Transfer pricing is a critical concept in international business and taxation, ensuring that transactions between related companies are conducted at arm’s length prices. This article explores the definition, importance, methods, documentation, and regulatory framework of transfer pricing in India, along with the penalties for non-compliance and the concept of advanced pricing agreements (APA).
SCOPE OF PRESENTATION
- Definition of Transfer Pricing
- Explanation on Need of Transfer Pricing
- Illustration Drawing the Importance of Transfer Pricing
- Transfer Pricing in India
- Transfer Pricing Documents
- Transfer Pricing Methods for Determining Arm’s Length Price
- Penalties for Non-Compliance
- Advanced Pricing Agreement
TRANSFER PRICING
Meaning :-
Transfer pricing refers to the prices of goods and services that are exchanged between companies under common control.
For example, if a subsidiary company sells goods or renders services to its holding company or a sister company, the price charged is referred to as the transfer price
Transfer pricing allows for the establishment of prices for the goods and services exchanged between subsidiaries, affiliates, or commonly controlled companies that are part of the same larger enterprise
ILLUSTRATION
Suppose, X Ltd. got an contract to supply good A to Y Ltd resident of Dubai from India worth Rs. 500 million having a Net profit margin of 25%. After supplying the goods, the Net profit of X Ltd. Will be 125 million which will create a tax liability of Rs. 37.5 million. (Assuming tax rate of 30%)
This is a Win-Win Situation cause, Company has made a Net profit (after tax) of Rs. 87.5 and tax department has collected their taxes.
But the problem comes here (continue…)
Ltd will set up an Entity A in some tax Heaven country (or where the tax rate is low) and they will transfer the goods from X ltd to A, which will eventually transfer the good to Y Ltd.
But here is the catch, X Ltd will transfer the goods to A at the cost or with some minimum profits. So that, X ltd liability to pay taxes in India can be minimised.
Being Entity A register in a tax heaven country, it will not have to pay any taxes. So the entire profits of 125 Million goes tax free.
To make sure that, the Transactions are at a Arm’s length Price, Transfer Pricing is necessary
TRANSFER PRICING IN INDIA
Introduction :-
Hence to prevent such avoidance of tax in India by manipulation of Transfer prices, the government has Introduced the Detailed transfer Pricing regulation in India in 2001. The Indian TP Regulations are contained in Chapter X of the Income-tax Act, 1961 (“the Act”) under the title “Special Provisions relating to avoidance of tax”.
Development :-
Over the past two decades the regulations have evolved in order to catchup with both global and local developments. Introduction of the domestic transfer pricing regime and the Advance Pricing Agreement programme in 2012, the Safe Harbour rules in 2013, the framework for use of multiple year data and range concept in benchmarking analysis, three tier TP documentation structure as per BEPS (Base Erosion and Profit Shifting) Action Plan 13 in 2016, Secondary adjustment provisions and limiting interest deduction for thinly capitalized companies in 2017 are examples of evolution in the Indian TP Regime.
OECD (Organization for Economic Cooperation and Development) guidance:-
India is not a member of the OECD. However, India is a key partner country that actively participates in various committees, workshops and working groups of the OECD. The OECD and India have enhanced their co-operation in dealing with issues related to transfer pricing and to promote better tax compliance in order to improve the prevention of cross border disputes. As part of the G-20 group, India has played an active role in the OECD’s project for prevention of Base Erosion and Profit Shifting (BEPS) and is committed to the outcomes of the BEPS project.
Indian TP Regulations do not make a mention of the OECD TP Guidelines (updated in January 2022). However, the TP legislation in India is broadly based on the OECD TP Guidelines including the contents of the three-tier TP documentation structure, transfer pricing methods etc. Both the taxpayers and the Revenue authorities have placed reliance on the OECD TP guidelines especially in cases where guidance is not available under the domestic legislation. Similarly, the principles laid down in the OECD TP guidelines have been relied upon in several judicial rulings in India.
TRANSFER PRICING METHODS I N INDIA
The Indian TP Regulations prescribe the following six methods for determination of the arm’s length price:
1. Comparable uncontrolled price method;
2. Resale price method;
3. Cost plus method;
4. Profit Split Method;
5. Transactional net margin method; and
6. Other method*
*The sixth method (other method) has been prescribed by the Central Board of Direct Taxes (‘the CBDT’) as any method which takes into account the price which has been charged or paid, or would have been charged or paid, for the same or similar uncontrolled transactions, with or between non-associated enterprises, under similar circumstances, considering all the relevant facts.
There is no hierarchy in selection of methods and the most appropriate method can be any of the six prescribed methods. Selection of methods depends upon requirements and the needs of the user.
TRANSFER PRICING DOCUMENTATION
International Transactions:- Section 92 of the Income Tax Act and Rule 10D of the Income-tax Rules, 1962 (Rules) Mandates that TP documentation is required to be maintained by the Taxpayers where the aggregate value of international transactions with their Associated Entities exceeds INR 10 million.
Domestic Transactions:- Section 92 of the Income Tax Act and Rule 10D of the Income-tax Rules, 1962 (Rules) Mandates TP documentation is required to be maintained by the Taxpayers where the aggregate value of international transactions with their Associated Entities exceeds INR 10 million.
Content:- The prescribed documentation includes ownership structure, profile of multinational group, business description, nature and terms of international/ specified domestic transactions, functional asset & risk analysis, TP methods considered and analysis under those methods, budgets, forecasts & estimates, industry analysis and reports, any other information relevant for demonstrating the arm’s length standard of international/ specified domestic transactions.
Time Limit:- The TP documentation is to be maintained every year by the due date of filing Accountant’s Report in Form no. 3CEB, which is 31 October 20XX. The TP documentation is required to be submitted before the revenue authorities when information for the same is called for during the TP audits.
PENALTIES
Various penalties under the Indian TP Regulations are as follows:
a) Failure to maintain specified documents/ information:- Failure to report transactions in Form no. 3CEB and TP documentation, maintenance of incorrect information, failure to submit information during TP audits – 2% of the value of international/domestic transaction
b) Failure for filing of Form no. 3CEB – INR 0.1 million
c) Underreporting or misreporting of income – 50% of tax amount in case of underreporting and 200% of tax amount in case of misreporting
d) Concealment of income or furnishing inadequate particulars of income in respect of Arm’s length price (ALP) adjustments – 100% to 300% of the tax sought to be evaded
Penalties can be condoned where the taxpayer is able to demonstrate reasonable cause to support its position or delay in filings. The taxpayers can also prefer appeal before the appellate authorities against an order imposing penalty.
ADVANCE PRICING AGREEMENT (APA)
Definition : –
An APA is an agreement between a tax payer and tax authority Determining the transfer pricing methodology for pricing the tax payer’s international transactions for future years. The methodology is to be applied for a certain period of time based on the fulfillment of certain terms and conditions (called critical assumptions).
Introduction of APA in India:-
The APA programme was introduced in India in the Finance Act, 2012 and ever since its utility as an alternative transfer pricing dispute prevention mechanism has increased among taxpayers. As per CBDT’s annual report for FY 2018-19 on Indian APAs, India received most number of APA applications globally after USA in FY 2018-19.
Success of the APA programme:- It was introduced in India in the Finance Act, 2012 and ever since its utility as an alternative transfer pricing, dispute prevention mechanism has improved among taxpayers. As per CBDT’s annual report for FY 201819 on Indian APAs, India received most number of APA applications globally after USA in FY 2018-19.
As per CBDT’s Annual Report on Indian APA Programme released in December 2019, a total of 1,155 APA applications have been filed till FY 2018-19 which included 944 unilateral APA applications and 211 bilateral APA applications. Out of 1,155 APA applications filed 271 have been signed till FY 2018-19 (240 unilateral and 31 bilateral). Based on information available in the public domain, the total number of signed APAs increased to 421 till 31st March 2022.
SAFE HARBOUR PROVISIONS:
The Indian Safe harbour rules are an optional dispute avoidance mechanism that prescribe the minimum cost plus mark – up / transfer price that an eligible tax payer has to maintain in relation to eligible categories of international transactions for a specified block of financial years (FYs).
At present, safe harbour rules have been prescribed for the following international transactions:
1. Provision of software development services
2. Provision of IT-enabled services
3. Contract R&D services relating to software development
4. Contract R&D services relating to pharmaceutical drugs
5. Granting intra group loans denominated in Indian currency and Foreign currency
6. Providing corporate guarantee
7. Manufacture and export of core auto components
8. Manufacture and export of non-core auto components
9. Availing of low value adding intra-group services
Conclusion: Transfer pricing regulations are essential to prevent tax evasion and ensure fair tax distribution among jurisdictions. India’s TP regulations, aligned with global standards, have evolved significantly to address contemporary challenges. Understanding these regulations is crucial for multinational enterprises operating in India to ensure compliance and avoid penalties. Advanced pricing agreements further provide a mechanism for dispute prevention, enhancing the certainty and stability of tax obligations.
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