Frequently Ask Questions Transfer Pricing
It means a transaction between two or more associated enterprises, either or both of whom non-residents by way of are transfer of tangible or intangible property or advancing of loans or providing services having a bearing on income or assets. Certain specified domestic transactions prone to price manipulations were also included. The scope of the term ‘international transactions’ was expanded by providing a clarificatory amendment to include various modes of transactions, particularly, relating to intangible property, capital financing, provision of technical, managerial or consultancy services and business restructuring.
When two or more associated companies (Associate Enterprises) enter into a mutual contract during an international transaction in order to apportion a particular cost incurred in relation with a benefit, service or facility offered by any one or all of the companies, such a cost shall be calculated considering the arm’s length price of the particular benefit, service, or facility, as applicable.
The relationship of associated enterprises (AEs) is defined by Section 92A of the Income Tax Act 1961, to cover direct/ indirect participation in the management, control or capital of an enterprise by another enterprise. It also covers situations in which the same person (directly or indirectly) participates in the management, control or capital of both the enterprises.
For the purposes of the above definition, certain specific parameters have been laid down based on which two enterprises would be deemed as AEs. These parameters include:
- Direct/indirect holding of 26% or more voting power in an enterprise by the other enterprise or in both the enterprises by the same person.
- Advancement of a loan, by an enterprise, that constitutes 51% or more of the total book value of the assets of the borrowing enterprise.
- Guarantee by an enterprise for 10% or more of total borrowings of the other enterprise.
- Appointment by an enterprise of more than 50% of the board of directors or one or more executive directors of the other enterprise or the appointment of specified directorships of both enterprises by the same person.
- Complete dependence of an enterprise (in carrying on its business) on the intellectual property licensed to it by the other enterprise.
- Substantial purchase of raw material/sale of manufactured goods by an enterprise from/to the other enterprise at prices and conditions influenced by the latter.
- The existence of any prescribed relationship of mutual interest.
Tax Authorities are often concerned about multinationals underpaying taxes through incorrect transfer prices.
- Transfer pricing audits can result in substantial tax and penalties on a global basis.
- Over 100 countries now see transfer pricing enforcement as a top return on investment in auditing resources.
- Transfer pricing impacts a company’s global effective tax rate.
- Transfer pricing also affects FDII, GILTI, and BEAT calculations under US tax reform. We find that many companies can optimize cash flow with a strategic review of transfer prices.
The term ‘arm’s-length price’ is defined in Section 92F of the Income Tax Act 1961 means a price that is applied or is proposed to be applied to transactions between persons other than AEs in uncontrolled conditions.
The following methods have been prescribed by Section 92C of the Act for the determination of the arm’s-length price:
- Comparable uncontrolled price (‘CUP’) method.
- Resale price method (‘RPM’).
- Cost plus method (‘CPM’).
- Profit split method (‘PSM’).
- Transactional net margin method (‘TNMM’).
- Such other methods as may be prescribed.
There are various other procedures that are prescribed by the Central Board of Direct Taxes, generally known as the Board.
Any person who is involved in an international transaction in the previous year shall submit the report in Form 3CEB through a Chartered Accountant, duly verified by him, on or before the date prescribed by the authority, furnishing all the required details.
The Due date of filing a form 3CEB i.e. accountant report is 31st October, 20xx in the relevant assessment year.
The burden of proving the arm’s-length nature of a transaction primarily lies with the taxpayer. If the tax authorities, during audit proceedings on the basis of material, information or documents in their possession, are of the opinion that the arm’s-length price was not applied to the transaction or that the taxpayer did not maintain/ produce adequate and correct documents/ information/ data, the total taxable income of the taxpayer may be recomputed after a hearing opportunity is granted to the taxpayer.
The following stringent penalties have been prescribed for noncompliance with the provisions of the transfer pricing code:
- For failure to maintain the prescribed information/document: 2% of transaction value.
- For failure to furnish information/documents during audit: 2% of transaction value.
- For failure to disclose any transaction in Accountant’s report: 2% of transaction value.
- For adjustment to taxpayer’s income: 100% to 300% of the total tax on the adjustment amount.
- For failure to furnish an accountant’s report: INR 100,000. Further, taxable income enhanced as a result of transfer pricing adjustments does not qualify for various tax concessions/holidays prescribed by the Act.
Subsidiaries that generate minimal profits or incur losses are regularly audited for transfer pricing.
- Tax authorities argue that subsidiaries operating at arm’s-length would not agree to transact with companies without earning reasonable returns.
- Auditors often reject the argument that poor market conditions, rather than incorrect transfer prices, are the cause of losses.
Conversely, tax auditors of parent companies raise concerns over subsidiary companies generating large profit margins.
- Tax authorities question why companies would effectively shift profits to offshore companies that have limited functions, assets, and risks.
An international transaction is one which takes place between a resident and a non-resident or between two residents with a non-resident associated concern as an intermediary. There is bound to be a tax impact for one or the other, so that transfer pricing become relevant, if not for the non- resident but at least for the resident associate. Transfer pricing is bound to be relevant in such cases. It stands to reason, when the transfer pricing has no relevance at all for either party to the transaction, the rules would have no application, because the requirement of ascertainment of transfer pricing would not arise in such a case.
Transfer pricing rules relate to transactions. It is therefore reasonable to presume that the transaction covered in the last quarter of the previous year alone could be covered. There is possible view, that since it is an associate concern at any time during the year, all the transactions for the year are covered. The definition of “associated enterprise” in section 92A(2) would indicate, that an enterprise becomes an associate enterprise , if it becomes so “at any time during the previous year”. It would, therefore, mean that the associate enterprise is an associate enterprise for the whole year, so that the transaction for the period for which it was not associate enterprise may also be covered. This would, however, be a less plausible interpretation.
Head office and branch are consider one and the same in law. They are not an associate enterprise within the meaning of transfer pricing rules. But a branch may constitute itself as a permanent establishment, where it is located, so that the authorities would require the income attributable to the operations of such permanent establishment in the host country to be calculated. The principles under the transfer pricing rules would have application in such a case in determination of the income. But the partners may well expect the taxpayer to explain the basis adopted for accounting purposes. To the extent, that the principles adopted will have relevance to the transfer pricing rules, they cannot be ignored.
Yes, The Indian Transfer Pricing regulation provide various option to the tax payer to avoid any future litigation from Tax authority such as:
- Advance Pricing Agreements (APAs)
- Safe Harbour Rules (‘SHR’)
- Mutual Agreement Procedure (‘MAP’)