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Transactional Net Margin Method Transfer pricing – (TNMM).

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June 1, 2021 |

10 mins read

Transactional Net Margin Method

The application of Arm’s Length Principle while implementing the provisions of Transfer Pricing, to arrive at the price of a transaction between unrelated parties is essential. However different situations call for application of different methods of the ALP principle, depending on the mitigating factors in every transaction. One such method is the Transactional Net Margin Method. Let’s take an in- depth look into this concept.

Principle of International Taxation Transfer Pricing
Transaction between International Parties
Transfer Price Price charged between two Associated Enterprises
Arm’s Length Price Principle Price charged between two unrelated parties
Governing Provision Section 92C, Income Tax Act, 1961
Type of Method Transactional Profit Method
Application of method Comparison between the operating profit derived by tested party, from a controlled transaction with the operating profit of an independent uncontrolled third party, relative to an appropriate base.

 Under Transactional Net Margin Method Transfer Pricing (TNMM), a comparison is made for the operating profit derived by tested party,  from a controlled transaction, relative to an appropriate base (i.e., costs, sales, assets, etc.) . The results so obtained are then  compared  with the operating profit of an independent uncontrolled third party , engaged in comparable transaction, relative to the appropriate base .

The ratios most commonly used, express net profits as a percentage of : –

  • Costs (full cost or operating costs),
  • Particular Balance sheet category (example Assets, Capital Employed, etc.) or
  • Sales/ Service receipts.

Transactional-Net-Margin-Method

Steps involved in Transactional Net Margin Method (TNMM) Transfer pricing

Step 1 : – Determine Net Margin Realised

The net margin realised by the enterprise from an international transaction entered with an Associated Enterprise (Related party transaction) is computed, with regards to base discussed above, both for

  1. the unrelated party ; and
  2. the party under consideration.

Step 2 : – Net Margin is adjusted for differences

The net margin so derived is adjusted for any differences, between : –

  1. international transaction between related parties, and the comparable uncontrolled transaction, or
  2. between the enterprises entering into such transactions

Note : –

Adjustment should be made only when differences could materially affect the amount of net profit margin in the open market.

Step 3 : – Arring at the Arm’s Length Price

The margin so established is taken into account to arrive at an arm’s length price for the international transaction.

Let us understand this with the help of an example : –

Example 1 – Transactional Net Margin Method (TNMM) Transfer pricing

XYZ India procures computer software (“Z”) from SB Singapore @ Rs. 1,500 per Software. Subsequently the company incurs an additional advertisement expenditure in India of Rs. 600 per pack and the product is ultimately sold at Rs. 3,000 per Software. XYZ India also procures packaged software (“T”) from its subsidiary company in UK @ Rs. 700 per Software.

The company incurs an additional expenditure of Rs. 200 per Software  and the product is ultimately sold at Rs. 1,200 per Software. Compute the arm’s length price as per TNMM, assuming the difference in product is not material ?

International Taxation Services

Solution : –

Computation of Net profit margin realized from an unrelated party in a comparable uncontrolled transaction :

Particulars Amount (Rs.)
Sale price of product Z 3,000
Less: –
Purchase price 1,500
Additional expenditure in India 600
Net Profit Margin 900
Net profit margin ratio (% of sale) 30%

Computation of Arm’s length price of international transaction with the AE : –

Particulars Amount (Rs.)
Sale price of T – (A) 1,200
Net profit margin ratio 30%
Net profit margin – (B) 360
Total Cost (A – B) 840
Less: –
Additional expenditure in India 200
Arm’s length price per unit 640
Transfer price per unit 700
TP adjustment per unit 60

 Judicial Rulings on Selection of Transactional Net Margin Method (TNMM) Transfer Pricing

Case laws Held
Schutz Dishman Biotech Private Limited vs. DCIT – [2015] 60 taxmann.com 50 (Ahmedabad – Trib.) Schutz Dishman Biotech Private Limited was manufacturing medicines for export. It applied TNMM for benchmarking its transactions, which was rejected, and AO applied CUP.

The Court however accepted TNMM on the basis that margin earned by Schutz Dishman Biotech Private Limited PBIT was exactly similar or nearby with that earned by other uncontrolled transactions of unconnected enterprises.

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For any queries, please write them in the Comment Section or Talk to our tax expert

Arinjay Jain

Bio of author

Arinjay is a Chartered Accountant with more than 20 years of post-qualification experience. He worked as Director, in the M&A Tax Division at KPMG in India. Presently, he is advising several MNCs in UAE on Economic Substance Regulations and impact of the UAE Corporate Tax Law on their business and clients across globe on International Tax issues . He is a well recognised Trainer of International Tax and UAE Corporate Tax. The areas of service include the following : - Advise and Compliance relating to International Tax Issues; Advise relating to UAE Corporate Tax Issues; Advise and Compliance relating to UAE Economic Substance Regulations; Advise and Compliance relating to Indian Income Tax Issues; Other connected matters from a Regulatory perspective.

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