Aster Ltd., Australia, holds 30% equity shares in Bhuvan Ltd., India. Bhuvan Ltd. develops software and also provides related support services.…

CA Final · Direct Tax Laws and International Taxation · MTP · May 2024
Aster Ltd., Australia, holds 30% equity shares in Bhuvan Ltd., India. Bhuvan Ltd. develops software and also provides related support services. Bhuvan Ltd. during the year billed Aster Ltd., Australia for 150 man-hours at the rate of 2,700 per man hour. The total cost (direct and indirect) for executing this work amounted to 4,52,000. However, Bhuvan Ltd. billed Gaurav Ltd., India at the rate of 3,800 per man hour for the similar level of manpower and earned Gross Profit of 40% on its cost. The transactions of Bhuvan Ltd. with Aster Ltd. and Gaurav Ltd. are comparable, subject to the following differences: (i) While Bhuvan Ltd. also derives technological support from Aster Ltd., there is no such support from Gaurav Ltd. The value of technological support received from Aster Ltd. may be put at 15% of normal gross profits. (ii) As Aster Ltd. gives business in large volumes, Bhuvan Ltd. offered to Aster Ltd., a quantity discount which may be valued at 10% of the normal gross profits. (iii) In the case of rendering services to Aster Ltd., Bhuvan Ltd. neither runs any risk nor incurs any marketing costs. On the other hand, in the case of services to Gaurav Ltd., Bhuvan Ltd. has to assume all the risks and costs associated with the marketing function which may be estimated at 20% of the normal gross profits. (iv) Bhuvan Ltd. offered one month credit to Aster Ltd. The cost of providing such credit may be valued at 5% of the normal gross profits. No such credit was given to Gaurav Ltd. Compute the Arm's Length Price alongwith income to be adjusted under the cost plus method.

Suggested Answer and Working Notes:

Two enterprises are deemed to be associated enterprises where one enterprise, directly or indirectly, holds shares carrying not less than 26% of the voting power in the other enterprise. In this case, since Aster Ltd., a foreign company, holds 30% equity shares in Bhuvan Ltd., an Indian company, Aster Ltd. and Bhuvan Ltd. are deemed to be associated enterprises. Since the transaction of developing software and providing related support service by Bhuvan Ltd. to Aster Ltd. is an international transaction between associated enterprises, the provisions of transfer pricing would be attracted in this case. Computation of Arm's Length Price as per Cost Plus Method Particulars % % Gross Profit mark-up on cost in case of Gaurav Ltd. Ltd. [an unrelated party] 40% Less: Adjustments for functional and other differences - Value of technology support [Aster Ltd. provides technology support, but Gaurav Ltd. does not provide such support. Therefore, value of technology support shall be adjusted] [15% of 40%, being gross profit] 6% - Quantity discount to Aster Ltd. [Quantity discount is allowed to Aster Ltd. as it gives business in large volumes, but the same is not provided to Gaurav Ltd. Therefore, it shall be adjusted] [10% of 40%, being gross profit] 4% - Risk and cost associated with marketing [Bhuvan Ltd. has to bear all the risk and costs associated with the marketing function in case of Gaurav Ltd., while there is no such risk in case of services to Aster Ltd. Therefore, market risk and cost shall be adjusted] [20% of 40%, being gross profit] 8% 18% 22% Add: Cost of credit to Aster Ltd. [Bhuvan Ltd has provided credit of 1 month to Aster Ltd. but not to the unrelated party. Therefore, adjustment for the cost of such credit has to be carried out to arrive at the ALP] [(5% of 40%, being gross profit] 2% Arm's length gross profit mark up to cost 24% Cost incurred by Bhuvan Ltd. for executing Aster Ltd.'s work 4,52,000 Add: Adjusted gross profit (₹ 4,52,000 x 24%) 1,08,480 Arm's length billed value 5,60,480 Less: Actual Billed Income from Aster Ltd. (₹ 2,700 x 150 man hours) 4,05,000 Total Income of Bhuvan Ltd to be increased by 1,55,480

Topics: Transfer Pricing

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