International Taxation – Profit Level Indicators

International Taxation – Profit Level Indicators

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Profit Level Indicators 

A profit level indicator (PLI) is selected to test the profitability of tested party.

PLIs are ratios that measure relationships between profits and costs incurred or resources employed.

PLI should always have an untainted* base (denominator) like adopting cost as base for export transactions and revenue as base for import transactions.

*A tainted income or expense would mean one that is received from an AE paid to an AE and therefore cannot be considered to be independent or at arm’s length. Untainted on the other hand would mean revenue or costs which relate to transactions with independent third parties and are therefore more reliable.

Some of the PLIs:

  • Return on Assets (ROA):

          Operating profit divided by the operating assets (normally only tangible assets).

  • Return on Capital Employed (ROCE):

Operating profit divided by capital employed which is usually computed as the total assets minus cash and investments.

  • Operating Margin (OM):

Operating profit divided by sales

  • Return on Total Costs (ROTC):

Operating profit divided by total costs

  • Return on Cost of Goods Sold:

Gross profit divided by cost of goods sold

  • Berry Ratio:

Gross profit divided by operating expenses

Range Concept

Rule 10CA(4) provides that where the most appropriate method applied is –

a method other than the profit split method or a method prescribed by the CBDT under section 92C(1)(d)/(f); and

the dataset constructed in accordance with sub-rule (2) consists of six or more entries,

an arm’s length range beginning from the thirty-fifth percentile of the dataset and ending on the sixty-fifth percentile of the dataset shall be constructed.

If the price at which the international transaction has actually been undertaken is within the said range, then, the price at which such international transaction has actually been undertaken shall be deemed to be the arm’s length price [Rule 10CA(5)].

If the price at which the international transaction has actually been undertaken is outside the said arm’s length range, the arm’s length price shall be taken to be the median of the dataset [Rule 10CA(6)].

When to apply range concept?

  • Most appropriate method selected is Comparable uncontrolled price method, resale price method, cost plus method or transactional net margin method and
  • The dataset constructed has six or more entries.

How to apply?

  • Dataset to be constructed by using Weighted average of different data.
  • Arrange the values in the dataset in the ascending order. Where the actual transaction price falls within 35th and 65th percentile of the dataset, the value of transaction will be accepted to be arm’s length price.
  • Where the transfer price does not fall within the above range, then median of dataset shall be taken as the Arm’s Length price.

Meaning of certain terms:

  • The thirty-fifth & sixth-fifth percentile of a dataset (having values arranged in an ascending order):

The lowest value in the dataset such that at least 35% of the values included in the dataset are equal to or less than such value. However, if the number of values that are equal to or less than the aforesaid value is a whole number, then, the thirty-fifth percentile shall be the arithmetic mean of such value and the value immediately succeeding it in the dataset.

Same is applicable in the case of 65th percentile. Substitute 65% in place of 35% in the above paragraph.

  • The median of the dataset (having values arranged in an ascending order):

The lowest value in the dataset such that at least 50% of the values included in the dataset are equal to or less than such value. However, if the number of values that are equal to or less than the aforesaid value is a whole number, then, the median shall be the arithmetic mean of such value and the value immediately succeeding it in the dataset.

Notification No. 50/2017 dated 9.6.2017

The Central Government has, vide Notification No. 50/2017 dated 9.6.2017, notified that where the variation between the arm’s length price determined under section 92C and the price at which the international transaction or specified domestic transaction has actually been undertaken does not exceed 1% of the latter in respect of wholesale trading and 3% of the latter in all other cases, the price at which the international transaction has actually been undertaken shall be deemed to be the arm’s length price for Assessment Year 2017-2018 and 2018-19.

For the purposes of this notification, “wholesale trading” means an international transaction or specified domestic transaction of trading in goods, which fulfills the following conditions, namely:-

  • purchase cost of finished goods is eighty percent or more of the total cost pertaining to such trading activities; and
  • average monthly closing inventory of such goods is ten percent or less of sales pertaining to such trading activities.

So, here I am ending this part.

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