We are multinational listed automobile company, we purchase raw materials from our associated company in Japan.
With reference to the clause (xiii a) of Code of Corporate Governance, it requires that:
“The Board of Directors of a company shall approve the pricing methods for related party transactions that were made on the terms equivalent to those that prevail in arm’s length transaction only if such terms can be substantiated.”
We have certain following queries on the above clause:
1) Code has not prescribed any pricing methods for related party transactions. What are the pricing methods? Does it require the same methods prescribed under the Income Tax rules or OECD guidelines? Existing provisions of the code are silent on pricing methods. Therefore, the listed company can approve any pricing method to comply with the requirement of the code.
2) Code has also not mentioned the responsibility, is it the responsibility of buyer or seller in the case of sale/purchase of goods or services?
In our case, we are the buyer and purchase raw materials from Japan. We have been making the transactions since many years. Any change in prices is negotiated between the parties which are based on the factors changed, it is just the simple negotiation process, as between the unrelated parties.
It is the basic fact that no seller would disclose its pricing structure to its buyer that he is using either Cost plus or Resale price method. How the buyer can know the pricing method.
We recommend that it should be the responsibility of seller to disclose and approve the pricing method.
3) What are the benefits of this approval of the method by the board of directors? Because it is not related to income tax or other transfer pricing laws.
The Committee’s opinion on the three queries raised by you is as follows:
1. Currently there is no pricing method prescribed in the Fourth Schedule and the Code of Corporate Governance, however following pricing methods are internationally used and accepted which may be adopted for related party transactions:
I Traditional transaction methods
i. Comparable uncontrolled price method
ii. Resale price method
iii. Cost plus method
II Transactional profit methods
iv. Transactional net margin method
v. Transactional profit split method
2. It the responsibility of the reporting entity to approve the pricing method.
3. With regard to your third point regarding benefits of the approval of the method by the board of directors the Committee would not like to give any opinion on this as it does not come under the purview of this Committee.
(February 17, 2011)