India is one of those countries that view Transfer Pricing very seriously, at least amongst Asia Pacific countries. India requires an Annual Certification to accompany the auditor report. As we are fully aware that India is opening up its economies. The authorities would like to ensure that there is no unnecessary hanky-panky by investors to siphon foreign exchange from its country. Hence,the setting up proper transfer pricing methodology/documentation to comply with the authorities is indeed one of the hot topics amongst financial controllers.

Transfer pricing regulations started in Year 2000. As India’s fiscal year ends on 31st March, hence Indian subsidiaries with international links felt its impact in its submission of the annual financial statement ending 31st March 2001. Indian Tax authorities will need proof or evidence in order to believe that international transactions with their domestic organization are above board. Thus, if a group of companies has Indian subsidiaries, it is essential that their Indian subsidiaries need to keep records, registers, systems and general information to justify transfer pricing with its international counterpart.

In establishing the transfer pricing of the Company, it is essential that a Core Documentation File should be set up in the event of dispute or query from the Indian Inland Revenue. A typical TP Core Documentation File should include the profile of the international /multinational group, justification of the transfer prices with its function vs risk analysis, records , registers or systems (refer to details).

Let’s discuss more in detail what’s in the Core Documentation File :

(a) the profile of the International /multinational group like:

1. Multinational Group Promoters

2. Areas of Activity

3. Products Manufactured

4. Countries Operated

5. Group Capital

6. Group Turnover

7. Head office Address

8. Reason for Investment in India

9. Relationship with Indian Co

10. Place of Incorporation

(b) documentation of justifying your transfer pricing vide

Function and Risk analysis approach which is as follows:

Understanding the Enterprise Operations

A. Indian, enterprise operations

B. The operations of the associated enterprises.

C. The relationship between the Indian enterprise and its Associated enterprises

D. Role of each entity

E. Review of annual reports

F. Review of articles about the assessee from trade publications and other sources

G. Any reports of Financial Institutions, Credit agencies

H. Review of internal publications, viz. Corporate Brochure. Profile etc.

I. Review of legal entity and functional organization charts

J. Review of minutes of meetings of the following: Board of directors; Shareholders: Committees reporting to the board of directors

K. Review customs entry documents

L. Review of sales catalogs, brochures, and pamphlets

M. Identification of presence of Intangible

N. Review of Fixed Assets register

O. Identification of ownership through registration

P. Any reports indicating the brand value from the Industry Journals.

Q. Reviewing industry publications

R. Reviewing industry guidelines contained in the various handbooks

S. Are the associated enterprises manufacturing the same or similar products ?

T. Are the associated enterprises using the same or similar manufacturing intangibles? If so, were the manufacturing intangibles sold or licensed?

U. Is there a cost sharing agreement?

V. Are marketing intangibles being used to market the product?

W. What members of the controlled group developed the marketing intangibles?

X. What members of the controlled group advertise?

2. Functional Analysis

1. A functional analysis identifies the economically significant activities performed in connection with the transaction. An economically significant activity is one that, at arm’s length, materially affects the following:

A. The price charged in a transaction

B. The profits earned from a transaction

2. A functional analysis involves determining the following:

A. What functions were performed by the transacting parties concerning the transaction? B. Who performed the functions?

C. When were the functions performed?

D. Where were the functions performed?

E. How were the functions performed?

F. Why were the functions performed?

G. What intangibles were employed in the performance of functions?

H. How were intangibles employed in the performance of functions?

I. Why was the transaction structured the way it was?

3. A functional analysis involves tracing the flow of products and services within the organization. Delivering products to a market generally involves various stages. These may include the following:

A. Conceptualization

B. Research and development

C. Manufacturing

D. Testing

E. Marketing

F. Sales

G. Internal usage

4. In performing a functional analysis, additional considerations include:

A. Did the parent or another affiliate sell product in the subsidiary’s market: Before the subsidiary’s formation? After the subsidiary’s formation? If sales were to unrelated distributors, what resale margins did the unrelated distributors earn?

B. Does the subsidiary actively perform sales or marketing functions?

C. Does the subsidiary rely on a distribution network that was previously established by the parent?

D. Did the subsidiary develop new customers for the product it purchases from the parent?

E. Have sales of the parent’s product in the subsidiary’s market increased following the subsidiary’s formation?

F. Has the subsidiary entered into any exclusive or nonexclusive distribution agreements with the parent?

G. Are there any intangibles associated with the parent’s sales of products to the subsidiary?

H. Has the subsidiary entered into any license agreements with the parent?

Risk Analysis

A. Whether the assessee has the financial capacity to fund losses that may occur because having assumed a particular risk?

B. Does the assessee have control over the business activities that involve a particular risk?

C. Is the actual conduct of the transacting controlled taxpayers consistent with the contractual terms?

D. Are the risks assumed commensurate with the potential economic benefit of the controlled transaction? At arm’s length, the transacting party that can realize the benefit generally bears the risk.

E. Is the assessee engaged in the business activity to which the risk relates?

2. Examples of risks include the following:

A. Market risks including fluctuations in costs, demand, prices and inventory levels

B. Risks associated with the success or failure of research and development activities

C. Financial risks including fluctuations in foreign currency rates of exchange and interest rates

D. Credit and collection risks

E. Product liability risks

F. General business risks relating to the ownership of property, plant and equipment.

Functional Analysis of Manufacturing Administrative and Marketing Functions

List of Functions that needs to be analysed

Functional analysis of manufacturing activity

1. Develops products. Y/N

2. Develops manufacturing process and know-how. Y/N

3. Develops product specification plant design. Y/N

4. Designs manufacturing plant, machinery, and equipment. Y/N

5. Purchases capital equipment. Y/N

6. Supervises construction of manufacturing plants and other buildings. Y/N

7. Determines raw material and other supplies needed. Y/N

8. Develops source of raw material purchases. Y/N

9. Purchases raw material. Y/N

10. Warehouses raw materials and supplies. Y/N

11. Develops raw material flow technique. Y/N

12. Controls flow of raw materials. Y/N

13. Arranges for freight and insurance on purchases. Y/N

14. Plans productions schedules and output. Y/N

15. Co-ordinates production and selling. Y/N

16. Develops cost standards. Y/N

17. Develops quality control standards. Y/N

18. Performs quality control functions. Y/N

19. Manufactures components. Y/N

20. Manufactures other raw materials. Y/N

21. Manufactures finished goods. Y/N

22. Does manufacture engineering. Y/N

23. Determines factory personnel needs. Y/N

24. Hires and trains factory personnel. Y/N

25. Supervises the different manufacturing operations. Y/N

26. Performs maintenance of factory buildings, grounds and equipment. Y/N

27. Packages and labels products. Y/N

28. Plans investment in plant and equipment and handles financial needs of manufacturing functions. Y/N

Functional analysis of general, administrative and selling functions

1. Develops financial needs and budgets for the group. Y/N

2. Plans investments and makes investment decisions. Y/N

3. Develops overall marketing strategy. Y/N

4. Plans, co-ordinates and supervises market research. Y/N

5. Performs market research. Y/N

6. Determines advertising and marketing policy. Y/N

7. Supervises advertising and marketing. Y/N

8. Determines the needs for general, administrative and selling personnel. Y/N

9. Hires personnel. Y/N

10. Develops training materials. Y/N

11. Supervises training of personnel. Y/N

12. Trains general, administrative and selling personnel. Y/N

13. Determines compensation of personnel. Y/N

14. Determines pricing and pricing policy. Y/N

15. Establishes credit terms. Y/N

16. Develops advertising formats and translations. Y/N

17. Determines media in which advertising is to be placed and places advertising Y/N

18. Plans and develops TV commercials. Y/N

19. Plans sales promotion and develops promotional materials (eg, design point of display advertising, engineers manufacturing design and manufactures displays). Y/N

20. Plans trade conventions and shows. Y/N

21. Supervises sales force and does customer contact. Y/N

22. Designs and develops packaging material. Y/N

23. Manufactures packaging material. Y/N

24. Designs material for and develops catalogues. Y/N

25. Co-ordinates production schedules with sales. Y/N

26. Purchases finished goods. Y/N

27. Supervises purchasing and warehousing of finished goods. Y/N

28. Warehouses finished goods. Y/N

29. Performs inventory control. Y/N

30. Ships finished goods. Y/N

31. Provides insurance coverage. Y/N

32. Warrants product. Y/N

33. Handles patent and trademark protection. Y/N

34. Assumes inventory risk. Y/N

35. Assumes credit risk. Y/N

36. Develops accounting systems and software. Y/N

37. Maintains accounting records. Y/N

38. Performs tax planning and administration. Y/N

39. Handles customers’ complaints. Y/N

40. Handles billing and collection. Y/N

41. Handles government matters. Y/N

42. Prepares statistical data and financial reports. Y/N

Functional analysis of marketing function

1. Supervises marketing activities. Y/N

2. Develops new promotional themes for advertising; promotion and to whom such services are provided. Y/N

3. Develops training material and trains personnel. Y/N

4. Develops marketing plans for new products and guidelines for marketing. Y/N

5. Co-ordinates the execution of planned marketing foreign subsidiaries. Y/N

6. Approves product authorization. Y/N

7. Designs and develops packaging material to implement strategy and effort. Y/N

8. Plans and develops TV commercials. Y/N

9. Plans and develops advertising formats, and determines be used such as magazines, newspapers, etc. Y/N

10. Co-ordinates production schedules with sales. Y/N

11. Plans and develops other promotional material such as brochures, catalogues, display advertising, etc. Y/N

12. Plans trade conventions and shows. Y/N

13. Determines personnel needs. Y/N

14. Establishes compensation and other personnel incentives Y/N

15. Determines pricing and pricing policy and co-ordinate foreign subsidiary. Y/N

16. Establishes credit terms. Y/N

17. Responsible for customer contact. Y/N

18. Supervises sales force. Y/N

19. Performs market research and develops new market Y/N

20. Identifies need for product modification. Y/N

21. Warehouses finished product. Y/N

22. Ships product and provides insurance coverage. Y/N

23. Warrants product. Y/N

Records which need to be kept :

1. Develops financial needs and budgets for the group. Y/N

2. Plans investments and makes investment decisions. Y/N

3. Develops overall marketing strategy. Y/N

4. Plans, co-ordinates and supervises market research. Y/N

5. Performs market research. Y/N

6. Determines advertising and marketing policy. Y/N

7. Supervises advertising and marketing. Y/N

8. Determines the needs for general, administrative and selling personnel. Y/N

9. Hires personnel. Y/N

10. Develops training materials. Y/N

11. Supervises training of personnel. Y/N

12. Trains general, administrative and selling personnel. Y/N

13. Determines compensation of personnel. Y/N

14. Determines pricing and pricing policy. Y/N

15. Establishes credit terms. Y/N

16. Develops advertising formats and translations. Y/N

17. Determines media in which advertising is to be placed and places advertising Y/N

18. Plans and develops TV commercials. Y/N

19. Plans sales promotion and develops promotional materials (eg, designpoint of display advertising, engineers manufacturingdesign and manufactures displays). Y/N

20. Plans trade conventions and shows. Y/N

21. Supervises sales force and does customer contact. Y/N

22. Designs and develops packaging material. Y/N

23. Manufactures packaging material. Y/N

24. Designs material for and develops catalogues. Y/N

25. Co-ordinates production schedules with sales. Y/N

26. Purchases finished goods. Y/N

27. Supervises purchasing and warehousing of finished goods. Y/N

28. Warehouses finished goods. Y/N

29. Performs inventory control. Y/N

30. Ships finished goods. Y/N

31. Provides insurance coverage. Y/N

32. Warrants product. Y/N

33. Handles patent and trademark protection. Y/N

34. Assumes inventory risk. Y/N

35. Assumes credit risk. Y/N

36. Develops accounting systems and software. Y/N

37. Maintains accounting records. Y/N

38. Performs tax planning and administration. Y/N

39. Handles customers’ complaints. Y/N

40. Handles billing and collection. Y/N

41. Handles government matters. Y/N

42. Prepares statistical data and financial reports. Y/N

1. Supervises marketing activities. Y/N

2. Develops new promotional themes for advertising ;promotion and to whom such services are provided. Y/N

3. Develops training material and trains personnel. Y/N

4. Develops marketing plans for new products and guidelines for marketing. Y/N

5. Co-ordinates the execution of planned marketing foreign subsidiaries. Y/N

6. Approves product authorization. Y/N

7. Designs and develops packaging material to implementstrategy and effort. Y/N

8. Plans and develops TV commercials. Y/N

9. Plans and develops advertising formats, and determines be usedsuch as magazines, newspapers, etc. Y/N

10. Co-ordinates production schedules with sales. Y/N

11. Plans and develops other promotional material such asbrochures, catalogues, display advertising, etc. Y/N

12. Plans trade conventions and shows. Y/N

13. Determines personnel needs. Y/N

14. Establishes compensation and other personnel incentives Y/N

15. Determines pricing and pricing policy and co-ordinate foreign subsidiary. Y/N

16. Establishes credit terms. Y/N

17. Responsible for customer contact. Y/N

18. Supervises sales force. Y/N

19. Performs market research and develops new market Y/N

20. Identifies need for product modification. Y/N

21. Warehouses finished product. Y/N

22. Ships product and provides insurance coverage. Y/N

23. Warrants product. Y/N

2 (a) Economic and market analysis Product;-

Forecast and budgets

Costing Other financial estimates like interest, exchange difference etc. Analysis of international prices, margins and costs with local prices, margins and costs and variance analysis.

Division:-Forecasts and budgets w.r.t machines capacity, demand forecasted, manpower availability for each division etc.Forecasts and budgets w.r.t machines capacity, demand forecasted, manpower availability for each division etc.

SUPPORTIVE RECORDS

3(a) Official Publications, reports, studies and data from the government of the Associated Enterprise like eg.:- If the company is dealing in computers then:- PC Quest Market

(b)research, study and technical publication by an International/National Institution involving graphs and pie diagrams as compiled by the Organisations, or any other research body.

© Commodity market quotations or price publications e.g. as occuring in the Economic Times every Monday.

Published accounts of the Associated Enterprise with whom the transaction is entered into.

Agreements and contracts with Associated Enterprise and also with non Associated Enterprise for similar products for the purpose of comparability.

Correspondences with the Associated Enterprise concerning price negotiations, if any with proofs like letters of correspondence. General documents like invoices, bill of lading, delivery orders and vouchers.

Records of assumptions, policies and price negotiations with the Associated Enterprise (Foreign parties)

Assumptions in pricing the product as to the demand forecasted the markets to be catered, the level of competition, the entry strategy etc.Policies with such as penetration policy or aggressive pricing policy based on the above assumptions.Price negotiation documents, correspondence, if any like the agreements, contracts etc.

OTHER INFORMATION

Whether a similar product is manufactured in India? Y/N

If yes, by whom? Y/N

At what cost? Y/N

What are the differences & their effect on price?

What is the selling price in India?

What is it outside India?

Whether the Indian concern is selling similar product in India? Y/N

If yes, to whom? Y/N

What is the cost of production?

What is the selling price in India?

Whether the Indian concern is selling similar product outside India? Y/N

If yes, to which countries and on what terms? What is the selling price abroad?

Whether the AE is buying any product of similar nature from India from any other person or from any other country? Y/N If yes, at what price? If comparable with the controlled transaction then terms of such uncontrolled transaction.

What is the purpose to which the AE puts the purchased goods?

What is the margin of profit on resale?

What is the source of the goods supplied by AE to us?

What is his cost?

What is his margin of profit?

GENERAL INFORMATION·

Specific Characteristics of the property.e.g.:- its purpose, significance, description.

Functions performed (As per Annexure)

· Assets employed

· Risks assumed (As per Annexure)

· Manner of sharing the risk and benefit (What is the %, terms & conditions, if any).

· Size of the market

· Geographical Location.

· Laws and government orders like the price regulations, the quantity allowed to be sold, quotas if any etc.

· Cost of labour in both the countries (wages paid to them skilled & unskilled)

· Cost of capital in both the countries.

· Wholesale or retail market

· Economic development (Whether developing or developed, capital or labour oriented economy).

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