Indian Transfer Pricing regulations provide methods for determining arm's-length price (‘ALP’) of transactions that qualify as International Transaction/Specified Domestic Transaction(‘SDT’). The regulations also provide for the tolerance range for the variation between the ALP and the transaction price.
Under the transfer pricing methodologies, the computation of ALP is based on a set of comparable companies’ margins. When the dataset constructed for determining ALP consists of 6 or more comparable companies, ALP shall be determined on the basis of the range concept (i.e., 35th percentile and 65th percentile of the dataset).
In case the number of comparable companies is less than 6, then the arm’s length margin is derived based on the arithmetic mean of margins of such comparable companies. The tolerance range is relevant when there is variation between the arithmetic mean (or ALP) and the transaction price. If the variation between the transaction price and ALP is within the “tolerance range”, then the actual transaction price shall be deemed to be ALP and no transfer pricing adjustment is warranted.
Central Government has the power to notify the tolerance limit for every assessment year. In the previous Financial Year, Central Government vide notification no. 83/2020 dated 19 October 2020 has notified a tolerance range of 1% for wholesale trading and 3% in all other cases.
Recently, the Ministry of Finance (MoF) released Notification No. 124/2021 dated 29 October 2021 on transfer pricing tolerance range for FY 2020-21.
Highlights of the notification dated 29th October 2021
The tolerance range of 1% for wholesale trading and 3% in all other cases is extended to the FY 2020-21. The definition of wholesale trading remains unchanged, which is reiterated below:
“wholesale trading” means an international transaction or SDT of trading in goods, which fulfils the following conditions:
- purchase cost of finished goods is 80% or more of the total cost pertaining to such trading activities; and
- average monthly closing inventory of such goods is 10% or less of sales pertaining to such trading activities.”
Also, explanatory memorandum clarifies that none will be adversely affected by the retrospective effect being given to the notification.
It is a yearly ritual to review the tolerance limit applicable for the respective financial year. Tolerance limit is most useful particularly when the arithmetic mean is used to arrive at the arm’s length price. MNE’s are closing their transfer pricing compliance requirements for the FY 2020-21. This explanatory memorandum on the tolerance limit would certainly provide clarity for those benchmarking the international or specified domestic transactions using arithmetic mean of comparable companies’ margins. In any case, if there are sufficient comparable companies, i.e., 6 or more, the MNE’s can adopt an arm’s length margin range of 35th & 65th percentile of the data set to benchmark the intercompany transactions.