This article is an attempt to understand
the purpose of transfer pricing software and to review the existing databases
based on certain parameters. But first a basic introduction to transfer pricing
will help us to appreciate the importance of these databases.
WHAT IS TRANSFER PRICING?
Transfer pricing (TP) refers to the pricing
of cross-border transactions between two related entities, referred to as
associated enterprises (AEs). When two AEs enter into any cross-border
transaction, the price at which they undertake the transaction is called
transfer price. Due to the special relationship between related companies, the
transfer price may be different from the price that would have been agreed to
between two unrelated companies. Thanks to their control over prices,
Multinational Enterprises (MNEs) have the flexibility to influence –
i) Tax liabilities of individuals or a group of
persons / entities
ii) Government tax targets
iii) Cash flow requirements of the MNE group.
Every Government wants to prevent erosion
of its tax base and plug potential tax leakages, and hence there are TP regulations all over the world. In India, section 92 of the IT Act
was substituted by the Finance Act, 2001 with a set of new sections, 92 to 92F,
providing a detailed statutory framework for the determination of arm’s length
price (ALP) and maintenance of documentation.
TRANSFER PRICING DOCUMENTATION
As per Rule 10D(2) of the Income Tax Rules,
1962, when transactions with related parties cross the threshold of Rs. 1
crore, it is mandatory to keep and maintain information and documents as per
Rule 10D(1). TP Documentation also includes maintenance of proper records and
the process of how the ALP has been determined. The relevant extracts of Rule
10D which require proper documentation of process are reproduced below:
|
Rule
|
Description of the Rule 10D
|
|
10D(1)(h)
|
A record of the analysis performed to evaluate comparability
of uncontrolled transactions with the relevant international transaction
|
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10D(1)(i)
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A description of the methods considered for determining the
arm’s length price in relation to each international transaction or class of
transactions, the method selected as the most appropriate one along with
explanations as to why such method was selected and how such method was
applied in each case
|
|
10D(1)(j)
|
A record of the actual working carried out for determining
the ALP, including details of the comparable data and financial information
used in applying the most appropriate method and adjustments, if any, which
were made to account for the difference between international transactions,
or between the enterprises entering into such transactions
|
As per the rules, the entire analysis /
search process needs to be documented including the procedure being followed
and financial information of comparables. In such a case, the transfer pricing
database helps in the entire analysis and the working of documentation to a
great extent. This depends on which database is used and the features of each
database.
WHY A DATABASE IS REQUIRED
A TP database for determination of ALP can
be employed when the following methods are used:
(a) Cost plus method (CPM)
(b) Transactional net margin method (TNMM)
(c) Resale price method (RPM) sometimes to
ascertain the gross margin earned by traders.
The above methods require a comparison of
the assessee’s gross / net margin with that of the industry.
A question that arises here is, how to
calculate the industry-wide margin. Can the assessee choose to pick companies
having similar transactions or competitors in their industry; ferret out their
financial information from the Ministry of Company Affairs (MCA) site; the BSE
/ NSE website; other private websites and then work out the industry margin?
Tribunals have generally held that the search process should be systematic and
consistent year on year. They have also held that cherry-picking of comparables
is not allowed. This approach will not only enable officers to only cherry-pick
companies having higher profitability but they can also reject the search
process and hence prove that the assessee’s transactions are not at ALP.
However, the ALP determined based on a detailed search process cannot be
rejected without any cogent reasons. Therefore, Transfer Pricing Databases are
used to remove the ambiguity involved and to bring standardisation in the
search process.
Apart from comparison margins, there are
some transaction-specific databases also available, such as Royalty Stat, Loan
Connector, OneSource, etc., which are used to benchmark specific transactions
like royalty and loan transactions and where the gross / net margins of
companies are not required.
GENERAL
SEARCH PROCEDURES IN A DATABASE
In general, a comparable search begins with
the identification of all companies appearing in the database in a particular
period in the relevant industry. Whenever the potential comparable is believed
to be spread over more than one industry, searches are supplemented by text
searches for business descriptions / products containing appropriate keywords.
Various filters (quantitative) are then applied in the database to arrive at a
set of reasonably comparable companies. Textual descriptions including the
background report and directors’ report identified by the database in the
initial screens are reviewed, along with the website details of certain
relevant companies (qualitative filters), first to eliminate companies that are
misclassified and then to narrow down the search to a reasonable number of the
most potentially comparable companies which can be selected.
A list of common filters (quantitative)
applied in the database is as follows:
1. Select companies in the same / similar industry
according to business activity and finished products produced / services
rendered. The first step is like creating a basket of similar companies.
2. Data Availability Filter to select companies
having data availability for the past three years. Companies for which the
latest financials are not available for the last three years are excluded
because their margin will not reflect the current trends.
3. Turnover Filter depending on the turnover of
your company as these companies would not be comparable to assess due to
differences in their scale of operations.
4. Net Worth Filter to select companies having net
worth > 0 because companies having negative net worth have a bankruptcy risk
and therefore margins may not be comparable to a normal company.
5. Select companies having manufacturing / sales
or services / sales ratio > X% depending on the industry in which the
company operates to restrict the list of selected companies with comparable
size and operations.
6. Select companies with related party transactions
< X% as a company having significant related party transactions would itself
be prone to incorrect transfer prices among related parties.
7. Other specific filters can be applied depending
on the facts of each case and the industry in which the company operates.
After applying all these filters, finally,
companies are accepted by applying Qualitative Filters. Qualitative Filters
include reviewing short business descriptions / directors’ report / annual
reports / generated from the database to ensure that their primary line of
business activities is matched with the assessee by excluding companies that
(a) were misclassified
(b) performed activities which involved
significantly different functions, assets and risks (FAR Analysis) as compared
to the assessee.
Having identified the comparable companies,
it is necessary to analyse the nature of these companies by performing a FAR
Analysis. A FAR Analysis identifies the functions undertaken by each party, the
risks each party assumes and the assets used by each party to the transaction.
It also assists in determining the economic value added by each relevant party.
Further, this analysis can help in
identifying specialised and critical business assets and activities that are
fundamental to the business. The CBDT emphasises the importance of the
functional analysis in determining the arm’s length price and identifying
suitable entities for comparison purposes.
Once the final companies are selected after
applying Qualitative Filters, the next step is to remove margins of companies
selected from the database / annual reports and compare the same with our
margin.
Adjustments, if any, can be made to the
margin of companies depending upon the difference, if any, in the FAR Analysis
of comparable companies. For example, Working Capital Adjustment, Risk
Adjustment, Idle Capacity Adjustment, etc.
DIFFERENT
TRANSFER PRICING DATABASES CHOSEN FOR DISCUSSION
We have analysed the three databases
mentioned below from the software available in India for transfer pricing
purposes. We have also identified certain objective parameters based on which
these databases can be evaluated.
(I) Prowess1
- Developed by the Centre for Monitoring
Indian Economy (CMIE) Private Limited.
- The service is only available for desktop version
but the application can be downloaded on any number of desktops.
* Number of Companies – Over 50,000
* Unique Data fields – Over 3,500
* Data Availability – from 1989
- Prowess as a software is extensively used
in research projects and its usage is not restricted to only transfer pricing.
Since it is not created specifically for transfer pricing, data collation and
maintenance in the way that is required by Transfer Pricing Reports is a more
cumbersome process. However, it also has an advantage over other databases
based on the numbers of companies analysed and the years of experience in the
statistical field.
(II) Ace-TP2
- Developed by Accord Fitch Private Limited.
- It is a web database-based browser
application for comparing company financial information of Indian business
entities. The service is available for both web-based and desktop versions.
* Number of Companies – Over 38,000
* Unique Data fields – Over 1,750
* Data Availability – Past 15 years of
historical data
- Ace-TP was the first software which was
specifically designed for TP and therefore has a very easy User Interface. It
directly saves stepwise information and speeds up the documentation process.
However, it is a relatively newer setup compared to the other software.
(III) Capitoline TP3
- Developed by Capital Markets Publishers
India Pvt. Ltd.
- It is an
internet web portal related to transfer pricing issues. The service is
available for both web-based and desktop versions.
* Number of Companies – Over 35,000
* Unique Data fields – 1,250
Capitoline TP
Database has entered into an arrangement4 with ICAI wherein CA firms
would be charged a discounted rate.
- Capitoline TP is an extension of Capitoline
Software which is extensively used for the stock market. Thanks to its arrangement
with ICAI, its web version is one of the most used TP software by SME firms.
COMMON
FEATURES OF ABOVE DATABASES
# Categorisation of companies based on industry,
sub-industry, NIC 2008 classification, business activities, products sold, raw
material consumed and various other factors. (Helpful in Search Procedure
Common Filter – Step 1 as mentioned above.)
# Historical Data of Financials of company for
many years in easy-to-download Excel format. (Helpful in Search Procedure
Common Filter – Step 2 as mentioned above.)
# Query Triggers and Formula Filters depending
on requirement of turnover, net worth, net profit and other parameters. Various
formulae can be clubbed together to derive more complex parameters. (Helpful
in Search Procedure Common Filter – Steps 3, 4, 5 and 6 as mentioned above.)
# Data of both listed and unlisted companies.
Plus brief description / profile of companies and their business. (Helpful
in Search Procedure qualitative filters.)
# Annual Report and financials of various companies
available in database. (Helpful in finding margins of comparable companies.)
# Automation of filters applied for future use
by saving the process which is defined once.
- Database does not cover Proprietorship,
Partnership and LLP.
Data is also compiled from notes of
accounts and aspects such as related party transactions, capacity utilisation,
export and import figures, etc.
__________________________________________________________________________________________________
1
As per website https://prowessiq.cmie.com/ and brochure shared by the company’s
representatives with the authors
*
Kindly review prices from vendors before taking a decision
2
http://www.acetp.com/
3
https://www.capitaline.com/Demo/tp.aspx and brochure shared by the company’s
representatives with the authors
4
https://www.icai.org/post/16361
* Kindly review
prices from vendors before taking decision
SELECTION
PARAMETER FOR ANY DATABASE
Many professionals use two databases for
getting a higher number of companies in the search process. However, the same
could also create duplication. With the above three options available, the
following major parameters can be kept in mind to select any one TP Database.
• Number of companies available,
• Pricing of the software,
• User interface,
• Training and customer support provided.
TP
DATABASE – CAN IT ONLY BE USED FOR TP?
TP Database contains various data points
for various companies for several years. These can also be used for various
other functions such as the following:
- Industry Peer and Trend Comparison –
Some clients are interested in comparing their own companies’ financial health
and growth with their competitors / industry leaders. These databases are a
very effective tool to do the same.
- Due Diligence – If any of the
companies on which due diligence needs to be conducted is presented in the
database, it is easy to collate all the information and work upon it in a
readily available manner. Even if the company is not available, these databases
are an excellent tool to understand the industry dynamics.
- Stock Market – While investing in
shares of a particular company / sector, a deep-dive analysis of a company /
industry and its comparative peer set can be done in the database.
- Analysis of Business Ratios – Various
ratios based on specific industry and specific companies can be collated
instantly from these databases, thereby making them a very effective research
tool.
Authors’ suggestions to database
companies based on our survey:
+ Instead of a yearly subscription, the
database should also be made available for short tenures. This will enable more
users to subscribe to them.
+ High pricing is the general concern of
respondents. They should target an increase in the number of users rather than
frequent increases in prices.
+ Users should be educated about the usage
of the database over and above transfer pricing. This will enable more
subscribers to join.
+ Companies can consider having a tie-up
with professional bodies for increasing awareness amongst users.
CONCLUSION
India is one of the fastest-growing
economies. A lot of businesses are being set up abroad by Indian MNC’s and many medium-sized companies are also expanding their footprints
globally. Besides, many foreign companies are setting up businesses in India. This
will lead to further increase in cross-border transactions between AEs.
Transfer Pricing Practice in India is about to step out of its teens. It’s
young, bubbling with energy and still shaping up. A more complex, granular and
widely covered yet affordable database will take this practice from the Metros
to Tier-II cities and can be a good practice area for budding chartered
accountants.
This article was an attempt to touch
base on the usage of the various databases available and to evaluate them in the
backdrop of various parameters. The user should assess or evaluate all the
databases before making any subscription decision.
Disclaimer: None of the authors is associated with / interested in any of the
databases and any relationship with them is purely restricted to the usage /
subscription of database licenses. All the information that is part of this
article has been gathered from the respective websites and brochures shared by
the databases with the authors.
