Sennheiser Electronics (India) Private Limited: Transfer Pricing Documentation

SENNHEISER ELECTRONICS (INDIA)
PRIVATE LIMITED
TRANSFER PRICING DOCUMENTATION
Analysis of International Transactions with

Associated Enterprises
FISCAL YEAR ENDED MARCH 31, 2009

Prepared on 25.09.09
Privileged & Confidential
Prepared by
MEHRA GOEL & CO

Chartered Accountants
505, Chiranjiv Tower
Nehr Place
NEW DELHI – 110019
Website-mg@mehragoel.com
[A member firm of KS International]
2
TRANSFER PRICING ANALYSIS – FINANCIAL YEAR 2009
I N DE X
Clauses of Paragraph Page

CONTENTS Rule No.
10(D(1)
I. Introduction
A. Glossar & terms 3
B. Scope of the Study 1.1-1.1.5 4,5
C. Summary of Approach 1.2-1.2.5 5-7
D. Framework of Transfer Pricing 1.3-1.3.24 7-15
Regulations
II. Group Overview (a),(b),(c),

A. Objective (d) 2.1-2.1.1 16
B. Ownership Structure 2.2 16
C. Group Overview 2.3-2.3.8 17,18
D. Company Overview 2.4-2.9 19,20
III. Industry Scenario (c)

A. Objective 3.1-3.1.1 20-21
B. The Global Consumer Electronics 3.2.1-3.2.10 21-25
Market Scenario 3.2.11-
C. Indian Industry 3.2.25 25-31
D. Competitors profile 3.2.26- 32-36
3.2.23
IV. Functional Analysis (e)

A. Objective 4.1-4.1.5 37-40
B. Functions performed by Associated 4.2.1-4.3.2 40-41
Industries
C. Risks assumed 4.4-4.4.8 41-43
D. Assets employed 4.5-4.5.1 43-44
E. Characterization 4.6-4.6.1 44-45
V. Economic Analysis (f),(g),(h).

A. Objective (I).(j),(k). 5.1 45
B. Prerequisite to analysis (l) & (m) 5.2 45
C. Legislative background relating to 5.3-5.3.28 45-57
selection of the most appropriate method
D. Application of transfer pricing method 5.4-5.4.14 58-61
E. Conclusion 5.5-5.5.4 61-62
SENNHEISER ELECTRONICS INDIA PRIVATE LIMITED

MEHRA GOEL & CO.
CHARTERED ACCOUNTANTS
3
GLOSSARY AND TERMS USED

OECD Organisation for Economic Cooperation and Development
TP Transfer Pricing
CUP Comparable Uncontrolled Price Method
RP Retail Sale Price Method
PS Profit Split Method
TNMM Transactional Net Margin Method
CP Cost Plus Method
USA United States of Amerika
R&D Research and Development
AE Associated Enterprises
GP Gross Profit
PLI Profit Level Indicator
FAR Functions Performed, Assets Employed, Risk Assumed
TV Television
LCD Liquified Crystal Display
CEA Consumer Electronics Association
CEAMA Consumer Electronics Appliances Manufacturers Association
DTH Direct To Home
GDP Gross Domestic Product

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I. INTRODUCTION
A. Scope of the Study:

1.1 The transfer pricing provisions/regulations were introduced in the Income-tax
Act ('the Act') by the Finance Act, 2001, with effect from 1.4.2002 i.e.
assessment year 2002-03. The said provisions are contained in sections 92 to
92F of the Act read with Rules 10A to 10E of the Income Tax Rules, 1962
(‘the Rules’). The transfer pricing provisions provide for computing income
from ‘international transactions’ between ‘associated enterprises’ on ‘arm's
length basis’ as per the most appropriate method of the prescribed five
methods. The transfer pricing provisions also provide for onerous
documentation requirement to support the transfer prices of such transactions.
These documents are to be supported by a report from an Accountant in Form
3CEB of the Rules and the documentation is to be in place before the due date
of filing of income-tax return.
1.1.1 Sennheiser Electronics (India) Private Limited {“Sennheiser

Electronics( India)”}, a company incorporated under the Companies Act,
1956, is a subsidiary of Sennheiser Global Operations Gmbh. The company is
into wholesale trading of Headphones, Microphones (Wired and RF wireless),
Aviation headsets, Acoustic equipment etc. It imports goods from Sennheiser
Group Companies for reselling through its Distributors in India.
1.1.2 Sennheiser Global Operations Gmbh is engaged in the business of

manufacturing and selling of headphones. The company has a centralised
logistics and delivery system through its subsidiary called Sennheiser
Logistics Services.
1.1.3 Sennheiser Global Operations Gmbh has its business presence over the Asian,
European and all the sophisticated American market.

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Transactions under Scanner

1.1.4 During the Financial Year 2008-09, Sennheiser Electronics (India) Private
Limited has international transactions with its Associated Enterprises on
account of expenses aggregating to Rs.8,46,68,904 as per Annexure- A. Also
included in the Annexure are transactions with Associated Enterprises
reflecting income of the Assessee amounting to Rs. 3,89,91,082.
1.1.5 The objective of this study is to examine whether the ‘international

transactions mentioned in the preceding paragraphs are at arm's length price,
having regard to the transfer pricing provisions. This study provides an
analysis of cross border transactions entered into with associated enterprises
during the financial year 2008-09 and includes an overview of the operations
and organization structure of Sennheiser Electronics ( India) , it’s relationship
with the associated enterprise, industry analysis, analysis of the functions
performed, assets utilized and risks assumed by the associated enterprises and
establishment of arm's length price as per the most appropriate method. This
study also serves as a facility for compliance with the statutory obligations
relating to maintenance of the requisite documentation, etc.
1.1.6 Analysis of the cross border transactions is subject to the assumptions and
limitations as enumerated in this study.
B. Summary of Approach:
1.2 On the basis of functional analysis, the international transaction of Rs.
12,36,59,985 (Rs.3,89,91,082 towards income and Rs.8,46,68,903(Refer
Annexure-A) towards expenses) by Sennheiser Electronics ( India) from the
associated enterprises, are covered under the transfer pricing regulations, and
are required to be tested for arm’s length pricing.

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1.2.1 In determining the most appropriate method, the methods prescribed under
section 92C of the Act were evaluated, based on the function, asset and risk
analysis and on the basis of availability of data. The results of the transfer
pricing analysis in respect of the aforesaid international transactions are
summarised as under:
1.2.2 During the financial year 2008-09, Sennheiser Electronics ( India) has entered
into international transactions on account of imports and reimbursement of
expenses from/to its associated enterprise(s). During the relevant previous
year, Sennheiser Electronics (India) has paid a total consideration of
Rs.8,46,68,904. To determine the arm’s length characteristics of the
international transactions as aforesaid, For import made from Sennheiser
Logistics Services, Gmbh. An Associated Enterprise, Comparable
Uncontrolled Price Method (CUP) was applied as the most appropriate method
to justify the arm’s length price of such international transactions. The
transactions of reimbursement are against expenses incurred on behalf of the
assessee and being on actual subjected against proper bills and management
approval. There being no underlying element of profit shifting, in our view
these transactions are self explaining as to its arm length and do not warrant
for a benchmarking.
1.2.3 Apart from above, not included in the analysis, are service revenue
aggregating to Rs.38,991,082/- consisting of mainly the reimbursement of
advertisement cost and warranty bonus recovery etc. While the warranty
bonus recovery is equal for all enterprise across the Sennheiser Group, as
explained to us, the company includes a mark up of 5% on the bill for
reimbursement. Since the arrangement is a revenue favour, we are of the view
that the underlying economic benefit of such transactions is self justifying of
the arm’s length character. Also included in above, Rs. 14,859,461 is the
service revenue received from Associated Enterprises. As explained to us, this
income is for facilitating the AE(s) to make direct sales to third party
customers. Sennheiser India, under the arrangement charges a service fees of

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the price differential of its listed sales price and the imported price. The
arrangement being revenue favour and there not being any element of price
shifting, it do not call for a bench mark analysis.
1.2.4 For application of CUP, The product price catalogue of Sennheiser Logistics
Services Gmbh. was studied. The price at which similar product supplied by
Sennheiser Logistics Services Gmbh to other unrelated enterprise was
benchmarked with the price at which the same product was imported by
Sennheiser Electronics ( India).
1.2.5 As the Purchase price of Sennheiser Electronics (India) on controlled

transactions, is well below standard price at which similar products are sold by
Sennheiser Logistics Services Gmbh to other comparable uncontrolled
enterprises It is within the safe harbour of the transfer pricing regulation. The
international transactions of import of products by Sennheiser Electronics
( India) from Sennheiser Logistics Services Gmbh are, therefore, considered
being at arm’s length applying the Comparable Uncontrolled Price Method
(CUP), which is identified as the most appropriate method in terms of section
92 of the Act (Refer Annexure-B).
C. Framework of Transfer Pricing Regulations:

General:
1.3 Transfer pricing refers to the price at which related parties enter into
transactions of transfer of property, goods or services, which may take place
under conditions or prices different from those taking place between
independent parties. The transfer pricing regulations as contained in the Act
empower the tax authorities to determine arm’s length price in respect of cross
border transactions in accordance with the transfer pricing provisions. The
statutory framework of transfer pricing regulations is contained in sections 92,
92A, 92B, 92C, 92D, 92E and 92F of Chapter X of the Act. Further, Rules
10A to 10E of the Rules provide, inter alia, factors and circumstances for

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selection of the most appropriate method for determining arm's length price,
the manner in which the prescribed methods should be applied, the
information and documentation required to be maintained by the assessee for
the transfer pricing audit report etc.
1.3.1 The Organization for Economic Co-operation and Development (OECD), as

early as in 1970's realized the importance of transfer pricing and the OECD
Committee on Fiscal Affairs (CFA) made a study on issues arising due to
transfer pricing between related parties. The CFA issued the first major
landmark report in 1979 titled "Transfer Pricing and Multinational
Enterprises” which reaffirmed and elaborated the arm's length principle set out
in Article 9(1) of OECD Model Convention. This report defined the term
'Arm's length price' as the price 'which would be agreed between unrelated
parties in the same or similar transactions under the same or similar conditions
in the open market and prescribed methods for determining the arm's length
price.
1.3.2 Regulation 482 (which is the governing provision for transfer pricing in the
USA) was amended for the first time in 63 years, by the Tax Reforms Act of
1986 issued by the Internal Revenue Service of USA. The amendment
required that inter-company charges for the use of intangible property should
be commensurate with the income attributable to the use of the intangible
property. Since then, significant changes to the USA regulations have
occurred. In the light of this in the early 1990's, OECD reviewed the
implications of the regulation and issued a "Report on Inter-company Transfer
Pricing Regulations under Sec. 482 Temporary and Proposed Regulations", in
December 1993. The CFA, thereafter, in 1993 began to revise the landmark
1979 OECD report as supplemented by the 1984 OECD report and issued
guidelines titled 'Transfer Pricing Guidelines for Multinational Enterprises and
Tax Administration' in 1995, which focuses on both transaction oriented and

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profit oriented approach for arriving at arm's length price and provides
guidelines on a wide range of topics for determining arm's length price.
1.3.3 The Indian Transfer Pricing Legislation to a great extent embodies the
principles enshrined in the OECD guidelines on transfer pricing.
Arm's Length Principle:

1.3.4 The arm's length principle, which is the cornerstone of OECD transfer pricing
guidelines, is found in paragraph 1 of Article 9 of the OECD Model Tax
Convention, which forms the basis of bilateral tax treaties involving OECD
Member countries and an increasing number of non-Member countries.
1.3.5 As per Article 9, when conditions are made or imposed between two
associated enterprises in their commercial or financial relations which differ
from those which would be made between independent enterprises, then any
profits which would, but for those conditions, have accrued to one of the
enterprises, but, by reason of those conditions, have not so accrued, may be
included in the profits of that enterprise and taxed accordingly. Thus, it is
sought to adjust profits to bring them to a level that would prevail when
independent enterprises would enter into comparable transactions during
comparable conditions.
1.3.6 Section 92 of the Act provides that any income arising from an international
transaction shall be computed having regard to the arm's length price. Income
arising from an international transaction, allowance for any expense or interest
or allocation or apportionment of any cost incurred in connection with benefit,
service or facility provided by two or more associated enterprises shall be
determined having regard to the arm's length price of such benefit, service or
facility, as the case may be. 'Arm's length price' as defined in section 92F(ii) of
the Act means a price which is applied or proposed to be applied in a
transaction between persons other than associated enterprises, in uncontrolled
conditions.

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Associated Enterprises:
1.3.7 Sub-section (1) of section 92A of the Act defines the term 'associated
enterprise', in relation to another enterprise, to mean an enterprise which
participates, directly or indirectly through one or more intermediaries, in the
management or control or capital of the other enterprise, in respect of which
one or more persons who participate, directly or indirectly, or through one or
more intermediaries, in its management or control or capital are the same
persons who participate, directly or indirectly, or through one or more
intermediaries, in the management or control or capital of the other enterprise.
This part of the definition is similar to the one established by OECD
guidelines and article in Indian tax treaties addressing transactions with
associated enterprise also has similar definition.
1.3.8 Sub-section (2) of Section 92A of the Act further provides the circumstances
in which enterprises shall be deemed to be associated enterprises at any time
during the previous year for the purposes of sub-section (1) of that section.
1.3.9 In order that the parties involved in an international transaction be termed as

associated enterprises, the relationship shared by such parties should be one as
enumerated in sub-section (2) of section 92A of the Act. In terms of sub-
section (2) of section 92A of the Act, an enterprise would be deemed to be an
"associated enterprise" in relation to another, inter alia, in case of:
 equity holding of at least 26 per cent in the other enterprise;
 control over appointment of more than half of the Board of Directors of

the other enterprise;
 advancing of loans (at least 51 percent of book value assets) or providing

of guarantees (10 percent of total borrowings) to the other enterprise.
 wholly dependent on know-how, patent, business, or commercial rights

etc. provided by the other enterprise.

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 supply of 90% of raw materials, required for manufacture of finished

products by the other enterprise and effective influence of the other
enterprise to determine price and other conditions.
(a) International Transaction:

1.3.10 International transaction" as defined in section 92B of the Act is of wide
amplitude. The essential requirement for a transaction to come within the
ambit of section 92B of the Act is that it should be between two or more
associated enterprises, either of whom is non-resident. It includes all
transactions/ arrangements having a bearing on the profits, income, losses or
assets of such enterprises.
1.3.11 It is further provided that a transaction entered into by an enterprise with a

person other than an associated enterprise shall be deemed to be a transaction
entered into between two associated enterprises if there exists a prior
agreement in relation to the relevant transaction between such other person
and the associated enterprise, or the terms of the relevant transaction are
determined in substance between such other person and the associated
enterprise.
(b) Computation of Arm’s Length Price:

1.3.12 The method of computation of arm's length price is provided for in section
92C of the Act. The section provides that the arm's length price in relation to
an international transaction shall be determined by 'the most appropriate
method' out of the five specified methods, namely, (a) Comparable
Uncontrolled Price Method; (b) Resale Price Method; (c) Cost Plus Method;
(d) Transactional Net Margin Method and (e) Profit Split Method. The
methods are similar to the methods prescribed by OECD. In a case where
more than one price can be determined by the most appropriate method, the
arm's length price shall be the arithmetical mean of such two or more prices.
Section 92C (1) of the Act does not provide for any preference of methods. In
fact, it permits adoption of any of the prescribed methods, which is the most

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appropriate method, similar to the U.S Internal Revenue Service concept of

"best method rule".
1.3.13 'The most appropriate method' is defined in sub-rule (1) of Rule 10C of the
Rules as the method which is best suited to the facts and circumstances of each
transaction and which provides the most reliable measure of arm's length
price. The most appropriate method is to be selected having regard to the
nature of transaction and class of transaction or class of associated persons or
functions performed by such persons. Rule 10C of the Rules inter-alia,
provides for the factors which are to be considered in selecting the most
appropriate method. The major considerations in this regard have been –
 availability, coverage, and reliability of data necessary for

application of the method;
 the degree of comparability existing between the international

transaction and the uncontrolled transaction and extent to which
reliable and accurate adjustment can be made on account of
differences, if any, and the assumptions required to be made for
application of a method.
(c) Comparability Analysis:

1.3.14 Application of the arm's length principle is generally based on a comparison of
the conditions in a controlled transaction with the conditions in an
uncontrolled transaction between independent enterprises. In order for such
comparisons to be useful, the economically relevant characteristics of the
situations being compared must be sufficiently comparable. To be comparable
means that none of the differences, if any, between the situations being
compared, could materially affect the condition being examined in the
methodology (e.g. price or margin), or that reasonably accurate adjustments
can be made to eliminate the effect of any such differences.

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1.3.15 As per OECD guidelines, while applying any of the prescribed transfer pricing
method, adjustments must be made on account of differences between
controlled and uncontrolled situation that would significantly affect the prices
charged or received by an independent enterprise.
1.3.16 OECD guidelines provide that in making these comparisons, material

differences between the compared transactions or enterprises should be taken
into account. In order to establish the degree of actual comparability and then
to make appropriate adjustments to establish arm's length conditions, it is
necessary to compare attributes of the transactions or enterprises that would
affect conditions in arm's length dealings. Attributes that may be important
include the characteristics of the property or services transferred, the functions
performed by the parties (taking into account assets used and risks assumed),
the contractual terms, the economic circumstances of the parties, and the
business strategies pursued by the parties.
1.3.17 Sub-rule (2) of Rule 10B of the Rules refers to comparability of transactions.
Following the lead of OECD guidelines, the following factors are prescribed
in this regard:
 Characteristics of the property or services;

 Functions performed, assets employed and risks assumed;
 Contractual terms of the transactions;
 Market conditions - geographic allocation and size of the markets;
 Cost of labour and capital;
 Economic development; and
 Level of competition.
(d) Evaluation of Separate and Combined Transactions:

1.3.18 The OECD guidelines provide that in order to arrive at the most precise
approximation of fair market value, the arm's length principle should, ideally

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be applied on a transaction-by-transaction basis. However, there are often

situations where separate transactions are so closely linked or continuous that
they cannot be evaluated adequately on a separate basis. Examples may
include (a) long-term contracts for the supply of commodities or services (b)
rights to use intangible property, (c) pricing a range of closely-linked products
(e.g. in a product line) when it is impractical to determine pricing for each
individual product or transaction. Another example would be the licensing of
manufacturing know-how and the supply of vital components to an associate
manufacturer; it may be more reasonable to assess the arm's length terms for
the two items together rather than individually.
1.3.19 Combining more than one transaction becomes all the more necessary where
there exists an intentional set-off - one associated enterprise provides a benefit
to another associated enterprise which is balanced to some extent by different
benefits received from that enterprise in return. In such situation the
enterprises may claim that the benefit received should be set-off against the
benefit each enterprise has provided as full or part payment of those benefits
and only net gain or loss of the transaction need to be considered.
1.3.20 The Indian transfer pricing regulations also provide for the evaluation of
combined transactions. The term transaction has been defined in clause (v) of
section 92F of the Act to include the arrangement, understanding or action in
concert whether or not such arrangement, understanding or action is formal or
in writing. Similar transactions include a number of closely linked
transactions.
(e) Arm's Length Range:
1.3.21 Application of a method may give range of results, which are at arm's length,
but section 92C of the Act requires computation of arithmetical mean in cases
where more than one price is arrived at by the application of most appropriate
method.

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1.3.22 Further, the law provides flexibility to the taxpayers to adopt any prices falling
within (+/-) 5% of arithmetic average of price determined by the most
appropriate method meaning thereby that the tax authorities would not make
any adjustment to the arm's length price adopted by the taxpayer if such price
is 5 % less or 5% more than the arm's length price determined by the assessing
officer.
(f) Documentation:
1.3.23 The transfer pricing regulations provide onerous obligation on the assessee to
maintain prescribed documentation. Section 92D of the Act provides that
every person who has undertaken an international transaction shall keep and
maintain such information and documents as may be specified by rules made
by the Board. The documentation would have to be produced within 30 days
from the receipt of the notice, which is extendable for further 30 days. The
documentation required to be maintained has been prescribed under Rule 10D
of the Rules. The documentation requirement prescribed in the rules does not
apply in a case where the aggregate value of international transactions as
recorded in the books does not exceed Rs. ten million. However, even in such
cases arm's length price in relation to income arising from international
transactions is required to be substantiated on the basis of material available
with the assessee.
1.3.24 The assessee, who has entered into an international transaction, is also
required to furnish along with the return of income transfer pricing audit report
from an accountant in Form No. 3CEB of the Rules.

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II. GROUP OVERVIEW
A. Objective:
2.1 The transfer pricing provisions contained in Chapter X of the Income-tax Act (‘the
Act’) provide that any income or allowance for any expense or interest,
relating to an 'international transaction' between 'associated enterprises', shall
be computed having regard to the arm's length price. Section 92A and 92B of
the Act define the terms 'associated enterprise' and 'international transaction'.
Clauses (a), (b), (c) and (d) of sub-rule (1) of rule 10D of the Rules, as part of
documentation requirements oblige an assessee to, inter alia, provide
description of its ownership structure and interests, profile of the multinational
group of which assessee enterprise is a part, broad description of business of
the assessee and broad description of 'international transactions' entered into
with the associate enterprises, etc.
2.1.1 This part of the study provides an overview of the Sennheiser Electronics
(India) and the multinational group of which it is a part.
B. Ownership Structure:
2.2 Sennheiser Electronics (India) , a private limited company, was incorporated
as a subsidiary company of Sennheiser Global Operations Gmbh. which holds
99.9% of equity, represented by 6,993,000 equity shares of Rs.10 each (fully
paid-up) in Sennheiser Electronics ( India) . The ownership pattern of
Sennheiser Electronics ( India) is shown as under:
Sennheiser Global Operations Gmbh.(99.9%) Sennheiser Electronic

GMBH & Co., Germany(0.1%)
100%
Sennheiser Electronics ( India)

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A. Group Overview:
(Source: the company website www.sennheiser.com)
2.3 Sennheiser Global Operations Gmbh., headquartered in Hannover, Germany

Sennheiser Global Operations Gmbh. found its way into the business world
way back in 1945 by Dr. Fritz Sennheiser manufacturing tube voltmeters.
2.3.1 Sennheiser Global Operations Gmbh., a company incorporated in Germany, is

engaged in the business of distribution of headsets, Sound listening devices.
The range of products offered includes headphones, microphones, wireless
microphones and monitoring systems, conference and information systems as
well as aviation and audiology products.
History
2.3.2 About 62 years back, in 1945, Dr. Fritz Sennheiser together with seven
engineers and technicians set out on the venture to found a new company. The
research and development specialists converted their university institute,
which had been moved during the war to the small village of Wennebostel,
into what became known as "Labor W", and it was there that they began to
build measuring instruments. Less than a year later, microphones were added
to their product range, and soon the resourceful team became extremely
successful in numerous fields of audio technology. Now, for more than 60
years, the name Sennheiser has been synonymous with top-quality products
and tailor-made complete solutions for every aspect of the recording,
transmission and reproduction of sound.
2.3.3 Sennheiser Electronics, now, is a worldwide group of companies operating in
90 countries around the world with more than 2,000 employees and one of the
world´s leading manufacturers of complete audio solutions. Still a family-
owned company, Sennheiser has made a name for itself above all in the
development and manufacture of high-quality microphones, wireless RF
technology and headphones. Conference and information technology, infrared

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systems, products for the hearing impaired and aviation headsets round off the
comprehensive product portfolio. The Sennheiser Group also includes the
studio microphone specialist Georg Neumann GmbH, Berlin, K+H Vertriebs-
und Entwicklungsgesellschaft (loudspeakers and studio monitors) and the
Denmark -based joint venture Sennheiser Communications, which develops
headsets for the PC, office and call center markets.
2.3.4 There have been constant innovations made by Sennheiser, such as the
invention of open-back headphones in the 1960s, infrared transmission
technology in the 1970s, groundbreaking innovations in multi-channel
wireless transmission in the 1980s, head-based surround sound systems in the
1990s and intelligent audio information systems in the new millennium.
2.3.5 The group has its major research and development division in Germany and an
R&D center in California to ensure that the company maintains its
technological lead.
2.3.6 Numerous patents and awards, including two German Innovation Awards, a
Scientific and Engineering Award, an Emmy and a Grammy, are evidence of
the company´s capacity for innovation.
2.3.7 The headquarters of Sennheiser electronic GmbH & Co. KG are in
Wennebostel, which is a part of the municipality of Wedemark. The company
also has production sites at its second German location in Burgdorf
(electronics manufacturing, wireless technology), as well as in Tullamore,
Ireland (headphones production) and Albuquerque, USA (wireless technology
for the American hemisphere). Sennheiser´s products are sold by a worldwide
network of long-standing sales partners and subsidiaries.
2.3.8 In 2008, the Sennheiser Group had sales of approximately EURO 385.8
million, which experienced a nominal decline in turnover of 2.4% as
compared with the previous year.

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D. Company Overview:
Introduction:
2.4 Sennheiser India was set up on January 11, 2007 with an operational service
centre in India. The assessee is into wholesale trading of Headphones,
Microphones (Wired and RF wireless), Aviation headsets, Acoustic equipment
etc. It imports goods from Sennheiser Group Companies for reselling through
Distributors in India.
2.5 Sennheiser India distributes all brands of the Sennheiser group, namely
Sennheiser, Sennheiser Communications, Neumann and Klein and Hummel.
2.6 Its service centre is located in Haryana and it services products within and
outside warranty. It also import spares from Sennheiser group Companies.
Its major product range includes:
 Microphones, Aviation headphones, Spares.

 Earphones, Headphones, Headsets.
 Wired Microphones.
 Box/Speakers.
2.7 Sennheiser Electronics ( India) procures all the electronic components for the
trading operations from its associated enterprises(AE). The assessee does not
purchase any goods from any 3rd party vendor. However, there is no sale to
any AE by Sennheiser Electronics (India) i.e. the ultimate customers for the
traded products are unrelated parties alone. The majority of the sales take
place in the Indian Territory. The customers include Production Studios,
Airlines, Audio & TV Channels, Call Centres in India.
2.8 The AE sells goods to the assessee at a price list which is same for all the
other fellow subsidiaries. The Assessee sells goods to distributors or other
“middle men” at an average price of over 42% margin of sales.

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2.9 A summary of the financial accounts for the year ended 31.3.2009 is as under:
(Figures in INR)
Profit & Loss Account For year ended March
31, 2009
Sales and services(A) 157,611,603
Other income 543,675
Total of Revenue(B) 158,155,278
Cost of goods sold (C ) 91,163,767
Operating and other expenses 96,496,017
Depreciation 1,219,104
Total Expense (D) 188,878,888
Gross Profit E=(A-C) 66,447,836
(i.e. 42% of Sales)
Net Profit/(Loss) before Tax F= (B-D) (30,723,610)
(19% of Tot. Revenue)
Taxes (G) 752,101
Net Profit/(Loss) after Tax H=(F-G) (31,475,711)
III. INDUSTRY SCENARIO
A. Objective:
3.1 As per the documentation requirement provided under the transfer pricing
regulations (section 92D read with Rule 10D(1)(c)) every person who has
entered into an international transaction is required to keep and maintain
information and documents regarding the industry in which the assessee
operates. As per clause (d) of sub-rule (2) of Rule 10B comparability of an
international transaction with an uncontrolled transaction is to be judged, inter
alia, with reference to conditions prevailing in the market in which the
respective parties to the transaction operate, including the geographical
locations and size of markets, overall economic development and the level of
competition etc. OECD Transfer Pricing Guidelines (para 5.22) provides that
"for the purpose of determining the transfer pricing, general, commercial and
industry conditions affecting the taxpayer also may be relevant. Relevant
information could include information explaining the current business
environment and its forecasted changes; and how forecasted incidents

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influence the taxpayer's industry, market share, competitive conditions,

regulatory framework, technological progress and foreign exchange market.”
3.1.1 The current industry scenario, in which the company is operating, to the extent
considered relevant, is discussed in this part of the study.
B. The Consumer Electronics Market Scenario

Global Industry
3.2.1 The consumer electronics market consists of the total revenues generated
through the sale of audio, video, and games console products designed
primarily for domestic use. The audio sector consists of hifi systems, cassette,
CD, Minidisc and MP3 recorders and players, personal stereos, and radios.
The video sector consists of CRT and flat-panel television sets, videocassette
and DVD players and recorders (standalone and integrated with TV sets),
camcorders, digital cameras, and set-top boxes. Games consoles consist of all
hand-held and plug-in consoles. The market is valued at retail selling price
(RSP) with any currency conversions calculated using constant 2006 annual
average exchange rates.
3.2.2 The consumer electronics industry is a global business. In recent years, the
consumer electronics industry is in the midst of a new wave of change,
witnessing a phenomenal growth. It is ushering in a dawn of convergence, of
technologies, products and markets. Consumer electronics appliances such as
digital televisions, portable media players and educational toys are in a state of
constant flux. The convergence of digital-based audio, video and information
technology is a major reason. These changes began nearly two decades ago
and have resulted in an avalanche of state of the art electronic devices in the
market. The demand for a multitude of portable, in-home or in-car consumer
electronic items with multiple functions has increased tremendously.
3.2.3 Digitalization, miniaturization and mobility are the key elements for modern
consumer electronic products. Digitalization transformed the consumer
electronics sector, delivering new and exciting entertainment products that

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have changed the way we live. It paved the way for digital devices such as
camcorders, DVD player/recorder, still camera, computer monitor and LCD
TV. The computer industry has also benefited, making its way into the family
living room. Miniaturization also accelerates the growth of the consumer
electronics industry.
Fundamentally, the changes in the consumer electronics industry are not being
driven by product evolution, but by fluctuations in the industry's business
models. Companies that are capable of change and those that develop branding
will be most successful.
3.2.4 Consumer electronics companies producing computers, televisions, DVD
players and other household electronics face the same challenges as other
consumer goods companies. The lifecycle of consumer electronics products is
shrinking along with severe price deflation, a factor that makes demand,
pricing and promotions management even more challenging. Innovation,
differentiation and flexibility are critical to a company’s survival in the
consumer electronics market. The rapidly falling prices and improved
functionality provided by convergence are influential forces behind the
growing consumer demand for electronic items.
3.2.5 By definition, the buyers of consumer electronics are individual consumers.

The presence of large numbers of small customers in this market immediately
implies low buyer power, since the effect of any individual decision to buy or
not to buy has negligible impact on revenues for players in this market. Also,
as it is most unlikely that potential customers will choose to make their own
electronic products means that the threat of backwards integration can be
neglected.
However, buyer power is seen in the low switching costs incurred by

consumers if they decide to change their supplier. (There may be switching
costs if one manufacturer's music player is incompatible with certain content

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download sites.) In developed-economy markets, brand loyalty may diminish

buyer power, but price sensitivity may outweigh brand awareness in less
affluent societies. Overall, the global market has moderate buyer power.
3.2.6 Consumer electronics devices are manufactured using both commodity and
customized parts. Some large players (eg Sony, Philips, Samsung) are already
integrated backwards, designing and manufacturing semiconductor chips and
LCD screens, while companies specialising in device manufacture are less
prone to move forwards into making consumer products in their own right: it
would require a radically new set of competencies and major investment in
new production facilities. PC and mobile phone makers commonly use EMS
firms, like Flextronics, but this kind of outsourcing is currently relatively rare
for consumer electronics companies, which view manufacturing as a core
competency.
The strongest card in the hand of any supplier is the need of manufacturers to
source low-cost, good quality components, in quantities which reflect
fluctuations in consumer demand. Going forward, the increasing levels of
digitalization in consumer products may mean greater amounts of power being
ceded to chip manufacturers such as Texas Instruments and National
Semiconductor. However, at present, supplier power in this market is weak.
The major players have been household names for many years. Their scale
economies - for example, the financial muscle to develop innovative products,
build brands, and operate in diverse geographical markets - are considerable.
But the barriers to market entry are not insurmountable. To circumvent costly
R&D processes, a new company may gain access to technology through
royalty payments to the developers. Rather than aim for a prestigious brand
identity, a company can compete fiercely on price. In many developed
economies, the growth of nonspecialist distribution channels, such as hard
discounters and supermarkets, offers opportunities to manufacturers offering
low-cost, weakly branded products. In the UK and US, for example, it is not
unknown for supermarkets to sell DVD players for less than $40.

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3.2.7 At the high end of the market, players with core competencies in areas such as
computers are also entering the market, with the convergence of computer,
telecommunications, and consumer electronics technologies a significant
driver. Apple is a prime example of this trend. It is notable that Apple spent
more than two decades developing its competencies in striking visual design
and innovative user interfaces. It was then able to leverage these strengths in
order to produce the iPod.
In less mature markets, the prospect of rapid growth in revenue may be set
against the risks of counterfeiting, and the cost of import tariffs or the need to
establish manufacturing bases, in order to assess the likelihood of the
incumbents facing new competitors. Overall, the threat of new entrants in the
global market is strong.
3.2.8 Consumer electronics may be priced very favorably in comparison to products

with entertainment applications, such as home PCs, or service providers such
as cinemas. This reduces the impact of these substitutes. It is unusual for
developed-economy households not to own a television, for example, even
though similar content is available through other media, and although these
markets are mature there is little sign that people are ceasing to replace or
upgrade their consumer electronics.
3.2.9 The global market is highly competitive. Although the major players operate
in diverse businesses, consumer electronics forms a key segment of their
revenues. Product differentiation is challenging. Much of the underlying
technology is mature, and innovation is rapidly imitated; at a purely technical
level, the performance of existing products is already good. Furthermore,
consumers are free to change their brand allegiances at little cost to
themselves. In the mature markets, demand creation is vital, through the
strengthening of brand identity, and differentiating products in terms of visual
design, while price competition can be particularly important in markets where
consumers have lower disposable incomes.
3.2.10 The consumer electronic market has gained consistent growth over the last 4

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years. As per the study carried out by Consumer Electronic Association

(CEA), due to the Global recession the market will fill the pinch and
experience fall in the next two years.
Indian Industry
3.2.11 The consumer electronics market consists of the total revenues generated
through the sale of audio, video, and games console products designed
primarily for domestic use. The audio sector consists of hifi systems, cassette,
CD, Minidisc and MP3 recorders and players, personal stereos, and radios.
The video sector consists of CRT and flat-panel television sets, videocassette
and DVD players and recorders (standalone and integrated with TV sets),
camcorders, digital cameras, and set-top boxes. Games consoles consist of all
hand-held and plug-in consoles. The market is valued at retail selling price
(RSP) with any currency conversions calculated using constant 2006 annual
average exchange rates.Asia-Pacific comprises Australia, China, Japan, India,
Singapore, South Korea and Taiwan.
3.2.12 Although approximately 40% of India’s population live in serious poverty, the
growing middle class forms a large potential customer base for consumer
electronics. However, levels of disposable income for consumers in this class
may still be low relative to those expected in fully developed economies. This
means greater price sensitivity in the Indian market.

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A protectionist history has led Indian companies in retaining significant share

in several market segments. For example, while the multinationals LG and
Samsung account for around 30% of all colour TVs sold in India, domestic
players BPL and Onida sell over 20% of the total. The scale economies of the
leading incumbents - for example, the financial muscle to develop innovative
products, build brands, and operate in diverse geographical markets, so
protecting overall revenues - are considerable. Indian import tariffs are high,
although falling. If new entrants are to offer products with competitive retail
prices in this price-sensitive market, they must be able to keep their own costs
low enough to absorb the impact of import duties, or else invest capital in
developing manufacturing facilities in India.
There can be difficulties in reaching all potential customers, as distribution

networks can be limited, especially in rural areas. Although these barriers are
not insurmountable, India may be a more difficult market to enter than many
others.
3.2.13 Consumer electronics may be priced favorably in comparison to products with

entertainment applications, such as home PCs, or service providers such as
cinemas. This reduces the impact of these substitutes. Counterfeit products
and grey imports may also be seen as substitutes from the point of view of
manufacturers attempting to compete more straightforwardly.
3.2.14 The Indian market is highly competitive. Although the largest players operate
in diverse businesses, consumer electronics forms a key segment of their
revenues. Product differentiation is challenging. Much of the underlying
technology is mature, and innovation is rapidly imitated; at a purely technical
level, the performance of existing products is already good. Furthermore,
consumers are price-sensitive and free to change their brand allegiances with
no cost to themselves.

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Prospects: The consumer electronic market has huge unexploited potential

considering the growth potential of the following complementary industries.
3.2.15 The Indian economy has been growing at an average growth rate of 8.8%
since the past 4 years (2003-04 to 2006-07).The Industrial and service sectors
have been contributing a major part to the growth, suggesting the structural
transformation within the Indian economy.
The real GDP growth was better than expected in the 1st quarter of 2008,
growing at 8.8% on year-on-year basis. The slow growth in agricultural and
manufacturing sector was mitigated by surge in trade, hospitality,
transportation and telecommunication sectors, which represent 30% of the
economy. India has been one of the fast growing economies in the world
economy, but rapid rising inflation and complexity of it’s democratic structure
is proving the biggest challenge. Like other countries in the world, India has
also been facing testing times in 2008. The inflation reached above 11% and
even touched the highest level seen for a decade. The rising cost of oil, food
and other resources such as steel, cement etc are all playing a negative part.
The foreign reserves have decline in recent years but remained sizable over
$300 billion USD and the external debt is also at 13% after appreciating to
11% in 2007, and the rupee depreciating since beginning of the year 2008,
loosing over 20% against the USD.
3.2.16 Economic downturn slows sales growth

Retail sales growth in the consumer electronics sector slowed in India in 2008
as the global economic crisis brought with it a credit squeeze, making
consumer financing less available and reducing sales of such big ticket items
as LCD and plasma TVs, laptops and in-car DVD players.
Sales of white goods, such as refrigerators and washing machines, seem to
have fared better than sales of consumer electronics during the 2008 festival
season (September/October).

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3.2.17 Old technologies disappear

Analogue products like VCRs, cassette decks and analogue camcorders
virtually disappeared from the retail market in India during the review period.
There was dwindling demand and retailers saw no need to stock these
products.
Analogue cameras and in-car cassette players are expected to experience
reduced sales over the forecast period, with sales likely to continue for only a
couple more years before they too disappear from retailers’ shelves.
The switch from analogue to digital products has led to significant changes in
the structure of the Indian consumer electronics market. During the review
period, mobile phones replaced analogue televisions as the single largest
product in the market.
3.2.18 Falling retail prices get consumers’ attention-Emerging product subsectors,

like portable multimedia players, digital TVs and projectors, saw volume sales
increase significantly in 2008 over prior year as falling retail prices enticed
consumers to buy these once-expensive new products. As well, lower duties,
increased competition and cheaper technology costs contributed to the good
deals many customers got when purchasing consumer electronics products.
Parallel imports and the grey market generate significant retail sales. These
unauthorised imports typically have lower prices than legitimate retail
products, based on importers evading taxes and under-invoicing. Grey market
activity has also resulted in lower prices, especially for portable and in-car
consumer electronics products.
3.2.19 Nokia leads a highly fragmented market- The grey market and direct
imports are also responsible for some of the fragmentation in the Indian
consumer electronics market. The only brand with a double-digit percentage
share in the Indian market is Nokia, through its dominance of the mobile
phone sector. Nokia is not present in any other sector.

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On the other hand, brands like Sony and Philips are present in all of the major
product sectors, and this has helped boost their overall share. In 2008, strong
upward movers included Sony, Apple (with its iPod brand), Acer and Tata
Sky. In contrast, brands losing share included Philips and Videocon.
3.2.20 Expanded distribution is critical-In order to tap semi-urban and rural

demand, companies are expanding their distribution networks in these areas.
The move has positively impacted sales for companies opting for rural
expansion.
However, rural consumers have not been as brand-conscious as their urban

counterparts. Due to the lower prices of unbranded products, rural consumers
have been inclined to buy these products, although they often have poor
quality. As the awareness among rural consumers rises, they are expected to
show a preference for branded products. This is reflected by the fact that
established players are reporting higher sales of products in rural areas.
3.2.21 Domestic manufacturing to expand- iSuppli research expects domestic

manufacturing to be a key characteristic of this growth in the years to come.
Although electronics production has remained a miniscule portion of overall
Indian manufacturing for a long time, the trend is gradually changing. The
government has been focusing increasingly on developing the manufacturing
sector by developing infrastructure, rationalising duties and creating export-
promotion zones. This is in alignment with India figuring into the plans of
several companies that want to cater to the domestic and export markets.
Domestic consumption is reaching significant size to trigger manufacturing in
the electronics sector. India also is assuming a significant place in the global
plans of several major electronics manufacturers, thereby positioning it also as
an export base.
Furthermore, fabless companies are suitable to cater to such development

because they can assist in moving the industry up the value chain by creating
design-service opportunities for the Indian market.

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EMS and ODM companies in India have been associated with several design
companies, although such relationships represent an extension of their global
relationships. However, some local partnerships also are appearing, such as
Flextronics' deal with inSilica for the development of SoC devices.
Currently, such instances are few and far between. As the local market gains
size, these associations will become more common.
3.2.22 Significant challenges remain-iSuppli believes that there are still challenges
facing the India consumer electronics industry as the sector tries to realise its
full potential. These include declining margins for many players; inverted duty
structure; expansion of distribution reach; creating awareness about new
technologies and products and low affordability level of consumer products
among the rural masses.
However, these challenges are gradually being addressed. And looking ahead,
iSuppli believes that India will continue to grow as an important market for
the global consumer electronics industry. The future of India's market is
indeed bright.
3.2.23 Long-term growth still expected to be strong-Sales growth in the consumer

electronics sector over the forecast growth is not expected to be as strong as
that experienced during the review period. This is attributed, in part, to the
economic slowdown that is expected to continue until 2010. As well, several
products that are reaching their saturation points in India’s urban markets will
need to make an impression in the country’s rural markets, and that may be
more difficult than some anticipate.
High-growth subsectors over the forecast period are likely to be receivers for
DTH broadcasting, digital TVs, portable multimedia players and portable
DVD players. Sales of mobile phones are expected to continue to grow based
on increased consumer demand in rural areas.
The Present & Future of Indian Economy

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3.2.24 The CEAMA (Consumer Electronics Appliances Manufacturers Association)

predicts India to lead in steady growth in Consumer Electronic markets
amongst the Developing Countries.
Source: CEAMA
3.2.25 Research suggests the Indian Electronic Consumption will grow to US $ 150
Billion by 2015. This leaves remarkable opportunities of investment and
employment in the sector.
Competitors Profile
3.2.26 Sony India Pvt. Ltd.

Sony India is said to have 25% market share in the consumer electronics
market in India. And is expected to increase the same to 30% with new
product launches, increase in retail presence, competitve pricing, promotions

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and focussed market approch. As per industry analysts, Sony is likely to make
investments in LCD, audio hometheatre, digital imaging and laptop segments.
In India, like other players Sony is also feeling the brunt of higher duty
structures on imports and the depreciating rupee which are coming in the way
of making Sony select product range more affordable.
3.2.27 Philips Electronics India Pvt Ltd.

Philips Electronics India limited intend to position itself as market driven and
people centric company, as part of its vision 2010 strategy. The company
plans to unveil the new range of life style products in India, which will include
a gamut of products like shavers, home appliances and high end LCD
televisions. Philips has been operating in the Indian market for over 75 years
and has a high brand recall in the consumer’s minds. The company is focusing
on healthcare, lighting and consumer durables being its growth segments for
the coming year. It had integrated its erstwhile consumer electronics, domestic
appliances and personal care businesses into single lifestyle portfolio.
Apart from giving its global campaign “Sense and Simplicity” an Indian
touch, Philips also plans to introduce a new range of products across
categories like audio- video, domestic appliances, personal care and lighting
solutions. Philips is also looking at new product areas, where it will create the
customized products and introduce global product lines into the country. It
also plans to strengthen its existing distribution network, which is its key
strength compared to other market players.
3.2.28 Bose
Bose Corporation has presence in 5 verticals namely: home, professional,
automotive, noise reduction and scientific product division. In India,
institutional sales account for large chunk of its revenue. Bose products were
by large perceived to be at the vanguard of the technology, and the brand was

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perceived as an aspiration brand. Initially, its products were sold door-to-door

and later the company established a network of exclusive outlets called Bose
Stores, and shop-in shops in the multi band outlets. Unlike its competition the
Bose stores have limited product portfolio. Bose strategies primary focus on
the product, ensuring all its products are simple and user friendly. Its product
strategy is to offer superior sound and develop a range which is small, elegant
looking and easy to use. As part of its strategy it relies on human factor –
engineer to access human need, design user interface and evaluating the
usablity of the products. Bose is not away from criticism too, which is mostly
centred around its high prices. The success of the company is said to lay on the
fact that Bose products are able to create the feel of live music, which always
has an emotional impact on the listener. Most of the business comes from
word of mouth (recommendation from the customers). Bose is looking
aggressively at India to expand. The company has 16 exclusive company
owned stores in 9 cities spred across the country. It plans to increase the
number of its retail outlets in the country by expanding into tier 2 and tier 3
cities as well. It does not plan for setting up a manufacturing facility but
looking for IT support from India. The company does branding through select
press advertisements. Bose is heavily advertising in all print media for its QC
3 range of noise cancellation product range including daily newspaper across
metros towns and other key cities. Bose has also released ads in vancular
languages like Gujrata and Hindi to create more regional impact as a brand.
For first time Bose has released a consumer offer on its QC3 range, with its
dealer panel consisting of the contact details of the Bose stores across the
country for the magazines and the regional specific information for the
vanaculars.
3.2.29 Creative
In India, Creative brand has a strong presence in the PC & multimedia
industry. Creative is expanding its product range with wide range of

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interactive PDE products that includes MP3 players, portable media centers,
multimedia speakers and headphones, digital and web cameras, graphic
solutions, music key boards and PC keyboards and peripherals. To create
brand awareness in the Indian market, Creative has been advertising in both
print and electronic media. In print media, technology magazines, supplement
of daily newspapers are used specially for its multimedia speaker and PC
related product range. The electronic media, TV (news and other general
entertainment channels) is used to advertise its complete range of products and
specifically the headphone range.
3.2.30 Panasonic
Panasonic India Pvt. Ltd, was established, with the purpose of unifying all
Panasonic operations in India and to provide its customers with a combined
value, synergizing all the strengths of their various organizations into one. Its
various businesses include manufacture, import, marketing and sales of
kitchen appliances and small domestic appliances..
Panasonic will continue to increase its portfolio of product offering with

increasing its presence across various types of outlets in India. The key thrust
has been to establish and develop their exclusive Brand-shops, currently, 47
such exclusive brand-shops are operating in various parts of the country.
Panasonic plans to reach 200 nos. of such shops in the coming years.
Panasonic in India is also supported by a wide dealer and service network. As
far as headphones are concerned, they are sold and marketed only as
accessories and there is not much focus on this category.
3.2.31 Shure/Sun Infonet
Shure is traditionally being distributed through Sun Infonet, on an all India
basis. The global trend of strong presence of Shure is also followed in India
and created over the years the standard precedent of using it’s microphone
model SM58 is also followed here.

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Sun Infonet is a conglomerate of companies which are into diverse businesses,

audio, video, security systems, broadcast & professional equipment, medical
and healthcare technologies. It represents many brands in India, to name a
few, Honeywell, Sony, Allen & Heath, Nexo, Camco, Fischer Amps, etc.
Thus, they can act as a systems integrator and do a lot of planning support for
their customers through a well trained staff and strategically located branch
offices across all metro towns.

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Manufacturing in India: Impact

Assumption: $150B manufactured in India @ same level of value addition as Taiwan today.
$1B opportunity for EDA and Design players
Direct Employment of 3.58M
Indirect Employment of additional 5.77M
>$10B invested in physical infrastructure of industry
Build up of patent assets
Indirect revenue impact of $250B
The Industry end state at 2015 depends on our

collective actions now
Source: Frost and Sullivan.
Source: Frost and Sullivan.

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IV. FUNCTIONAL ANALYSIS
A. Objective:
4.1 As per the documentation requirement in the transfer pricing regulations (section
92D read with clause (e) of sub-rule (1) of Rule 10D) a description of
functions performed, risks assumed and assets employed or to be employed by
the assessee and by the associated enterprise involved in the international
transaction is required to be maintained. For selection of the most appropriate
method, clause (b) of sub-rule (2) of Rule 10C provides for taking into
account, inter alia, the class or classes of associated enterprises entering into
the transaction and the functions performed by them, assets employed or to be
employed and risks assumed by such enterprises. Further, for the purpose of
determining the arm’s length price as per section 92C read with clause (b) of
sub rule (2) of Rule 10B, comparability of an international transaction with an
uncontrolled transaction shall be judged with reference to, inter alia, the
functions performed, taking into account the assets employed or to be
employed and the risks assumed by the respective parties.
4.1.1 Functional analysis is the key for analyzing the nature of international
transactions, for determining where in a group of controlled entities
economically significant activities are performed, as well as to evaluate the
comparability of an uncontrolled and controlled transaction.
4.1.2 OECD Guidelines define functional analysis as "an analysis of the functions
performed (taking into account assets used and risks assumed) by associated
enterprises in controlled transactions and by independent enterprises in
comparable uncontrolled transaction".
4.1.3 OECD Guidelines further explain the process of functional analysis as

follows:

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"1.20 In dealings between two independent enterprises, compensation

usually will reflect the functions that each enterprise performs
(taking into account assets used and risks assumed). Therefore,
in determining whether controlled and uncontrolled
transactions or entities are comparable, comparison of the
functions taken on by the parties is necessary. This comparison
is based on a functional analysis, which seeks to identify and to
compare the economically significant activities and
responsibilities undertaken or to be undertaken by the
independent and associates enterprises. For this purpose,
particular attention should be paid to the structure and
organisation of the group. It will also be relevant to determine
in what judicial capacity the taxpayer performs its functions.
1.21 The functions that taxpayers and tax administrations might

need to identify and compare include, e.g., design,
manufacturing, assembling, research and development,
servicing, purchasing, distribution, marketing, advertising,
transportation, financing, and management. The principal
functions performed by the party under examination should be
identified. Adjustments should be made for any material
differences from the functions undertaken by any independent
enterprises with which that party is being compared. While one
party may provide a large number of functions relative to that
of the other party to the transaction, it is the economic
significance of those functions in terms of their frequency,
nature, and value to the respective parties to the transactions
that is important.
1.22 It may also be relevant and useful in identifying and comparing

the functions performed to consider the assets that are

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employed or to be employed. This analysis should consider the

type of assets used, such as plant and equipment, the use of
valuable intangibles, etc., and the nature of the assets used,
such as the age, market value, location, property right
protections available, etc.
1.23 It may also be relevant and useful in comparing the functions

performed to consider the risks assumed by the respective
parties. In the open market, the assumption of increased risk
will also be compensated by an increase in the expected return.
Therefore, controlled and uncontrolled transactions and entities
are not comparable if there are significant differences in the
risks assumed for which appropriate adjustments cannot be
made. Functional analysis is incomplete unless the material
risks assumed by each party have been considered since the
assumption or allocation of risks would influence the
conditions of transactions between the associated enterprises.
Theoretically, in the open market, the assumption of increased
risk must also be compensated by an increase in the expected
return, although the actual return may or may not increase
depending on the degree to which the risks are actually
realised.
1.24 The types of risks to consider include market risks, such as

input cost and output price fluctuations; risks of loss associated
with the investment in and use of property, plant and
equipment; risks of the success or failure of investment in
research and development; financial risks such as those caused
by currency exchange rate and interest variability; credit risks;
and so forth.

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1.25 The functions carried out (taking into account the assets used
and the risks assumed) will determine to some extent the
allocation of risks between the parties, and therefore, the
conditions each party would expect in arm's length
dealings…………"
4.1.4 Purpose of functional analysis is to assess the role/contribution to the

economic value by each of the associated enterprise in an international
transaction. The compensation earned by each participating associated
enterprise in an international transaction should correspond to their respective
contribution of functions performed, exposure to risk and assets utilised. The
functional analysis focuses on critical functions performed, assets utilised and
risks assumed in performing the functions by each of the entities (associated
enterprises involved). Comparability and economic analysis for determining
the arm's length price is based on the conclusion drawn from the functional
analysis of the enterprises.
4.1.5 Section 92C of the Act provides for determination of arm’s length price in
relation to an 'international transaction' by any of the methods provided
therein, having regard to, inter alia, the nature of the transaction or class of
transaction. Nature and structure of the transaction actually undertaken is the
basis for transfer pricing study. Nature is the characterisation, and structure,
the form. Functional analysis results in characterisation of enterprises
participating in the 'international transaction' in relation to each other.
B. Functions Performed:
Overview:
4.2.1 Sennheiser Logistics Services Gmbh. is supplying the "Electro Acoustic

Products" to Sennheiser India. Sennheiser Logistics Services Gmbh. also
provides the following services to it’s customers:

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Support service and product warranty services:

4.2.2 Sennheiser Logistics Services Gmbh. also bears the support services including
the product quality, replacement and technological obsolescence in respect of
which Sennheiser India grants the product warranty to the end consumers.
Functions performed by Sennheiser Electronics ( India) / Sennheiser

Logistics Services Gmbh.:
Sennheiser Electronics (India) Private Limited (“Sennheiser Electronics
India”) is engaged in selling the product to the ultimate customers in India.
4.3.1 Role of Sennheiser Logistics Services Gmbh.
Sennheiser Logistics Services Gmbh. is responsible for the manufacturing of

product, development and maintenance of technical upgrades, creation of
brands and market demands.
4.3.2 Role of Sennheiser Electronics India
Sennheiser Electronics India is responsible for the altimate consumers in

India. It also is responsible for providing after sales service and to a marginal
extend bears the warranty responsibility.
C. Risks assumed:
(i) Marketing Risk:
4.4 Market risk arises for a business due to the uncertainty in the structure of the
market, demand patterns and needs of customers, costs, pricing etc. Market
risk represents standard risk borne by any enterprise in market driven
transactions and would include the risk associated with failure of the
services/products in the market. Sennheiser Global is solely responsible for

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creating market presence by soliciting business in international market and is

exposed to normal marketing risk. Sennheiser Electronics (India) does not
have any significant exposure to this risk.
(ii) Credit risk:

4.4.1 This is the risk arising from non-payment of dues by customers. As Sennheiser
Electronics ( India) supplies to the ultimate customer, it faces considerable
risk arising out of non-payment of dues from customers.
(iii) Foreign Exchange risk:

4.4.2 This risk arises from any adverse revaluation of assets and liabilities due to
fluctuation in exchange rates, which would eventually have a negative impact
on the profitability of the enterprise.
4.4.3 In respect of invoices raised by Sennheiser Logistics Services Gmbh.. On

Sennheiser Electronics (India). Sennheiser Electronics ( India) bears foreign
exchange risk as such invoices are denominated Foreign currency.
(i) Technology risk:

4.4.4 This risk arises if the market in which the company operates is sensitive to
introduction of new services/products and variants. Hence, in that case,
business units may face loss of potential revenues arising from obsolete Stock
or un saleable products.
4.4.5 All such risks related to change in technology are borne by Sennheiser Global
except to the unsold stock in the hands of Sennheiser India.
(v) Manpower risk:

4.4.6 Any enterprise, which is greatly dependent, for its success, upon quality
personnel with required technical knowledge, is faced with this risk.
Competitive market forces expose such an enterprise to the risk of losing its
trained personnel.

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4.4.7 Sennheiser Electronics ( India) has a skilled workforce to perform the various
functions relating to it’s operations and is, therefore, exposed to the manpower
risk.
(vi) Price risk:

4.4.8 This risk arises as a result of price pressures in the market.
With increased competition, excess capacities worldwide and prevailing

recession, the Consumer Electronics Market has become extremely price
sensitive. No price risk is borne by Sennheiser Global as the altimate
responsibility of sales is casted on Sennheiser Electronics ( India).
D. Assets Employed:
4.5 Any business requires utilisation of tangible as well as intangible assets to
perform various functions so as to earn revenues. In the business carried on by
Sennheiser Electronics (India), the following tangible/intangible assets have
been utilised:
Type of fixed assets Gross block at cost
(as on 31.3.2009)
Leasehold Land -
Leasehold improvements -
Computer Peripherals,Software & 10,01,559
Networking Equipments
Office Equipment 313,060
Furniture & Fixtures 21,480
Tools & Testing Equipment 12,84,217
Total 26,20,316
Intangible Assets:
4.5.1 Sennheiser Electronics India deploys skilled manpower, infrastructure
facilities and necessary administrative assets for carrying out its business.
However, Sennheiser Electronics India does not own any valuable non-routine
intangibles. Sennheiser Electronics India does not spend any significant

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amounts in research and development. Any improvements in processes or

techniques arising out of execution of assignments / projects for Sennheiser
Electronics is the exclusive property of Sennheiser Global.
F. Characterisation:
4.6 Summary of Functional Analysis:
Particulars Participation Participation
of Sennheiser of Sennheiser
Electronics Logistic
( India) Services
Gmbh.
Functions performed
Strategic Planning ●● ●●
Product/ Technology development, ● ●●●
R&D, etc.
IT Enabled Services ●● ●●
Sales & Marketing ● ●●●
Training ●● ●●
Quality control ● ●●●
Administration, purchase, infrastructure, ●●● ●
etc.
General Management Functions ●● ●●
Risks Assumed
Marketing risk ●●●●
Credit risk ●●●●
Foreign exchange risk ●● ●●
Technology risk ● ●●●
Manpower risk ●●●●
Price risk ●● ●●
Service Warranty/Rework Risk ● ●●●
Assets Employed
Tangible assets ●● ●●
Intangible assets ●●●●
4.6.1 In view of the above analysis of functions performed, risks assumed and assets
employed by Sennheiser Electronics ( India), it is possible to characterise
Sennheiser Electronics ( India) under as low-risk-bearing consumer
Electronic Product selling company. Sennheiser Global Operations Gmbh can
be classified as the ultimate supplier, owning significant intangibles and

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entering into contracts with third parties, wherein it acts as a full fledged,
high-risk bearing product seller.
V. ECONOMIC ANALYSIS OF TP METHODS & THEIR

APPLICABILITY
A. Objective:
5.1 Economic analysis refers to application of the most appropriate method to
establish arm's length price in relation to an international transaction entered
into between associated enterprises. Clauses (g), (h), (i), (j), (k), (l) and (m) of
rule 10D of the Rules read with section 92D of the Act require the assessee
entering into an international transaction to keep and maintain, as part of
transfer pricing documentation working of arm's length price, analysis
performed for comparability and adjustments etc. to determine the arm's
length price of international transactions.
B. Prerequisite to analysis:
5.2 On the basis of functional analysis, the international transaction of purchase of
consumer electronics goods by Sennheiser Electronics ( India) from the
associated enterprise(s) (aggregating to a sum of 123.66 million), are covered
under the transfer pricing regulations, and are required to be tested for arm’s
length pricing.
C. Legislative background relating to selection of the most appropriate

method:
5.3 Section 92C of the Act provides that arm's length price in relation to an
international transaction shall be determined by any of the following
prescribed methods, being the most appropriate method, having regard to the
nature or class of transaction or class of the associated enterprise or functions
performed by the entities participating in the transactions.

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(a) Comparable uncontrolled price method (CUP method)

(b) Resale price method (RP method)
(c) Cost Plus method (CP method)
(d) Profit Split method (PS method)
(e) Transactional Net Margin method (TNMM)
5.3.1 Rule 10C of the Rules provides guidelines for selecting the most appropriate
method as follows:
“10C (1) For the purposes of sub-section (1) of section 92C, the most
appropriate method shall be the method which is best suited to the facts
and circumstances of each particular international transaction, and
which provides the most reliable measure of an arm’s length price in
relation to the international transaction.
2) In selecting the most appropriate method as specified in sub-rule (1),

the following factors shall be taken into account, namely: --
(a) the nature and class of the international transaction;
(b) the class or classes of associated enterprises entering into the

transaction and the functions performed by them taking into account
assets employed or to be employed and risks assumed by such
enterprises;
(c) the availability, coverage and reliability of data necessary for

application of the method;
(d) the degree of comparability existing between the international

transaction and the uncontrolled transaction and between the
enterprises entering into such transactions;
(e) the extent to which reliable and accurate adjustments can be made
to account for differences, if any, between the international transaction
and the comparable uncontrolled transaction or between the enterprises
entering into such transactions;
(f) the nature, extent and reliability of assumptions required to be made

in application of a method."
5.3.2 Regulation 482 of IRS regulations in USA also provides several methods for
determining transfer price, and requires that 'The Best Method' be applied to

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determine compliance with the arm's length standard for the controlled
transactions or operations. 'The Best Method' is defined under the USA
regulations as the method which produces the most reliable measure of an
arm's length result for the controlled transaction, considering all of the
relevant facts and circumstances (Reg.1.482-1(c)(1)). There are two primary
considerations that must be taken into account to determine which method is
the best method. The first consideration is the degree of comparability
between the controlled transaction or operation and uncontrolled comparable
transaction, and the second consideration in determining the best method is the
quality of the data and assumptions used in the analysis.
5.3.3 The 'Best Method' rule does not provide for a strict priority in the application
of the specified methods, and no method necessarily will be considered
invariably more reliable than another. There may be several methods that a
taxpayer may use to establish an arm's length benchmark against which its
transfer prices can be measured, or to corroborate the results achieved from
the application of other methods. 'The Best Method' rule is a rule of relative
comparability and reliability, and attempts to take into account all the facts
and circumstances, including the considerations described above with respect
to the application of a specified method, in determining which method is likely
to produce the most reliable measure of an arm's length result.
5.3.4 The Indian regulations provide no priority of methods. Rather, the selection of
the pricing method to be used to test the arm's length character of a controlled
transaction must be made under the 'Most Appropriate Rule', which under the
facts and circumstances of the transaction under review, provides the most
reliable measure of an arm's length result.
5.3.5 The transfer pricing methods described in the transfer pricing regulations are
analytical tools designed to test the arm's length character of transfer pricing
results between controlled parties. No method is itself right or wrong for any

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given set of facts and circumstances. The most appropriate pricing method to
be used to determine the arm's length character of a controlled transaction is
one which, under the facts and circumstances of the transaction under review,
provides the most reliable measure or best estimate of an arm's length result.
5.3.6 The transfer pricing methods that were reviewed on a checking of all the
relevant controlled transactions and operations and the relative reliability of
each specified method applied to the transactions and operations under review
are summarized below:
(a) TNMM -
5.3.7 TNMM examines net profit margin relative to an appropriate base, (e.g., cost,
sales, assets) that the tested party realizes in a controlled situation with that of
the uncontrolled comparables. The OECD guidelines explain the TNMM
method and its strengths in the following paras:
"3.26 The transactional net margin method examines the net profit margin
relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer
realises from a controlled transaction (or transactions that are
appropriate to aggregate under the principles of Chapter I). Thus, a
transactional net margin method operates in a manner similar to the
cost Plus and resale price methods. This similarity means that in order
to be applied reliably, the transactional net margin method must be
applied in a manner consistent with the manner in which the resale
price or cost Plus method is applied. This means in particular that the
net margin of the taxpayer from the controlled transaction (or
transactions that are appropriate to aggregate under the principles of
Chapter I) should ideally be established by reference to the net margin
that the same taxpayer earns in comparable uncontrolled transactions.
Where this is not possible, the net margin that would have been earned
in comparable transactions by an independent enterprise may serve as a
guide. A functional analysis of the associated enterprise and, in the
latter case, the independent enterprise is required to determine whether
the transactions are comparable and what adjustments may be
necessary to obtain reliable results.
b) Strengths and weaknesses

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3.27 One strength of the transactional net margin method is that net margins
(e.g., return on assets, operating income to sales, and possibly other
measures of net profit) are less affected by transactional differences
than is the case with price, as used in the CUP method. The net
margins also may be more tolerant to some functional differences
between the controlled and uncontrolled transactions than gross profit
margins. Differences in the functions performed between enterprises
are often reflected in variations in operating expenses. Consequently,
enterprises may have a wide range of gross profit margins but still earn
broadly similar levels of net profits.
3.28 Another practical strength is that it is not necessary to determine the

functions performed and responsibilities assumed by more than one of
the associated enterprises. Similarly, it is often not necessary to state
the books and records of all participants in the business activity on a
common basis or to allocate costs for all participants. This can be
practically advantageous when one of the parties to the transaction is
complex and has many interrelated activities or when it is difficult to
obtain reliable information about one of the parties. …. "
5.3.8 TNMM was not selected as the most appropriate method for justifying the
arm’s length price of such transactions. Transaction based methods - CUP
method could produce a reliable measure of an arm's length result. Sufficient
comparability to uncontrolled comparables could only be achieved by
application of a directly comparable method, such as the CUP which is based
on reasonable comparability of functions, risks, property employed and
financial results of the relevant transaction.
(b) CUP Method – Why Applied:

5.3.9 CUP method evaluates whether the amount charged in a controlled transaction
is at arm's length with reference to the amount charged in a comparable
uncontrolled transaction to provide a direct estimate of the price the parties
would have agreed to, had they resorted directly to an open market alternative
to the controlled transaction. Similarity of services/products in the controlled
and uncontrolled transactions will have the greatest effect on comparability
under this method. Minor differences in contractual terms or economic

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conditions could materially affect the amount charged in an uncontrolled

transaction. The method becomes a reliable substitute for arm's length dealings
if all significant characteristics of the uncontrolled transactions are
comparable. Thus, the results derived from applying CUP method generally
will be the most direct and reliable measure of an arm's length result for the
controlled transaction, if an uncontrolled transaction has no differences as
compared to the controlled transaction that would affect the price, or if
appropriate comparability adjustments can be made for such differences.
5.3.10 Where there are no differences, or where differences can be adequately

quantified, then, section 92C read with rule 10C of the Rules permits CUP
method to be used. If, however, there are significant differences for which
reliable adjustments cannot be quantified, CUP method will not produce a
reliable measure of an arm's length result. In addition, the reliability of the
results derived from CUP method is affected by the completeness and
accuracy of the data used and the reliability of the assumptions made to apply
the method.
5.3.11 CUP method could be applied for benchmarking the international transactions
as there were internal comparable available so as to apply CUP method as
Sennheiser Logistics Services entered into similar transactions with unrelated
parties. CUP method was therefore applied in respect of such transactions.
(c) Resale Price Method – not applied and Why:

5.3.12 RP method compares gross profit margin earned in a controlled transaction to
gross profit margins earned in similar uncontrolled transactions. The resale
price method is primarily intended to measure the value of the services
performed by a buyer/reseller of services/goods acting as a pure
provider/distributor. Ideally, the provider/distributor should not add a
significant amount of value to the products they resell or valuable non-routine
intangible that may affect the profits earned on the products they resell.

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5.3.13 Under RP method the reseller's gross profit provides compensation for the
performance of resale functions related to the transactions under review,
including an operating profit in return for the reseller's investment of capital
and assumption of risks. The comparison provides an estimate of the gross
profit margin the tested party could have earned had it performed the same
functions with independent enterprises and, therefore, provide an estimate of
the price that would have been paid/charged at arm's length for performing
such functions. Therefore, comparability under this method is particularly
dependent on similarity of functions performed, risks borne, and contractual
terms, or adjustments to account for the effects of any differences in these
factors. Comparability under RP method is less dependent on close physical
similarity between the products in the controlled and uncontrolled transactions
than under CUP method. Substantial differences in the services/products may,
however, indicate significant functional differences between the controlled
and uncontrolled transactions.
5.3.14 The reliability of profit measures based on gross profit may be adversely
affected by significant differences in the value of the services provided and
differences in cost structures, business experience, and management
efficiency. Accordingly, material differences in these factors affect the
reliability of the results derived. If there are material differences between the
controlled and uncontrolled transactions that would affect the gross profit
margin, adjustments must be made with respect to the uncontrolled
transaction. If such adjustments cannot be made with sufficient accuracy to
improve the comparability of the results, the reliability of RP method is
reduced.
5.3.15 In addition, the reliability of the results under RP method is affected by the
completeness and accuracy of the data used and the assumptions made. In
particular, the degree of consistency in accounting practices employed by the
controlled party as compared to the uncontrolled party affects the reliability of

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the results. For example, the controlled party and the uncontrolled comparable
should be consistent in their reporting of items (such as discounts, returns and
allowances, rebates, insurance, and packaging) as between cost of services
provided and operating expenses.
5.3.16 RP method is generally applied in cases of where service provider also

provides services to uncontrolled and not associated firms wherein
reseller/provider of goods/services acting as a pure distributor/provider does
not add significant value to the product for resale. Hence, application of RP
method was not applied in the present case.
(d) Cost Plus Method:- not applied and Why:

5.3.17 CP method evaluates whether the amount charged in a controlled transaction
is at arm's length with reference to the cost Plus mark up realized in
comparable uncontrolled transactions or operations. A producer's cost Plus
mark up provides compensation for the performance of the functions under
review, including an operating profit for the producer's investment in capital
and assumption of risks and thus provides an estimate of arm's length price for
performing such functions. Therefore, comparability under this method, like
RP method is also dependent on similarity of functions performed, risks borne,
and contractual terms, or adjustments to account for the effects of any
differences in these factors and is less dependent on close similarity between
the services in the controlled and uncontrolled transactions than under CUP
method. Material differences in these factors affect the reliability of the results
derived. If there are material differences between the controlled and
uncontrolled transactions that would affect the gross profit margin,
adjustments must be made with respect to the uncontrolled transaction. If such
adjustments cannot be made with sufficient accuracy to improve the
comparability of the results, the reliability of method is reduced.

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5.3.18 In addition, the reliability of the results under CP method is affected by the
completeness and accuracy of the data used, and the reliability of the
assumptions made. In particular, the degree of consistency in accounting
practices employed by the controlled party as compared to the uncontrolled
party affects the reliability of the results derived. An important consideration
while comparing costs (direct and indirect) and expenses (operating and non-
operating expenditure including financing expenditure) is the method used for
recognising these expenses and accountancy practices. The controlled and the
uncontrolled party must be consistent in their reporting of costs as between
cost of service provided and operating expenses.
5.3.19 The application of CP method requires a high level of comparability between

the tested party and the comparable companies used in terms of the intensity
of functions performed, particularly in the level of operating expenses
incurred. This again is subject to wide variation because of the varied nature
and mode of operations in the service sector.
5.3.20 Under CP method, the arm’s length transfer price is determined by identifying
the costs incurred by the provider of the services provided and adding an
appropriate gross profit mark-up to the cost. This mark-up is usually
established with reference to comparable uncontrolled transactions.
5.3.21 With regard to the significant international transaction of Import of Consumer

Electronic Goods from Sennheiser Global Operations Gmbh and is not to be
regarded as service contract and is not remunerated on a cost Plus basis. CP
method, therefore, could not technically be applied as the most appropriate
method. Again, cost Plus method is also a profit-based method and does
operate in a manner similar to that of TNMM. Having regard to the discussion
in the preceding paragraphs, CP method was ruled out as the most appropriate
method to determine the arm’s lengthy price of the ‘international transactions’

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of import of Consumer Electronic Goods by Sennheiser Electronics ( India)

and RPM was applied as the most appropriate method.
(e) Profit Split Method – not applied and Why:

5.3.22 PS method evaluates whether the allocation of the combined operating profit
or loss attributable to one or more controlled transactions is at arm's length by
reference to the relative value of each controlled party's contribution to that
combined profit or loss. The relative value of each controlled party's
contribution to the success of the relevant business activity must be
determined in a manner that reflects the functions performed, risks assumed,
and resources employed by each party in the relevant business activity. A
"comparable profit split" is derived by reference to the combined operating
profit of uncontrolled parties whose transactions and activities are similar to
those of the controlled parties in the relevant business activity. Another
variant, i.e. "residual profit split method” first allocates the profit to the
controlled parties based on their respective routine operations, and the residual
profit is allocated based on each controlled party's contributions of non-routine
intangibles.
5.3.23 PS method is based on comparison of profit margins between independent and

associated enterprises as a means to estimate the profits that one or both of the
associated enterprises could have earned had these dealt solely with
independent enterprises and the payments/receipts for use of their resources in
controlled transactions would have been on arm's length basis. Comparability
under this method is particularly dependent on the similarity of activities and
transactions between the controlled and uncontrolled parties. In addition,
because the contractual terms of the relationship among the participants in the
relevant business activity is a principal determinant of the allocation of
functions and risks among them, comparability under PS method depends
particularly on the degree of similarity of the contractual terms of the
controlled and uncontrolled transactions. The reliability of the results derived

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from PS method depends particularly on the degree of similarity of the

contractual terms of the controlled and uncontrolled transactions and is
affected by the quality of the data and assumptions used to apply the method.
5.3.24 PS method may be applicable when the various entities involved in an inter-
company transaction perform highly integrated operation, sharing more or less
proportionately the risks associated with their respective businesses. Also, in
general, PS method relies primarily on the internal data and assumptions
pertaining to each party to the controlled transaction instead of relying on
comparable uncontrolled transactions as market benchmarks, thus making the
use of the PS method ordinarily less reliable than the other methods.
5.3.25 Sennheiser Global Operations Gmbh. is the economic and legal owner of
significant intangible assets and does not share their ownership with
Sennheiser Electronics ( India) . Therefore, any allocation of the combined
profits or losses attributable to the transactions between Sennheiser Global
Operations Gmbh. and Sennheiser Electronics ( India) according to sales,
assets, expenses or any other allocation measure is likely to result in
Sennheiser Electronics ( India) receiving either too much or too little profit
depending on the overall profitability of the consolidated transactions. As a
quality improvement support services provider, Sennheiser Electronics ( India)
should achieve an amount of profit that is consistent with the other comparable
service provider.
5.3.26 In addition, since Sennheiser Global Operations Gmbh is engaged in

transactions with multiple related and unrelated parties, application of PS
method would require segmenting Sennheiser Global Operations Gmbh.’s
financial statements to reflect only transactions relevant to the business of
Sennheiser Electronics ( India) and consolidating these financial statements
with Sennheiser Electronics ( India) ’s financial statements. Performing this

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type of segmentation and consolidation would be extremely difficult and

unreliable.
5.3.27 PS method was rejected as the most reliable measure of an arm's length result
with respect to the transactions or operations under review, for the following
reasons: (i) the two associated enterprises do not share integrated operations,
equivalent intangibles and does not perform similar functions or assume
similar risk and intangibles that it would be appropriate to consider a profit
split; or (ii) the operations of Sennheiser Electronics India and Sennheiser
Electronics US are distinct such that there is no difficulty in evaluating either
entity separately.
5.3.28 The following table provides the factors in order to compare and analyse the
applicability of each method.
TABLE - A
Factors determining the applicability of the methods. Applicability
to Sennheiser
Electronics
( India)
TRANSACTIONAL NET MARGIN METHOD
(not applied)
 Identification of function of Sennheiser Electronics Y

( India)
 Identification of appropriate base Y
 Identification of comparable Y
 Identification of the appropriate margins to be applied. Y
 Identification of adjustments N
 Adjustment of net margins on the basis of the above N
adjustments.
 Application of method to Sennheiser Electronics N
( India)
CUP METHOD ( applied)
 Identification of price paid to related party. Y

 Identification of price paid to/charged from non- Y

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associated entity for the same services as procured

from related party.
 Identification of price paid for similar services Y
procured by other party.
 Application of method to Sennheiser Electronics Y
(India).
COST PLUS METHOD (not applied)

 Identification of the transaction. Y
 Determination of cost base for the transaction. Y
 Identification of similar service provider. N
 Identification of direct/indirect cost of similar service N
provided in similar transaction.
 Identification of gross margin in similar transaction N
 Identification of adjustments to be done with N
Sennheiser Electronics ( India) .
( India) .
PROFIT SPLIT METHOD (not applied)
 Identification of function of Sennheiser Electronics Y
( India) .
 Identification of function of AE. N
 Determination of the integration of the function of N
Sennheiser Electronics ( India) .
 Determination of FAR of Sennheiser Electronics Y
( India) .
 Determination of comparable of Sennheiser N
Electronics ( India)
 Determination of comparable of AE. N
 Identification of adjustments. N
( India) .
RESALE PRICE METHOD (applied)

 Identification of services provided. Y
 Identifying the function as provider of services. N
 Identification of internal/external data to determine Y
ALP.
( India) .

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D. Application of Transfer Pricing Methods by Sennheiser Electronics India

5.4 Following is a summary description of the application of the most appropriate
method applied by Sennheiser Electronics (India) with respect to the
international transactions under review for the financial year 2008-2009:
I. CUP method is applied on the following transactions:

5.4.1 Sennheiser Electronics (India) has entered into international transactions with
Sennheiser Global Operations Gmbh an associated enterprise, during the
financial year 2008-09 for import of trading goods. The total consideration
paid is Rs.81,443,102.
II. Application and meaning of CUP method:

5.4.2 CUP examines the price of product or services involved in the transaction
between the associated enterprises with the price of similar transactions
entered by the associated enterprises with an unrelated enterprise on similar
set of condition and equivalent economic conditions.
5.4.3 The first step in applying CUP is to choose one of the parties to the controlled
transaction or operation under review as the "Tested Party". The Tested Party
is usually the participant in the transaction or operation for which profitability
most reliably can be ascertained and for which reliable data on comparable can
be found. The next step is to characterize the Tested Party based on the
functional analysis and undertake a search for comparable engaged in similar
functions as the Tested Party. The third step is to determine an arm's length
price based on the price with respect to the price on a similar uncontrol
transaction with non AE after suitable adjustment for dissimilar functions, risk
factors economic conditions and product quality attributes etc. If the Tested
Party's price are favourable to the benchmarked uncontrolled price, the
transfer prices are deemed to be in compliance with the arm's length standard.
(a) Selecting the Tested Party and its characterization:

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5.4.4 The Tested Party is the enterprise whose prices/profit margin would be tested
or benchmarked using the most appropriate method. USA regulation 482
provides that one of the parties to the controlled transactions to be tested under
CUP will be the party whose price can be verified using the most reliable data
and requiring the fewest and most reliable adjustments and for which data
regarding uncontrolled comparables can be located. Consequently, in most
cases the tested party will be the least complex of the controlled taxpayers and
will not own valuable intangible property or unique assets that distinguish it
from potential uncontrolled comparables.
5.4.5 Sennheiser Global Operations Gmbh is involved in complex business

operations and is engaged in several businesses. It has diverse transactions
with several unrelated parties, is engaged in complex R&D operations and
owns valuable intellectual property rights. Therefore, comparability
adjustments that would be required for, segregation of (i) costs/profits and (ii)
net operating assets/receipts of Sennheiser Global Operations Gmbh that are
attributable solely to related party transactions with Sennheiser Electronics
( India) , would be complex and unreliable, if Sennheiser Global Operations
Gmbh were to be selected as the Tested Party. The costs incurred and the
operating assets owned by Sennheiser Electronics (India) are, on the other
hand, generally easily segregated and identified.
5.4.6 For purposes of this study, Sennheiser Electronics (India) is selected to be the
Tested Party because their operating profit attributable to the controlled
transactions or operations could be reliably verified and requires fewest
adjustments. Sennheiser Electronics (India) has been characterized as service
provider as determined by the results of the functional analysis. Sennheiser
Electronics ( India) is engaged in substantially routine and less complex
operations involving insignificant R&D as compared to Sennheiser Global

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Operations Gmbh and does not own unique or valuable tangible or intangible
property, which might distinguish it from potential comparables.
c) Search of comparables:
I. Search of Internal Comparables for Application of CUP :
5.4.11 For application of CUP for benchmarking the international transactions
entered into by an entity, both internal as well as external comparable can be
used. However, the use of external comparables is advisable only in case
where the entity does not enter into similar transactions with unrelated third
parties in similar economic environment of the transactions under scanner.
5.4.12 Clause (a) of Sub-rule (1) of Rule 10B of the Income-tax Rules provides for
manner of application of Comparable Uncontrolled Price Method as under:
“(i) the price charged or paid for property transferred or services provided in
a comparable uncontrolled transaction, or a number of such transactions,
is identified;
(ii) such price is adjusted to account for differences, if any, between the
international transaction and the comparable uncontrolled transactions
or between the enterprises entering into such transactions, which could
materially affect the price in the open market;
(iii) the adjusted price arrived at under sub-clause (ii) is taken to be an arms
length price in respect of the property transferred or services provided in
the international transaction;”
5.4.13 The OECD guidelines, too, provide in this regard as under:
Comparable Uncontrolled Price (CUP) method compares the price at which a

controlled transaction is conducted to the price at which a comparable
uncontrolled transaction is conducted. Comparability between a controlled and
uncontrolled transaction exists when there are no differences between these

MEHRA GOEL & CO.
61
transactions or, if there are differences, when such differences do not have a
material effect or for which reasonable adjustments can be made. Hence, an at
arm's length transfer price can be determined through a comparison with the
sales price between two unrelated corporations executing a (comparable)
transaction However, the fact that virtually any minor difference in the
circumstances of trade (billing period, amount of trade, branding, etc.) may
have a significant effect on the price makes it exceedingly difficult to find a
transaction--much less transactions--that are sufficiently comparable.
Should they exist, such comparable transactions fall into two categories:
external comparables and internal comparables. The former is a comparable
uncontrolled transaction in the purest sense of the term--if Company A, in
France, sells widgets to its subsidiary A(sub) in Turkey, then an external
comparable transaction would be the sale of widgets from an unrelated French
Company B to an unrelated Turkish Company C on comparable terms as the
trade between Company A and its subsidiary A(sub). An internal comparable
transaction, then, would be either the trade of widgets between Company A
and an unrelated Company C, or the trade of widgets between an unrelated
Company B and Company A's subsidiary, with the term "internal" referring to
the fact that one of the parties involved in the tested transaction is also
involved in the comparable uncontrolled transaction
E. Conclusion:
5.5 Sennheiser Global Operations Gmbh entered into contract with related party
customer for the supply of earphones and performs marketing function and
undertakes significant marketing risks. While Sennheiser Electronics (India)
also performs the marketing function, it does not undertakes significant
corresponding risks. A substantial function relating to such quality
maintenance, product improvement, technical upgradation etc. are performed
by the AE which also assumes enterprise risk, such as, marketing risk, credit

MEHRA GOEL & CO.
62
risk, etc. As Sennheiser Electronics (India) operates as a contract retailer , it

does not undertake such enterprise risk.
5.5.1 Further, under the Indian Transfer Pricing Regulations, proviso to sub-section
(2) of section 92C of the Act provides that assessee has an option to take the
arm’s length price determined by applying the most appropriate method at a
variance of +/(-) 5% of the arithmetic mean of the prices determined applying
such method.
5.5.2 The price at which Sennheiser India imports form its AE were compared with
the catalogue price of AE to other entities (Detailed comparison refered in
Annexure-B). It was observed that Sennheiser imports at a much cheaper price
than its counter part. Hence it can be concluded that Sennheiser India is within
the safe harbour of arm’s length pricing applying the CUP method.
5.5.3 Having regard to the aforesaid analysis, the international transactions of

import entered into by Sennheiser Electronics (India) with Sennheiser Global
Operations Gmbh. are considered being at arm’s length applying the CUP
method which is identified as the most appropriate method in terms of section
92 of the Act.
5.5.4 Further, it is recommended for Sennheiser Electronics India to make review of

and frame its pricing policy accordingly based on the significant changes in
the functions or economic character surrounding this study that are the subject
matter of arm’s length character of inter company pricing.

MEHRA GOEL & CO.
63
ASSUMPTIONS AND LIMITATIONS
1. The analysis in the transfer pricing study are based on review of the company's
relevant business and financial data, information and explanations as provided
by the company officials subjected to our limited verification of the same.
2. The transfer pricing study is based on our reasonable interpretation of the

Indian Transfer Pricing Regulations and are not binding on the tax authorities.
The study should not be taken as assurance that the tax authorities would agree
with the conclusions arrived at in the report.
3. Chapters of the report regarding Industry Scenario is based on published

information and interviews conducted with the company official.

MEHRA GOEL & CO.

Sennheiser Electronics (India) Private Limited: Transfer Pricing Documentation

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SENNHEISER ELECTRONICS (INDIA)

TRANSFER PRICING DOCUMENTATION

Analysis of International Transactions with

FISCAL YEAR ENDED MARCH 31, 2009

MEHRA GOEL & CO

TRANSFER PRICING ANALYSIS – FINANCIAL YEAR 2009

Clauses of Paragraph Page

II. Group Overview (a),(b),(c),

III. Industry Scenario (c)

IV. Functional Analysis (e)

V. Economic Analysis (f),(g),(h).