Introduction to Transfer Pricing
I. Terms to understand:
1. Transfer Pricing– In general, refers to price agreed for transfer of goods, services and technology between Associated enterprises (generally referred as related parties) or between unrelated parties which are controlled by a common party.
2. Associated Enterprises (AEs)- Direct/indirect participation in the management, control or capital of an enterprise by another enterprise [OR] same person in both the enterprises.
3. International transaction– transaction between two (or more) Associated enterprises (AEs), where either of them are non-resident, for sale, purchase or lease of tangible or intangible property, provision of services, cost-sharing arrangements, lending/borrowing of money etc…
4. Deemed international transaction- a transaction with unrelated party shall be deemed to be an international transaction with AE, if
i. There is a prior agreement between such unrelated party and AE or
ii. The essential terms are determined by such person and AE relevant to the above referred transaction.
5. Specified domestic transaction (SDT)– transactions with certain related domestic parties, if the aggregate value of such transactions exceeds Rs.20 crores during the financial year.
1. Report-3CEB: Every person who has entered into an “international transaction” or “specified domestic transaction” during the year, shall obtain a report in Form 3CEB and furnish on or before the filing of income tax return (i.e. 30th November).
2. Documentation: Every person who has entered into an “international transaction (aggregate value > Rs.1 crore)” or “specified domestic transaction” during the year, shall maintain prescribed information and documents (i.e. TP documentation)]
3. Penalties for non-compliance: The penal provisions for non-compliance with TP provisions severe and the same are discussed in the article.
Objective of Transfer Pricing:
In our recent discussions, we had come across that many of the business people and few of the professionals were not aware/familiar with the Transfer Pricing (TP) provisions and the related compliances. This document is intended to provide the basic knowledge of the same.
1. What is Transfer Pricing?
2. When the TP regulations were introduced in India?
i. Various transfer pricing methods
ii. Impose extensive annual transfer pricing documentation requirements and
iii. Contain harsh penal provisions for noncompliance.
3. Who are Associated Enterprises (AEs)?
AEs – In general, direct/indirect participation in the management, control or capital of an enterprise by another enterprise [OR] same person in both the enterprises.
Certain specific parameters have been laid down based on which two enterprises would be deemed as AEs. These parameters include:
4. What all types of transactions covered under TP?
i. Inter-national Transaction
Inter-national transaction– means
a) a transaction between two (or more) AEs
b) At least one of them must be a non-resident
Following transactions with AEs covered under inter-national transactions:
a) Purchase/sale/transfer/lease/use of Tangible Property including building, transportation vehicle, machinery, equipment, tools, plant, furniture, commodity or any other article, product or thing
b) Purchase, sale, transfer, lease or use of intangible property, including the transfer of ownership or the provision of use of rights regarding land use, copyrights, patents, trademarks, licenses, franchises, customer list, marketing channel, brand, commercial secret, know-how, industrial property right, exterior design or practical and new design or any other business or commercial rights of similar nature
c) Capital financing, including any type of long-term or short-term borrowing, lending or guarantee, purchase or sale of marketable securities or any type of advance, payments or deferred payment or receivable or any other debt arising during the course of business
d) Provision of services, including provision of market research, market development, marketing management, administration, technical service, repairs, design, consultation, agency, scientific research, legal or accounting service
e) a transaction of business restructuring (i.e. operational change or organizational change) or re-organisation, whether or not it impacts on the profit, income, losses or assets of such enterprises at the time of the transaction or at any future date
f) Cost-sharing agreement or arrangement
Business restructuring – Could be:
ii. Deemed Inter-national transaction
i. There exists a prior agreement between such other person and AE
ii. The essential terms are determined by such other person and AE relevant to the above referred transaction.
iii. Specified domestic transaction (SDT)
i. Any expenditure with respect to which deduction is claimed while computing profits and gains of business or profession (i.e. deductions u/s 80C to 80U)
ii. Any transaction related to business eligible for profit-linked tax incentives, for example, infrastructure facilities (Sec 80-IA) and SEZ units (Sec 10AA)
5. What is arm’s length price (ALP)?
ALP – means a price which is agreed or proposed to be agreed in a transaction between persons other than associated enterprises, in uncontrolled conditions (i.e. open market).
Accordingly, ALP demonstrates that the price that should have been charged between related parties, if those parties were not related to each other.
6. Types of methods prescribed for computation of ALP?
i. Comparable Uncontrolled Price (CUP) Method
ii. Resale Price Method (RPM)
iii. Cost Plus Method (CPM)
iv. Profit Split Method (PSM)
vi. Any Other Method
7. What type of information and documents to be maintained?
Shall keep and maintain the following information and documents in respect of “international transaction” or “SDT”:
i. Enterprise-wise documents:
a) Ownership structure of the enterprise (i.e. “assessee) including details of shares held by other enterprises_ Shareholding Structure.
b) Profile of the multinational group in which assessee is a part including name, address, legal status and country of tax residence of all the enterprises with whom assessee entered into international transaction and relationship among them_ Group Overview.
c) Broad description of the business of assessee, associated enterprises and the industry in which assessee operates_ Business and Industry Overview.
ii. Transaction-specific documents:
d) Details of transactions entered with each related party_ International transaction/SDT:
e) Functions performed, risks assumed and assets employed by both the parties_ FAR Analysis.
f) Economic and market analysis, forecasts, budgets or any other financial estimates prepared by the assessee for the business as a whole and for each division or product separately (i.e. Segment) _Economic Analysis/Selection of Tested Party.
g) Record of similar transactions entered with unrelated parties_ Uncontrolled Transactions (i.e. transactions with third parties).
h) Analysis to check whether transaction with unrelated party can be compared with international transaction_ Comparable uncontrolled transaction.
iii. Computation related documents:
i) Selection of most appropriate method (MAM):
j) Workings for computing ALP, including details of comparable data and financial information used in applying the MAM and adjustments, if any_ ALP Computation.
k) Assumptions, policies and price negotiations, if any, which have critically affected the computation of ALP.
l) Details of adjustments, if any, made to transfer prices (i.e. price agreed) to align with ALP computed and consequent adjustment made to total income for tax purposes.
m) Any other information/data/document which may be relevant for computing ALP.
8. Who has to maintain prescribed information and documents?
9. Who has to obtain and furnish a report in Form No.3CEB?
Every person who has entered into an “international transaction” or “SDT” during the financial year shall obtain a report in Form 3CEB and furnish on or before the due date of filing of income tax return (i.e. 30th November).
10. What are the penal provisions for non-compliance with TP provisions?
|Sl.no||Non-compliance/Default||Nature of penalty|
|1||Failure to maintain TP documentation||2% of value of each transaction|
|2||Failure to report a transaction in Form No.3CEB report|
|3||Maintaining or furnishing incorrect information or documents|
|4||Failure to furnish Report in Form No.3CEB||Rs.1,00,000|
|5||Penalty for under reporting of income||50% of tax payable on such under reported income|
|6||Penalty for under reporting of income on account of misreporting||200% of tax payable on such under reported income|
|7||In case of a transfer pricing adjustment, in the absence of good faith and due diligence by the taxpayer in applying the provisions and maintaining adequate documentation||100-300% of the tax on the adjusted amount|
However, penalty for concealment of income shall not be levied if the taxpayer demonstrates that the price charged or paid has been determined in ‘good faith’ and with ‘due diligence’. Further remaining penalty provisions also do not apply in case the taxpayer proves that there was ‘reasonable cause’ for failure to comply.
We will be covering the following topics in our upcoming articles:
1) Master File (Form No. 3CEAA (Part-A & B) and 3CEAB)
2) Country-by-Country Report (CbC Report – Form No.3CEAC, 3CEAD & 3CEAE)
3) Secondary adjustments
5) Use of Multi-year data
6) Range concept
7) Other related topics
Thank you for the patient reading. Hope this document has added value to your knowledge.
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Disclaimer: This document had been written to provide updates under Income Tax in a simple manner. The author shall not be responsible for any of the decision made based on the contents of this document.