Canada Ltd., (a company incorporated in Canada) holds 35% voting powers in LMN Ltd. (a company registered in Indian Companies Act, 1956) through…

CA Final · Direct Tax Laws and International Taxation · PYQS · January 2026
Canada Ltd., (a company incorporated in Canada) holds 35% voting powers in LMN Ltd. (a company registered in Indian Companies Act, 1956) through holding 35% shares of LMN Ltd. LMN Ltd. is engaged in providing software development and consultancy services (both onsite and offsite). LMN Ltd. during the financial year 2024-25, billed Canada Ltd. for 120 man-hours at the rate of 3,600 per man hour. The total cost (direct and indirect) for executing this work amounted to 4,50,000/-. LMN Ltd. during the same financial year, for the similar services rendered billed XYZ Ltd., India at the rate of 5,400 per man hour (for similar level of manpower and resources) and earned a Gross Profit of 50% on its cost. The transactions of LMN Ltd. with Canada Ltd. and XYZ Ltd. are comparable, subject to the following differences: While LMN Ltd. derives technology support from XYZ Ltd., there is no such support received from Canada Ltd. The value of technology support received from XYZ Ltd. may be assumed at 4% of normal gross profits.Assuming that Canada Ltd. gives business in large volumes, LMN Ltd. offered to Canada Ltd. a quantity discount which may be valued at 20% normal gross profits.In the case of rendering services to Canada Ltd., LMN Ltd. neither runs any risk nor incurs any marketing costs. On the other hand, in case of services to XYZ Ltd. LMN Ltd. has to assume all the risk and costs associated with the marketing function which may be estimated at 10% of normal gross profits.LMN Ltd. offered one month's credit to XYZ Ltd. The cost of providing such credit may be valued at 2 % of the gross profits. No such credit was given to Canada Ltd. Compute the Arm's length Price along with income to be increased under the Cost-Plus Method.

Suggested Answer and Working Notes:

Computation of Arm's Length Price as per Cost Plus Method % Gross Profit mark-up on cost in case of XYZ Ltd. [an unrelated party] 50% Less: Adjustments for functional and other differences Quantity discount to Canada Ltd. [Quantity discount is allowed to Canada Ltd. as it gives business in large volumes, but the same is not provided to XYZ Ltd. Therefore, it shall be adjusted] [20% of 50%, being gross profit] 10% Risk and cost associated with marketing [LMN Ltd. has to bear all the risk and costs associated with the marketing function in case of XYZ Ltd., while there is no such risk in case of services to Canada Ltd. Therefore, market risk and cost shall be adjusted] [10% of 50%, being gross profit] 5% Cost of credit to XYZ Ltd. [LMN Ltd has provided credit of 1 month to XYZ Ltd. but not to the Canada Ltd., a related party. Therefore, adjustment for the cost of such credit has to be carried out to arrive at the ALP] [(2% of 50%, being gross profit] 1% 16% 34% Add: Value of technology support [XYZ Ltd. provides technology support, but Canada Ltd. does not provide such support. Therefore, value of technology support shall be adjusted] [4% of 50%, being gross profit] 2% Arm's length gross profit mark up to cost 36% Cost incurred by LMN Ltd. for executing Canada Ltd.'s work 4,50,000 Add: Adjusted gross profit (₹ 4,50,000 x 36%) 1,62,000 Arm's length billed value 6,12,000 Less: Actual Billed Income from Canada Ltd. (3600 x 120 manhours) 4,32,000 Total Income of LMN Ltd to be increased by 1,80,000

Topics: Transfer Pricing

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