Taxation – The Game of Life – Transfer Pricing & International Taxation

INTRODUCTION:

The rapid globalisation and the ever growing multinational groups in the economic activity of the country has given rise to new and complex issues emerging from the transactions entered into between two or more enterprises belonging to the same multinational group. The profits derived by such enterprises carrying on business in India can be controlled by the multinational group, by manipulating the prices charged and paid in such intra group transactions, thereby leading to crosion of tax revenues.

With a view to provide a detailed statutory framework which can lead to computation of reasonable, fair and equitable profits and tax in India, in the case of multinational enterprises, chapter of transfer pricing consisting of sec 92 to 92F has been introduced.

TRANSFER PRICE:

Transfer Price is the actual price charged in a transaction between related entities which are part of the same Multi National Enterprises (MNE) group. The tax rates vary from country to country. So, there is incentive for MNE group to set transfer prices for transactions between its group members such that tax liability for the group as a whole is minimized. This involves setting transfer prices in such a way that less profits are booked in countries with higher tax rates. For example, a company which is a member of group manufactures products in a high tax country. The company would sell them at a low price/ profit to its affiliates/associates in tax haven countries at lower prices/ profits. These prices are lower than the prices that would have obtained had these enterprises been unrelated and dealt at “arm’s length” and erode the tax revenues of the host country. Thus, transfer pricing refers to tax avoidance practiced by MNE groups by setting transfer prices of intra group transactions such that these differ from the prices that would be obtained had the group members been unrelated entities dealing at arm’s length.

APPLICABILITY OF TRANSFER PRICING PROVISIONS:

An assessee is required to comply with TP provisions when:

• He has entered into an international transaction with his associated enterprise.
• He enters into a transaction where one of the parties to the transaction is a person located in a notified jurisdictional area (NJA) or
• He enters into a specified domestic transaction (SDT).

INTERNATIONAL TRANSACTION:

• International Transaction means a transaction between two or more associated enterprises, either or both of whom are non- residents, in the nature of purchase, sale or lease of tangible or intangible property, or provision of services, or lending or borrowing money, or any other transaction having a bearing on the profits, income, losses or assets of such enterprises and shall include a mutual agreement or arrangement between two or more associated enterprises for the allocation or apportionment of, or any contribution to, any cost or expense incurred or to be incurred in connection with a benefit, service or facility provided or to be provided to any one or more of such enterprises.

ASSOCIATED ENTERPRISE:

According to section 92A (1), Two enterprises are shall be deemed to be associated enterprises if at any time during the previous year,

1. One enterprise holds, directly or indirectly, shares carrying not less than 26% of the voting power to the other enterprise; or

2. Any person or enterprise holds, directly or indirectly, shares carrying not less than 26% of voting power in each of the enterprises; or

3. A loan advanced by one enterprise to the other enterprise constitutes not less than 51% of the book value of the total assets of the other enterprise; or

4. One enterprise guarantees not less than 10% of the total borrowings of the other enterprise; or

5. More than half of the board of directors or members of the governing board, or one or more executive directors or executive members of the governing board of one enterprise, are appointed by the other enterprise; or

6. More than half of the directors or members of the governing board, or one or more of the executive directors or executive members of the governing board, of each of the two enterprises are appointed by the same person or persons; or

7. The manufacture or processing of goods or articles or business carried out by one enterprise is wholly dependent on the use of know-how, patents, copyrights, trademarks, licenses, franchises or any other business or commercial rights of similar nature, or any data, documentation, drawing or specification relating to any patent, invention, model, design, secret formula or process, of which the other enterprise is the owner or in respect of the other enterprise has the exclusive rights; or

8. 90% or more of the raw materials and consumables required for the manufacture or processing of goods or articles carried out by one enterprise, are supplied by the other enterprise; or

9. The goods or articles manufactured or processed by one enterprise, are sold to the other enterprise and the prices and other conditions relating thereto are influenced by such other enterprise; or

10. Where one enterprise is controlled by an individual, the other enterprise is also controlled by such individual or his relative or jointly by such individual and relative of such individual; or

11. Where one enterprise is controlled by a Hindu Undivided Family, the other enterprise is controlled by a member of such Hindu Undivided Family, or jointly by such member and his relative; or

12. Where one enterprise is a firm, association of persons or body of individuals, the other enterprise holds not less than 10% interest in such firm, association of persons or body of individuals.

13. There exists between two enterprises, any relationship of mutual interest.

NOTIFIED JURISDICTIONAL AREAS:

The Central Government may notify any country or territory outside India as a Notified Jurisdictional Area (NJA), if such country or territory does not share tax information with India.

SPECIFIED DOMESTIC TRANSACTION:

Section 92BA provides the meaning of “specified domestic transaction”. As per sec 92BA, Specified Domestic Transaction shall mean any of the following transactions, not being an international transaction namely,

1. Any transaction referred to in section 80A Le., Inter Unit transfer of goods and services by an undertaking or unit or enterprise or eligible business to other business carried on by the assessee or vice versa, for consideration not corresponding to the market value on the date of transfer;

2. Any transfer of goods and services referred to in section 80-IA(8) i.e., inter unit transfer of goods and services between eligible business and other business, where the consideration for transfer does not correspond with the market value of goods and services;

3. Any business transacted between the assesse carrying on eligible business and other person as referred to section 80-IA(10);

4. Any transaction, referred to in any other section under chapter VI-A or section 1OAA, to which the provisions of section 80-IA(8) or section 80IA(10) are applicable; or

5. Any business transacted between a company opting for section 115BAB and person with whom the company has close connection; or

6. Any business transacted between a co-operative society opting for section 115BAE and the person with whom the co-operative society has close connection; or

7. Any other transaction as may be prescribed.

However, the above mentioned transactions shall not be treated as specified domestic transaction in case the aggregate of such transactions entered into by the assesse in the previous year does not exceed a sum of Rs.20 crore.

ARM’S LENGTH PRICE:

Arm’s length price is defined as:

> A price applied or proposed to be applied

> Ina transaction between persons other than associated enterprises

> In uncontrolled transactions.

METHODS FOR DETERMINATION OF ARM’S LENGTH PRICE:

According to section 92C(1), the arm’s length price in relation to an international transaction or specified domestic transaction shall be determined by any of the following methods, being the most appropriate method, having regard to the nature of transaction or class of transaction or class of associated persons or functions performed by such persons or such other relevant factors as the Board may prescribe (Rules 10A, 1OAB, 10B, 10C and 10CA), namely

(i) Comparable Uncontrolled Price Method (CUP method)

The CUP method compares the price charged for goods and services in a controlled transaction to the price charged in an uncontrolled transaction with comparable economic circumstances. If the price charged in the controlled transaction is not significantly different from the price charged in an uncontrolled transaction, the transaction is deemed to be executed at arm’s length.

(ii) Resale Price Method (RPM)

The resale price method compares the gross margin retained in a controlled transaction to the gross margin retained in uncontrolled transaction (internal or extemal) where the following components of the transaction are comparable:

• • Functions performed
  • Risks assumed
  • Assets employed

If there is a significant difference in the way the controlled transaction is carried out to the way the uncontrolled transaction is carried out and an adjustment cannot be made to eliminate the difference, the validity of the resale price method is impaired.

iii) Cost Plus Method (CPM)

The cost plus method compares the cost plus mark-up used in a controlled transaction to the cost plus mark-up used in an uncontrolled transaction in light of the functions performed, risks assumed and market circumstances. This method is often used when the goods transferred require additional value adding procedures or when services are involved.

(iii) Profit Split Method (PSM)

The profits should be split on an economically valid basis that reflects the functions and risks of each of the parties. In order to apply this method, it is necessary to identify the total profit arising from the related party transactions and split that profit between the parties according to their respective contributions.

Comparability under this method is particularly dependent on the similarity of the activities and transactions between the controlled and uncontrolled patties.

(iv) Transactional Net Margin Method (TNMM)

The transactional net margin method examines the net profit margin relative to an appropriate base (e.g. costs, sales, assets) that a taxpayer realizes from a controlled transaction. This means in particular that the net margin of the taxpayer from the controlled transaction 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. Even if comparable companies appearing in the database use different accounting yardsticks for computing the gross profits, the inconsistencies get eliminated at the net profit level.

For the purpose of TNMM, the net profit margins of the comparable companies could be calculated on a relative uniform, consistent and meaningful basis based on their financial information appearing in publicly available database.

(v) Any other method prescribed by CBDT.

COMPUTATION OF THE ARM’S LENGTH PRICE:

• ALP for international transaction has to be computed in accordance with any of the six methods prescribed above.
• The method chosen should be the most appropriate method having regard to:

√ Nature /Class of transaction

√ Class of associated persons and the functions performed by them

√ Such other relevant factors by CBDT.

• Where more than one price is determined by the most appropriate method, the arm’s length price shall be taken as the arithmetic mean of such prices.
• If the variation between the arm’s length price so determined and the price at which the international transaction or SDT has been undertaken does not exceed 3% of the latter, it is deemed to be ALP.

OBLIGATION OF A PERSON WHO ENTERS INTO INTERNATIONAL TRANSACTION/SDT

• Every person who has entered into an international transaction or specified domestic transaction] during a previous year shall obtain a report from an accountant(CA) and furnish such report on or before the specified date in the prescribed form duly signed and verified in the prescribed manner by such accountant and setting forth such particulars as may be prescribed.
• Prescribed form for report from accountant is Form No. 3CEB on or before 31st October of relevant AY.
• Every person who has entered into an international transaction or specified domestic transaction shall keep and maintain such information and document in respect thereof as may be prescribed [clause (7) of sub-section (1) of section 92D.

ADVANCE PRICING AGREEMENT (APA):

> APA is a binding agreement between the taxpayer and tax authority to determine in advance, a set of criteria that would govern the transfer prices for covered inter-company transactions for a fixed period of time.

> It can be valid for up to five years and additionally for a period of four consecutive previous years. The APA filing process includes an optional pre-filing submission, the filing of the APA request, negotiation of the APA, execution and monitoring.

> Taxpayers are required to prepare and file an annual compliance report for each year under the APA. It helps that taxpayer in attaining certainty on the transfer price adopted and assists in mitigating the risks of litigation for the period covered under APA.

PENAL CONSEQUENCES FOR UNDER REPORTING OR MIS REPORTING:

As per Sec 270A,

Conclusion: Navigating the complexities of international taxation and transfer pricing is essential for multinational enterprises operating across borders. With the rise of globalization, the intricacies of associated enterprises, specified domestic transactions, and determining arm’s length prices have become increasingly important. By understanding these concepts and complying with relevant regulations, businesses can effectively manage their tax liabilities and ensure fair and equitable taxation across jurisdictions.