How we calculate margins and ranges
This page sets out how TP Bharat turns a company’s accounts into a margin, how the range is worked out, and how each company in an Arm’s Length Analysis is reviewed by our Transfer Pricing team.
Operating profit
A published profit and loss account mixes operating and non-operating items. Before we calculate any margin, we rearrange each company’s accounts like this:
| Item | What it includes |
|---|---|
| Operating revenue | Revenue from operations: sales of goods and services and other operating income |
| Operating cost | Materials and goods purchased (adjusted for stock), employee cost, other operating expenses, depreciation and amortisation |
| Operating profit | Operating revenue less operating cost |
| Gross profit | Operating revenue less the cost of goods sold |
| Left out | Other income such as interest and dividends, finance costs, exceptional and prior-period items, and foreign exchange (except in the forex versions) |
Where the accounts report a total and its parts, we count only one of them, so costs are not counted twice. Every workbook includes a reconciliation so this can be checked.
Profit level indicators
| PLI | Calculation | Usually used for |
|---|---|---|
| OP/TC | Operating profit ÷ total operating cost | Service providers and contract manufacturers paid on a cost-plus basis |
| OP/Sales | Operating profit ÷ operating revenue | Distributors and traders |
| Cash profit / Sales | (Operating profit + depreciation) ÷ operating revenue | Businesses where depreciation policies differ a lot |
| GP/Sales | Gross profit ÷ operating revenue | Resale price method for distributors |
| OP / VAE | Operating profit ÷ (operating cost − cost of materials and goods) | Where pass-through costs carry no mark-up |
| Berry ratio | Gross profit ÷ operating expenses other than cost of goods | Low-risk distributors and agents |
| With forex | Any of the first five, with exchange gains and losses treated as operating | Exporters, where forex is part of the business |
You choose the PLI when you set up a search. An Arm’s Length Analysis can show more than one for the same set of companies.
Three-year margins
A company’s margin for the period is a weighted average: the total of its operating profit for the three years divided by the total of its cost (or sales) for the same years. It is not the average of three yearly percentages, so a larger year counts for more. The yearly margins are shown alongside.
The search also shows how many years of data each company has, so a company with a missing year is easy to spot.
The range
With six or more comparables, the range is the 35th to the 65th percentile, as Rule 10CA requires. The percentiles are found by position in the sorted list, not by interpolation: multiply the number of companies by the percentile; if the result is a whole number, take the average of that value and the next one, otherwise round up to the next position.
If the price is inside the range, it is accepted as arm’s length. If it is outside, the median is used. For regional and global files we can also give the OECD interquartile range, which uses interpolation.
Fewer than six companies
With fewer than six comparables, the arithmetic mean applies. The price is accepted if the arm’s length price differs from it by no more than the notified tolerance: 1% for wholesale trading and 3% in other cases in recent years.
The tolerance is tested on the price, not the margin, so we convert the margin to a price using the tested party’s own cost or sales. If the tested party’s margin is above the range, no adjustment is made, because Transfer Pricing cannot reduce the income taxable in India.
Reviewing each company
Filters narrow the list. The review decides it. In an Arm’s Length Analysis, every company that passes the filters is marked accept, reject or look again, with a reason from a fixed list and a comment in our own words. Companies removed by a filter carry that filter as their reason.
| Decision | Reasons used |
|---|---|
| Reject | Functionally different · related-party transactions above 25% · persistent losses · merger, demerger or other exceptional event · significant intangibles, R&D or brand · different accounting year · government controlled · not enough reliable data · scale not comparable · other |
| Accept | Functionally comparable · same products or services · same industry and market · business description matches · comparable segment · other |
| Look again | Check the annual report · segment data needed · check related-party transactions · business description unclear · other |
While reviewing, we have each company’s business description, industry and products, related-party share and full statements in front of us, and the decision is recorded against the company.
What you receive
An Excel workbook in the layout Indian reviewers expect: a lead sheet with the companies accepted and rejected at each filter, one sheet per filter, the business description review, the PLI working for each comparable (latest year first, with formulas) and one benchmarking sheet per PLI with the 35th percentile, median and 65th percentile. The Word report sets out the identification of comparables, the database, the years, every search step, the summary table, the financial analysis, the business descriptions and the conclusion, with the accept / reject matrix as an appendix. See the sample report.
Each analysis notes the version of our calculation rules it used, so the same figures can be reproduced later.
Try a search on your own case
It is free and you do not need an account. Company names stay hidden until you order the analysis.