Q : Transactional Net Margin Method (TNMM) has been considered as the widely used TP methodology. With the availability of further data by way of master file and CbCR, do we anticipate a change in the trend?

Kunj Vaidya (Partner and Leader, Transfer Pricing, PwC India)

There has been a general tendency for the tax authorities to consider TNMM (or an equivalent operating profit based methodology) for evaluating arm’s length. The reasons for this could be two fold:

a) Taxes are paid on net profits and hence, evaluating profitability would ensure protection of tax base (this would be a conservative approach)

b) There is no significant data evaluation process required as the requisite information is generally available in the audited financial statements.

As being evidenced, the above approach places hardship on companies which operate in a unique industry or in the start-up stage. Absence of consistent reporting standards and lack of access to information on the value chain has also contributed to the lack of adoption of other methods.

With the increased global alignment to IFRS and introduction of CbCR/ Master File, both the above points could largely get addressed. While there may still remain some hesitancy to move from TNMM, we do expect other methods such as profit split method being used going forward.

Profit split method attempts to share the profits/ losses amongst various entities in the value chain by identifying and attributing the same to key value drivers. Due to lack of information on the entire value chain with any single tax jurisdiction, this method ended up being one of the least used methods

Under the CbCR and Master file, information on the entire value chain of a particular operation would be available to the tax authorities allowing them to evaluate profit split method in better light. Better quality of information for application of other methods (consistent reporting of gross profits, availability of comparable group sales to third parties etc) would also be available going forward.

Considering all of the above, it can be expected that there could be a gradual shift from TNMM to other approaches.

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