of multiple year data

Key Point and Analysis of Final Rules on ‘Range Concept’ and ‘Multiple year data’ in Transfer Pricing provisions

A. Introduction

The Income-tax Act provides for determination of income having regard to Arm’s Length Price (ALP) in case of international transactions and specified domestic transactions. The provisions of the Income-tax Act were amended through the Finance (No.2) Act, 2014 to facilitate alignment of Indian transfer regime with international best practices. The manner of computation of ALP is laid down under the Income-tax Rules. 

The Government has notified the amended Rules for determining ALP vide S.O. No. 2860 (E) dated 19/10/2015. The amended regime will be applicable for computation of ALP of international transactions and specified domestic transactions undertaken on or after 1/04/2014 i.e. on and after PY 2014-15.

The amended rules allow for introduction of a “range concept” for determination of ALP and “use of multiple year data” for undertaking comparability analysis in transfer pricing cases. The use of range concept being a statistical tool enhances the reliability of analysis undertaken for computation of ALP. The range concept will be applicable in certain cases for determining the price and will begin with the 35th percentile and end with the 65th percentile of the comparable prices. Transaction price shown by the taxpayers falling within the range will be accepted and no adjustment will be made. The use of multiple year data allows for yearly variations to be averaged out and would therefore add value to transfer pricing analysis. 

The amended rules would therefore provide clarity in determination of price in transfer pricing cases and reduce disputes on transfer pricing issues. It is a part of the Government’s continuing initiative of providing a stable and certain direct tax regime. 

B. Key points of the amended provisions

a. The range concept is applicable, where method used for benchmarking the international transaction and specified domestic transaction are either transaction net margin method (‘TNMM’) or Resale price method (‘RPM’) or Cost plus method (‘CPM’) or Controllable Uncontrolled (‘CUP’).

b. There must be atleast 6 number of comparables for the transaction to be covered under the ‘Range concept’.

c. For the transaction to be benchmarked as in Arm’s length, the data points must lye between lower range of 35th percentile and upper range of 65th percentile of the dataset.

d. Amended provisions allowed the use of 3 year data for computation of ALP in case of comparables. In addition, 2 years (out of 3 years) data, a single year margin can also be used provided that the single year data is for the relevant year in which the tested transaction is undertaken or a year prior to the relevant year (in case of non-availability of data for the relevant year)

e. Where the company is found not to be comparable for the relevant year (i.e. the year in which the transaction is undertaken by the tested party), based on the data available at the time of assessment proceedings, the company cannot be accepted for the earlier years (even if it is comparable for earlier years)

f. Multiple year data can only be applied only in case where ALP is determined through TNMM or CPM or TNMM

g. The rules prescribed the use of weighted average in case of multiple year data, by aggregating numerator and denominator of the chosen Profit Level Indicator (‘PLI’) for all years and for all comparable entities. The illustration is provided below:

h. In case the transfer price falls outside the range, the median of the dataset would be taken as ALP and adjustment to the transfer price shall be made.

i. In case the range concept cannot be applied as per the provisions, it is prescribed that concept of Arithmetic mean along with tolerance band shall be applicable.

C. Analysis

a. The Rules are applicable for transactions undertaken on or after 1 April 2014 (i.e. from FY 2014-15 and onwards). The due date for transfer pricing compliance for the international transactions/SDTs undertaken by assessee during FY 2014-15 is 30 November 2015. There may be cases where the compliance would have already been completed or would be in finalisation stage. Now there is been amendment in the provision to determine ALP, the benchmarking analysis now has to  be undertaken considering new provisions and needs to be reevaluated in the light of the notified final Rules.

b. As per the amended provisions, it is prescribed that there has to be minimum of 6 comparables for the purpose of applying range concept. The provisions may not benefit the sectors like shipping, oil and gas etc where the of comparables accepted are below 6 in number and will have to resort to the same old arithmetic mean and use of tolerance band (3 or 1 percent) for determination of ALP.

c. The rules specify that in case based on available data, the company is not comparable for the relevant year in which the transaction is undertaken by the tested party, such company cannot be considered comparable for the past 2 years also, even if such company satisfy all comparability criteria for the past 2 years. This may lead to issues in case of transfer pricing analysis where there is a shortage of comparable companies. In such cases, this provision may lead to rejection of companies from the set of limited comparable. Further, in case the rejection of companies leads to the number of comparable companies in the set to below 6, even the range benefits would not be available. Furthermore, during assessment, there is a risk associated with the rejection of few companies due criteria like significant related party transaction, turnover filter etc leading to rejection of the entire company and reduction in number of comparables. Consequently, the range benefit may not be available in cases where after the rejection of few comparable the number of comparables falls below 6.

The introduction of Range concept and use of multiple year data is a welcome step and clearly shows CBDT’s intent to reduce litigation in the area of Transfer Pricing. However, the final rules are still not completely aligned with the approach followed internationally.

By: Raghav Gupta
Partner – Legal Quotient Consultants
E: raghavguptamail@gmail.com, legalquotient@gmail.com